Tuesday, December 16, 2014

Korea should rethink trickle-down policies


First published in The Korea Herald.

It is no secret that the Park Geun-hye administration and the ruling Saenuri Party are vehemently against raising corporate taxes, arguing that higher taxes could affect economic growth. They instead want to go easy on the corporate sector and the wealthy, all in the name of trickle-down economics ― a theory closely identified with Reaganomics, which states that decreasing tax rates especially for corporations, investors and entrepreneurs can stimulate production in the overall economy.

So it may come as a surprise to them that the latest OECD working paper released on Dec. 9 strongly denounced the trickle-down theory while pushing for higher taxes on the rich and policies aimed at improving the lot of the bottom 40 percent of the population. Coming from an organization of the “elite” countries, it must really mean something for the Korean policymakers.

Drawing on harmonized data covering the 34 OECD countries over the past three decades, the econometric analysis in “Trends in Income Inequality and its Impact on Economic Growth” suggests that income inequality has a sizable and statistically significant negative impact on growth, and that redistributive policies achieving greater equality in disposable income have no adverse growth consequences.

Further, it suggests that it is inequality at the bottom of the distribution that hampers growth. Additional analysis suggests that one key channel through which inequality negatively affects economic performance is through lowering investment opportunities ― particularly in education ― of the poorer segments of the population.

These findings have relevant implications for Korea, which is grappling with slow economic growth.

“On one hand, it points to the importance of carefully assessing the potential consequences of pro-growth policies on inequality: focusing exclusively on growth and assuming that its benefits will automatically trickle down to the different segments of the population may undermine growth in the long run inasmuch as inequality actually increases. On the other hand it indicates that policies that help limiting the long-run rise in inequality would not only make societies less unfair, but also richer,” according to the report.

“In particular, the analysis highlights the importance of two pillars of a policy strategy for tackling rising inequalities and promoting equality of opportunities. One policy avenue to reduce inequality involves reforms to tax and benefit policies,” the paper notes.

“As top earners now have a greater capacity to pay taxes than before, governments may consider reexamining their tax systems to ensure that wealthier individuals contribute their fair share of the tax burden.”

It adds that the unequal tax treatment of income from different asset classes increases inequality in some cases and distorts the allocation of capital.

Undoubtedly, this is very valuable advice for Korean policymakers, and something they should heed.

That is not all. A recent survey by Statistics Korea found that from 2011 to 2013, more than 3 million people fell into relative poverty, with their households earning less than half of the median income. In addition, according to the OECD Economic Survey 2014, Korea’s middle class is shrinking and its relative poverty rate is the eighth highest among the 34 member countries.

As some experts have noted, the major sources of rising income inequality are closely related to the neoliberal transformation of the Korean economy. The neoliberal reform of the labor market over the past decade and a half produced a sharp cleavage between regularly employed workers and nonregular workers. The Korean working class, which used to be relatively homogeneous in terms of the job market and wage conditions, has become internally divided, and this reflects growing income inequality in the country. It is therefore essential to address the underlying causes by reducing the share of nonregular workers.

Furthermore, in recent years, the significant income disparities that have long existed between the chaebol and SMEs have become even greater.

Due to economic structural problems, the rigidity of the regular labor market and an environment that favors temporary employment, the creation rate of stable, decent jobs has waned.

Also, factors pushing fundamental inequalities are increasing while Korea’s redistribution remains poor due to weak welfare policies. Although the government has long talked about redistribution, and President Park has long touted her welfare pledges, the pace at the ground level is really slow.

Ignoring the widening income inequalities in Korea, the government appears to be only paying lip service to income redistribution and social welfare while focusing on efforts to reinvigorate the economy.

Park recently pledged to expand social welfare programs without raising taxes, something that is not feasible. The government and the ruling party should not be afraid that introducing excessive welfare measures and tampering with tax rates will rein in economic growth.

Korea should focus on inequality at the bottom income bracket in an earnest way. As has been widely acknowledged, the size and nature of the Korean welfare system is currently unsatisfactory, and there certainly is a need to expand and improve it. This should go hand in hand with strengthening the progressive tax and expanding the sources of taxation ― not just by raising taxes for the poor smokers.

Public welfare spending takes up 10 percent of GDP, close to half of the 21 percent average among OECD members. The prospects for declining economic inequality in Korea in the near future are very dim and over the years the welfare cost will increase. On the other hand, the tax rate is equal to 20 percent of the GDP, lower than the OECD average of 25 percent.

Clearly, it is time the government took a hard look at its trickle-down policies.

Thursday, December 4, 2014

Validity of deflation concerns in Korea

First published in The Korea Herald:

With the latest consumer price index showing a further decline in Korea’s inflation rate, the scaremongers are having a field day. While some suggest that the country is staring at deflation, others are going so far as to suggest that Korea has to brace itself for a “lost decade,” similar to what Japan faced.

A government report released on Tuesday showed that Korea’s consumer prices grew at the slowest pace in nine months in November. The CPI rose 1 percent last month from a year earlier, slowing from October’s 1.2 percent gain, the lowest rise since March.

The Statistics Korea data showed that from a month earlier, the price index also inched down 0.2 percent, the third straight on-month decline. The core inflation, which excludes volatile oil and food prices, rose 1.6 percent on-year, the slowest increase since August 2013, when it gained 1.5 percent.

Technically speaking, Korea is experiencing a period of temporary decrease in prices, or disinflation. Historically, the country has avoided long periods of declining prices, so it is natural that when it experiences disinflation, economists and policymakers start getting cautious. More so since just next door, Japan experienced disinflation in the first half of the 1990s, which expanded to deflation from 1994 through 2004, bogging down its economy; and therein lies the concern.

However, we should not start confusing the concepts of deflation and disinflation.

Deflation is characterized by a sustained aggregate fall in the Consumer Price Index or gross domestic product deflator. A sustained price fall can exert more or less permanent influence on a country’s economy with consumption and demand remaining sluggish.

The reasoning is simple: During deflation, if consumers and corporations expect prices to go down, they will often delay purchases, waiting for a better price, which in turn will dramatically slow down demand, causing prices to drop further. This leads to a downward spiral that reduces the circulation of money through the economy, which may limit growth.

Moreover, it generally occurs during long periods of high unemployment, industrial overcapacity, stagnant wages and falling labor costs. High unemployment leads to lower aggregate consumer demand for goods and services. As demand decreases, businesses generally lower the prices of their goods and services. Over time, lower prices can result in less cash flow and profits for companies, which then are inclined to reduce or postpone hiring and initiate layoffs.

The concerns of the deflation scaremongers in Korea are valid, no doubt, but at the ground level, there is a marked difference in what Korea is experiencing now and what Japan experienced in the ’90s.

True, prices are decreasing, economic growth is low and private consumption is down, but then there are valid explanations for these.

In Korea, the slowing price hikes are attributable in large part to falling international crude oil costs, which puts downward pressure on many product prices. The data referred to earlier showed that oil prices in November dropped 7.7 percent on-year and 2.7 percent on-month. Affected by the falling energy costs, factory product prices inched down 0.1 percent in November from a year earlier.

There are outside influences on core commodities that move prices and cause them to stay unnaturally low or high.

With regards to low GDP growth, any economic upheaval in China, the U.S or the eurozone has a great impact on Korea’s economy since it is mostly export-driven. That is precisely the reason for the slow growth.

The Korea International Trade Association has forecast that Korean exports will top the $600 billion mark for the first time ever in 2015 thanks to the faster pace of global economic growth and trade. The landmark figure represents a 4.3 percent increase from the expected $576 billion worth of goods to be exported this year.

There is not much the government can do directly on the trade front to revive the economy. It can, of course, try to stimulate the economy by reviving consumer demand, which it is trying to do. The results will take time and cannot happen overnight.

Further, as noted earlier, deflation generally occurs during long periods of high unemployment, industrial overcapacity, stagnant wages and falling labor costs. That is not the case in Korea.

The country’s official jobless rate was 3.2 percent in October, unchanged from the previous month and up from 2.8 percent a year earlier. The per capita real wage for salaried workers was 2.95 million won per month in the third quarter, inching up 0.08 percent from 2.94 million won over the same period last year.

The OECD seems to be more bullish on the Korean economy and policies than the local experts and economists. In its latest country report, the OECD forecast that Korea’s economy would grow 3.8 percent in 2015 on the back of the government’s fiscal stimulus and monetary policy easing. The inflation rate will reach 2.2 percent next year, private consumption will grow to 3 percent and exports may rise 4.9 percent.

The Bank of Korea still has room to become more aggressive in quantitative easing if growth continues to falter. On Dec. 11, the central bank is slated to announce its decision on whether it would further lower the current interest rate of 2 percent following previous rate cuts in August and October.

The irony is that while many experts are calling for more cuts now to stimulate the economy and avoid deflation, there are even more who are against it because of its impact on household debt. The BOK is damned if it does and damned if it does not.

Theoretically, deflation is hard to predict and almost impossible to verify until it has set in. It also makes it difficult to determine if it is really all that bad for the economy.

It may sound strange, but deflation can also be perceived to have positive effects. After the 2008 financial collapse of Ireland and the resulting recession, deflation was treated as a temporary condition that allowed for an improvement in competitiveness and balancing the budget. Additionally, moderate deflation may benefit savers and investors because the value of their assets appreciates and the immediate impact is an increase in purchasing power.

Either way, it is also possible that some deflation may be a normal part of our economic cycle, and is not always such a bad thing.