Impact of the Global Investment Slowdown on the Korean Economy Kyu-Chul Jung, Fellow 1. Issues As world trade slows amid a weakening global economy, Korea s exports exhibited relatively poorer performance, weighing down on the nation s economic recovery. Although most countries are seeing sluggish exports, the slowdown is particularly fast for Korea. Before taking a downturn in 214-15, growth in Korea s exports (volume) exceeded that of global trade (5.2%) at a yearly average of 8.9% since 2. World trade has fallen behind global growth after the global financial crisis, deepening concerns over the negative repercussions on the highly trade-dependent Korean economy. 16 Growth in World Trade and Korea s Exports (Volume) (Year-on-Year % Change) 12 8 4-4 World Trade Korea's Exports -8-12 25 26 27 28 29 21 211 212 213 214 215 Note: Based on real trade and exports excluding the direct impact of price fluctuations and including all goods and services sectors. Source: IMF, World Economic Outlook, April 216; Bank of Korea. 1
This paper intends to draw on implications by analyzing the impact of the contraction in global investment, a main cause of the global trade slowdown, on the Korean economy. 2. Declining Global Investment and Trade Growth The proportion of investment, which is closely linked to trade, has fallen since the global financial crisis, consequently dragging down world trade. The proportion of fixed-asset investment against global GDP, which expanded pre-crisis, turned to a decline and has remained low since. In cyclical terms, investment and private consumption move similarly to the economy. But, volatility in private consumption is low while that in investment exceeds that in GDP, thus the economic slump is the cause of the decline in investment proportion. Government consumption tends to be counter-cyclical. Accordingly, advanced countries led the aggressive expansion of government consumption to boost the economy after the global financial crisis, thus increasing the proportion of government consumption. 2 1 Changes in the Proportion of Respective Global Final Demand Components: Pre- and Post-Global Financial Crisis Government Consumption (Against 27, %p) Private Consumption -1 Fixed-asset Investment -2-3 21 22 23 24 25 26 27 28 29 21 211 212 213 214 Note: Changes in component proportions (excluding inventory changes) against final demand. As of 27, private consumption, government consumption and fixed-asset investment account for 58.8%, 16.6% and 23.8% of GDP, respectively. Source: World Bank. 2
The relative sluggishness in fixed-asset investment, which induces more import than government and private consumption, combined with the global economic slowdown has stagnated trade. According to an analysis of 18 OECD countries (Bussière et al., 213), a 1 unit increase in private and government consumption and investment will increase imports by.25,.1 and.32, respectively. 1) This implies that a reduction in the proportion of investment, a high generator of imports, slows global trade. 3. Korea s Dependence on Global Final Demand Compared to other countries, Korea s exports are more concentrated in intermediate and capital goods, which are closely linked to investment, implying a high dependence on global investment demand. Compared to the worldwide export portfolio, Korea s consists of a larger share of intermediate and capital goods and smaller share of raw materials and consumer goods. But, it is difficult to differentiate whether the exported intermediary goods are processed and consumed or invested. And, as Korea s export portfolio includes imported intermediate goods, which are not recognized as a GDP contributor, quantitative analysis of the impact on the Korean economy is limited. 1) Bussière et al., Estimating Trade Elasticities: Demand Composition and the Trade Collapse of 28-29, American Economic Journal: Macroeconomics, 213. 3
Proportion of Export Items by Type 7 6 5 47.9 64.2 Worldwide Korea (%) 4 3 2 1 23.2 22.3 15.6 1.7 12.1 3.5.4.1 Raw material Intermediate goods Capital goods Consumer goods Others Note: As of 214. Source: Calculation based on the UN Comtrade Database. The following analyzes the impact of changes in global final demand components in terms of value-added on the Korea economy, using data on the input-output structure between countries and industries from the World Input-Output Database (WIOD). The WIOD international input-output table was used to identify the impact of the final demand components in one country on the value-added of respective industries in other countries. The 211 WIOD (most recent) categorizes 4 countries, covering advanced and emerging markets and other regions, into 35 industries including product and service sectors. By identifying the input structure of intermediate goods between countries and industries, this paper analyzes the impact of demand fluctuations in terms of value-added. Revealed is that Korea s exports and GDP are more dependent on global investment demand than other countries. The dependence of Korea s exports (value-added) on global investment is the highest among the countries analyzed, posting an impact level of 47.9% and surpassing the world average of 33.7%. 4
With respect to national GDP, the impact of global investment on Korea s GDP marked 15.5%; 2.4 times that of the world average (6.4%). Highly probable is that this is due to the higher contribution of Korea s exports to GDP (32.3%) than the world average (18.8%) in terms of value-added. For the same reason, Korea s GDP is also much more susceptible to global demand in terms of other components, although still less than investment. Such results imply that a continuing dullness in global investment could generate more adverse impact on Korea than other countries. Export Dependence on Each Global Final Demand Component GDP Dependence on Each Global Final Demand Component 7 6 5 (% of exports) 57.1 44.3 Worldwide Korea 47.9 2 15 (% of GDP) 14.3 Worldwide Korea 15.5 4 3 2 1 9.2 7.8 33.7 1 5 1.8 1.7 2.5 6.4 Private consumption Government consumption Investment Private consumption Government consumption Investment Note: Based on value-added. Worldwide percentage is the weighted average of each country s dependence on respective global final demand using exports (left) or GDP (right) as a weight. Source: Calculated using the WIOD. 4. Impact of the Global Investment Slowdown on the Korean Economy Analysis of the international input-output table finds that shrinking global investment has significant negative impact on the Korean economy, which is highly dependent on investment demand. 5
Given Korea s dependence, there could be more adverse impact from a slowing global economy as a result of shrinking global investment. A 1%p drop in global growth is estimated to pull down Korea s growth by.8%p on average. 2) If global growth falls 1%p solely due to private or government consumption, Korea s growth rate will decrease.41%p and.25%p, respectively. Meanwhile, if the sole cause is investment, the decrease is estimated much higher at 1.17%p. These results imply that even when global growth evens out over time, a change in the final demand composition caused by sluggish global investment could negatively affect Korea s economic growth. For instance, when the proportion of private consumption increases by 1%p in the global GDP and that of investment decreases by 1%p, Korea s GDP would recede by.76%p (1.17%p.41%p). Impact of a 1%p Drop in Global Growth due to Declining Global Demand Components on Korea s Economic Growth. (%p) -.2 -.4 -.6 -.8 -.41 -.25-1. -1.2-1.4 Global private consumption Impact on average: -.8 Global government consumption -1.17 Global investment Source: Estimated based on the proportions of respective global final demand components in 214, using the hypothetical case that there is a 1%p drop in a specific global demand component against GDP. 2) In the hypothetical case that the global growth rate drops 1%p, this analysis estimates responses of respective global final demand components and then calculates the average impact on the Korean economy. 6
By industry, Korea s flagship industries, such as electrical and electronic devices, machinery, metals and transport equipment, have been significantly affected by shrinking global investment. Strong negative impact is evident mainly in industries that produce investment-related products and depend heavily on exports. -1 Impact of the Decline in Global Investment on Korea s Industrial Growth (%p) -.21 -.59-2 -1.94-1.9 All industry: -1.17-3 -4-3.57 Electrical & electronic devices -3.29-2.94-2.92 Machinery Metal Transport equipment Chemicals Marine Aviation Textiles Food & Beverage Note: Estimated based on the hypothetical case that the global growth rate drops 1%p solely due to the global investment slump. A simulated calculation based on the above analysis reveals that the post-crisis reduction in the proportion of global investment has already caused an annual average drop of.21%p in Korea s growth rate. In 28-214, the proportion of private and government consumption rose and that of investment receded in global final demand, which caused Korea s yearly growth rate to drop by.21%p. This analysis examines the impact on Korea s growth rate by making comparisons with the hypothetical case that although the 214 GDP is the same, the final demand composition is that of 27. The global final demand composition (excluding inventory changes) in 214 relative to 27 changes by.9%p in private consumption,.8%p in government consumption and 1.7%p in investment. 7
Such changes in the component ratios cause Korea s GDP to fall 1.5% in 214, or a yearly average of.21%p (1.5% over seven years) in Korea s economic growth rate. The above changes in the global final demand composition will have a larger impact on Korea than on Germany (-.14%p) or Japan (-.8%p) whose industrial structures are similar to Korea s. Possibly because Germany s dependence on global investment is lower than Korea s, and Japan s export contribution to GDP is also lower than Korea s. The slump in global investment is driven not only by short-term but also by structural factors, indicating that it will continue to weigh down on Korea s growth. With regards to the short-term, global investment slowed with the global economy, meaning that when the latter recovers, the former will follow suit. The slump is particularly evident among raw-material exporters, suggesting that their investment situation will improve with the recovery of the global economy. Besides, China s massive overinvestment via debt expansion during the global financial crisis could result in a rapid short-term contraction in investment in the global economy with the start of deleveraging. China rapidly increased debt to respond to the global financial crisis, thus private credit soared to as high as 15% of GDP as of late 215. This implies that China s already sagging investment could shrink further with deleveraging. Meanwhile, the population aging (reduced proportion of working-age population) in Korea s major export partners could also hinder the return on investment, eventually weakening global investment demand in the medium- to long-run. Additionally, the fact that the global economic stagnation is partly due to slowing productivity growth implies that without improvements, the global investment slump will continue to persist for a considerable time. 8
The Conference Board (May 215) reported that the yearly growth in global productivity would gradually decline to 1.5% (21-7),.3% (28-11), and.1%(212-14). China s Fixed-asset Investment Proportion of the Working-age (Aged 15-64) & Private Credit Population by Region 4 (Year-on-Year % change) (% of GDP) 16 75 (%) 3 Private Credit (right) 14 China 2 12 7 1 Fixed-asset Investment (left) 1 United States 26 29 212 215 8 EU 65 22 26 21 214 Source: National Bureau of Statistics of China; World Economic Outlook, April 216; World Bank. 5. Summary and Implications The negative impact on Korea s growth from the slump in global investment cannot be overlooked. Analysis reveals that shrinking global investment has a large negative impact on the Korean economy, as Korea s GDP dependence on global investment demand is higher than other countries, Korea s economic growth could be hurt not only by a slowing global economy but also by a drop in the investment proportion in the global final demand composition. Changes in the composition of global final demand in the post-crisis period have caused an annual average decrease of.21%p in Korea s growth rate. 9
The global investment slump will deal a strong blow to Korea s flagship industries, such as electrical and electronic devices, machinery, metals and transport equipment. It is highly probable that the slump will persist for a considerable time, as such an environment must be created in which Korea s industrial structure can efficiently respond. Given that shrinking global investment is attributed to short- as well as mid- to long-term factors, Korea s industrial structure must be adjusted accordingly. Global population aging and productivity slowdown will continue to weaken global investment demand. China s continued push towards consumption-driven demand could put downward pressure on global investment demand for a considerable time. In preparation, efforts are required to foster flexible industrial structures that can better respond to the changing external environment. An excessively rigid industrial structure could eliminate opportunities for promising companies to grow as production resources keep flowing into declining businesses. Policy efforts to restructure distressed companies and heighten flexibility in the labor market should be implemented aggressively so that Korea s limited resources are used with better efficiency. Moreover, Korea must also be more active in seeking new breakthroughs in major export markets such as China whose demand structure is shifting toward consumption. 1