Skidding on oil prices

First published in The Korea Herald.

The biggest “energy story” in 2014 was no doubt the oil price crash, which many say has “upended the geopolitical chessboard.” Worth watching in 2015, therefore, is who will recover and dominate the play ― the Organization of Petroleum Exporting Countries, Russia’s President Vladimir Putin who is fighting with his back against the wall, or the U.S. shale companies who are allegedly being targeted by OPEC members.

As the U.S. Energy Information Administration has noted in its latest outlook, “The recent declines in oil price and associated increases in oil price volatility have created a particularly uncertain forecasting environment, and several factors could cause oil prices to deviate significantly from current projections. Among these is the responsiveness of supply to the lower price environment.”

Despite OPEC’s recent decision to leave its crude oil production target at 30 million barrels per day, if crude oil prices continue to fall, Saudi Arabia and others could choose to cut production, tightening market balances.

“The level of crude oil production outages could also vary from forecast levels for a wide range of producers, including OPEC members Libya, Iraq, Iran, Nigeria and Venezuela. Additionally, the price and lag time required to cause a reduction in forecast non-OPEC supply growth, particularly U.S. tight oil, is not known. The degree to which non-OPEC supply growth is affected by lower oil prices will also affect market balances and prices.”

In layman terms, it’s a very complex situation and to clearly understand the dynamics of oil prices and its impact on the world economy, we need to analyze major events in the past 50 or so years that affected the price and availability of oil.

Brief history of oil prices

The formation of OPEC: OPEC is an intergovernmental organization that was founded in Baghdad in 1960. Comprising 12 members today ― Algeria, Angola, Ecuador, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela ― it has the capability and clout to create a major impact in world oil markets as they hold more than 40 percent of the total oil supply. After five years, OPEC relocated its headquarters from Geneva to Vienna.

The first “oil shock”: In 1973, during the Arab-Israeli War, Arab members of OPEC imposed an embargo against the U.S. for supporting Israel. The embargo caused the price of oil to quadruple and led to an “energy crisis” in Western countries. This led to a high inflation rate in the industrialized countries as they depended on oil supplies from the OPEC nations. This was actually a turning point, as the developed countries realized the need and importance of finding new sources of oil, alternate fuels and better conservation techniques.

The second “oil shock”: In 1979, the Shah of Iran was deposed and oil exports from Iran stopped. The U.S. was importing a large part of its crude oil from Iran and was badly affected by this shortfall.

The Iran-Iraq War: In 1980, Iraq launched a war against Iran, the battle between two big oil producing countries blocked about 8 percent of the total crude oil supply. However, Saudi Arabia and other OPEC nations increased production to avert a supply crisis.

Oil glut: In 1986, the oil price fell from $27 to below $10 a barrel. This was because of slow economic growth in industrial countries due to oil shocks, energy conservation initiatives and overproduction.

First Gulf War: In August 1990, Iraq invaded Kuwait. The combined loss of production along with the threat of a blockage of production in Saudi Arabia made prices spiral. The war was started by a U.N.-authorized force from 34 nations led by U.S, against Iraq in response to invasion of Kuwait.

Early 2000s: In early 2000, a weakened U.S. economy and increases in non-OPEC production put downward pressure on prices. In addition, crude oil prices plummeted in the wake of the Sept. 11, 2001, attack on the U.S.

The Iraq War: During this fragile time, 2003, inventories remained low in the U.S. and other OECD countries, while Asian demand for crude oil was growing rapidly. In 2004 and 2005, the war and struggle in the Middle East continued as the spare capacity fell. The lack of assurance in production ability to cope with further disruptions added a substantial risk premium to crude oil prices.

Global economic crisis: 2008 saw crude oil prices fall about 80 percent before OPEC put in place its largest-ever production cut at 2.5 million barrels a day in December. The member countries largely adhered to assigned quotas and saw oil prices substantially recover by 2009.

Turmoil in the Middle East: In the beginning of 2011, political turmoil in Egypt, Libya, Yemen, Syria and Bahrain, known as the “Arab Spring,” shook the oil markets once again. The oil market, already volatile in the aftermath of the global financial crisis of 2008, became even more volatile as fears that a drop in oil supply could occur due to the Arab Spring conflict drove oil prices to high levels.

Iran sanctions and Syrian violence: The push for tighter sanctions on Iranian oil exports and chaos in Syria in 2012 erupted and unnerved market participants, leading to spikes in oil prices.

Continuing unrest: Prices rose as tensions escalated between the U.S. and Syria, and have been volatile ever since. Then they started dipping suddenly. The reason for that is actually simple but complicated by geopolitics.


Back to basics

Prices fall when supplies are up and demand is down. New sources of oil ― including shale oil production, which has been booming in the U.S. ― has added significantly to the global supply. Coupled with the fact that Europe is still fighting off a recession, and alternative energy sources are price-competitive, demand for oil has fallen well below expectations.

Without being too simplistic, we must acknowledge that OPEC is manipulating oil prices. It has decided to keep production at current levels, which will actually end up driving prices down more.

Why would they do that? There are many observations. Many suggest that it is an attempt by OPEC producers, especially Saudi Arabia, to drive higher-cost U.S. shale drillers out of the market.

The theory is that because OPEC cartel members can drill at dirt-cheap prices, they can inflict despair on the lightly defended shale patch. In the end, U.S. drillers will have to surrender and shut down. Given their deep pockets this is likely, despite the denials.

As The Economist notes: “Four things are now affecting the picture. Demand is low because of weak economic activity, increased efficiency and a growing switch away from oil to other fuels.

“Second, turmoil in Iraq and Libya has not affected their output. The market is more sanguine about geopolitical risk.

“Thirdly, America has become the world’s largest oil producer. Though it does not export crude oil, it now imports much less, creating a lot of spare supply.

“Finally, the Saudis and their Gulf allies have decided not to sacrifice their own market share to restore the price. They could curb production sharply.”

We shall wait and see what 2015 holds for us.

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For world economy, a year of divergence

First published in The Korea Herald.

As we step into 2015, it would appear that on the back of a U.S. economic recovery, the dark days of the financial crisis are behind us. As the largest economy, accounting for more than one-fifth of global gross domestic product, the health of the U.S. economy has been critical for steady growth in the rest of the world through trade, foreign investment, financial markets and capital flows. Until now.

But, as recent developments have shown, going ahead, there are many more variables that will impact the global economy. Leave aside the fact that the International Monetary Fund has projected the global economy to grow by 3.8 percent in 2015, a little better than the estimated pace of 3.3 percent for the previous year.

Europe continues to deleverage with serious risks of falling back into a recession, Japan’s prospects remain clouded despite “Abenomics,” China’s growth is slowly throttling back, and Latin America and Southeast Asia remain a mixed bag, while India’s growth prospects are up in the air. The health of the world’s important economies is clearly diverging, and to understand this better we need to look at the prospects in all the major economic blocs.


Still miles to go

The world’s largest economy is still climbing out of the deep hole created by the recession with an annualized growth rate of around 2 percent over the past five years. However, over the last few quarters, the pace of growth has picked up and the broad consensus is that the U.S. economy is back on track.

The U.S. economy grew at a much faster pace than initially thought in the third quarter of 2014, with the Commerce Department raising its GDP growth estimate to a 3.9 percent annual pace from the 3.5 percent rate reported previously.

There is no doubt that the economy has hit a pivotal point, with many positive developments ― consumer confidence, the manufacturing sector in an expansion mode, strong corporate balance sheets, firmer global trade, less fiscal drag, a stronger job market and falling oil prices.

U.S. consumers also appear to be in better financial shape, with household debt falling. The fiscal restraint that has held back growth in recent years has more or less ended and the federal budget deficit is now at a consistent level as shown by the slowly declining federal debt-to-GDP ratio.

To top it off, businesses are once again hiring and investing, as a result of which the job market is quickly picking up and wage growth is reviving. With more money in their pockets, it will lead to more spending and fuel even more business expansion. The volatile housing sector is currently in much better shape with the number of foreclosures continuing to fall. Adding to consumers’ purchasing power is the sharp decline in oil prices.

The key to its economic story this year will be how fast the Federal Reserve raises interest rates, and the ensuing market reaction. Tapering of the Fed’s quantitative easing program has already begun, although an actual tightening is likely to take some time. It does appear though that the interest rate will remain near zero percent ― where it has been for six years ― through mid-2015.

With the economy in good shape, everyone is hoping that the global economy will move forward. Of course, geopolitical events overseas, and the domestic political wrangling between the Democrats and Republicans could put a wrench in the works.


Clouds across the Atlantic

Across the Atlantic, except for the United Kingdom, which is experiencing steady growth that will likely continue, the situation in the European Union does not appear too rosy. The eurozone is back in an economic rut with Germany, France and Italy still battling Depression-era levels of unemployment and the threat of deflation.

It appears that the European banking system has never really recovered from the financial crisis. As such, Europe’s slow economic recovery, which began in the second quarter of 2013, remains fragile.

Only recently, the IMF marked down prospects in the three largest economies ― Germany, France and Italy ― which it says are headed into their third consecutive year of recession. The fund warned that the probability of the eurozone reentering a recession has increased.

The German economy grew by 0.1 percent in the third quarter of 2014. Another quarter of contraction would have meant that Germany was officially in a recession. France reported 0.3 percent GDP growth, rebounding from a 0.1 percent decline in the second quarter and thereby avoiding falling back into a technical recession. Italy was not so lucky, with a contraction of 0.1 percent confirming that the economy has entered a technical recession.

The European Commission has observed that the eurozone would need another year to reach even a modest level of growth. The main risk, it has said, is that stalling or partial implementation of structural, fiscal and institutional reforms by member states may result in low actual and potential growth and protracted high unemployment. Moreover, the debt overhang, the investment shortfall in recent years and slowing total factor productivity could hurt growth in the medium term if they are inadequately addressed by structural reforms, resulting in an extended period of low growth. Deflation is another serious threat.

As regards the U.K., although the economy is in a recovery phase, household indebtedness is high and the fiscal position weak. Experts have noted that additional growth may be held back by continued difficulties in generating a trade-led recovery in addition to the austerity measures that will be needed. While the recovering economy is boosting tax receipts for the government, high levels of spending are keeping the deficit high.

U.K. economic growth slowed in the third quarter of 2014, with the economy expanding by 0.7 percent, weaker than the 0.9 percent expansion recorded for the second quarter, according to the Office for National Statistics.

Added to this is the uncertainty posed by the 2015 general election, which many expect to result in a hung parliament. That would be a challenge, more so as its relations with the EU are becoming increasingly strained.


Gloomy situation

Meanwhile, the disappointment continues in Japan, where Prime Minister Shinzo Abe has emerged stronger after the snap polls, even as the economy entered into technical recession amid growing concerns that the government is failing to pull the country out of decades of stagnant growth and deflation.

Japan’s economy shrank an annualized 1.6 percent in Q3 2014, confounding expectations of a modest rebound after a severe contraction in the previous quarter.

Less than two years into Abenomics ― a three-pronged strategy to pull Japan out of two decades of stagnation through monetary stimulus, fiscal flexibility and structural deregulation ― the program has yet to spark sustained growth. As he currently holds a comfortable majority in the parliament it is likely that he will give a greater push to his policies. It needs to be seen whether the Bank of Japan’s second round of quantitative and qualitative easing will result in substantial boost to the economy.

It is highly likely that Abe will turn his attention to designing a 3 trillion yen ($25 billion) fiscal stimulus package to help to revive growth, but the economy will continue to turn in a subpar performance this year.

Analysts note that the continuation of loose fiscal policy and aggressive monetary easing could cause a loss of confidence in Japan’s ability to maintain debt sustainability. So we’ll have to wait and watch.


Shaky foundation

The situation in BRICS is a mixed bag, and the foundation appears a little shaky.

Brazilian President Dilma Rousseff was reelected by a small margin in the October elections for a second four-year term, even as the economy technically exited recession. However, virtually no growth in 2014, double-digit interest rates and inflation breaching the government’s own target bands all paint a grim picture.

Brazil’s economy officially exited recession with growth of 0.1 percent in the third quarter of 2014.

It is expected that fiscal discipline and growth-enhancing measures will take priority, even though Rousseff pledged further support for subsidies and social programs during her election campaign. A stable government, and a new finance minister operating with a greater degree of autonomy, could just ensure that the framework is in place for a more authoritative and credible response.

Economists have noted that the widening fiscal and current account deficits will require both policy adjustments and market-driven asset price corrections. On the other hand, weaker labor market dynamics, softer Chinese demand, slower credit growth and a failure to advance structural, growth-enhancing reforms are risks that would undermine growth. Stimulating growth while getting the country’s finances in order will take up much of the year. There is no doubt that the Brazilian economy will remain fragile as a new team introduces policy adjustments to build confidence.

Meanwhile, Russia’s energy-dependent economy has suffered a severe economic shock over the past few months, largely because oil prices have tanked. The conflict in Ukraine and the international sanctions have also weighed heavily on the economy, which is forecast to be flat next year. The weaker ruble and Russian countersanctions on Western food imports are likely to push up inflation and hold down household consumption. The ruble has already lost close to 50 percent in value as we enter the new year.

Economic growth in Russia slowed to 0.7 percent in the third quarter of 2014. Falling oil prices and sanctions should continue to be headwinds going forward.

The Russian government, in an official statement that was hurriedly withdrawn, has warned the economy will fall into recession next year as Western sanctions, in response to its role in eastern Ukraine, and falling oil prices begin to bite. Household disposable income is also forecast to decline.

The World Bank stated in its economic outlook that, “In the baseline scenario, investment is projected to contract for a third year in a row in 2015, because of continued uncertainty, restricted access to international financial markets by Russian companies and banks, and lower consumer demand.”

The situation is different for India. Confidence in the economy has soared in recent months under the leadership of its new prime minister Narendra Modi, who appears to be genuinely working to pull the country out of the economic mess brought about by his predecessor. However, there is concern about economic growth, as the pace of reform has been slower than expected. To facilitate rapid economic growth, structural reforms would be necessary, but the ruling party’s weak position in the upper house limits the scope for any major change. Experts note that growth is still uneven and weak overall and remains susceptible to many downside risks.

However, they do agree that, with economic activity buoyed by expectations from the newly elected government, India is benefiting from a “Modi dividend.” Structural reforms related to land, labor and tax would support the economy’s growth. Private investment is expected to pick up thanks to the government’s business orientation, and declining oil prices should boost private-sector competitiveness.

GDP growth in the third quarter of 2014 slowed to 5.3 percent from 5.7 percent in the previous quarter. However, this was better than expected.

As for Asia’s largest economy, China is having trouble maintaining the kind of growth it has become accustomed to in recent years. The most recent readings suggest that its economy could grow at roughly 7.5 percent this year, down from the 10 percent growth it averaged for two decades before the slowdown began three years ago.

As Goldman Sachs pointed out in a recent note, it’s been a bumpy ride for China’s economy in 2014, with multiple growth scares followed by bouts of policy stimulus, and this year will be no different.

“A housing market adjustment, decelerating credit growth and an advancement of difficult structural reforms in areas such as local government debt management and interest rate liberalization, will present continued headwinds,” Goldman Sachs reported.

The real estate sector, of course, remains a key uncertainty, and as weakness builds up it will pose a risk to the economy.

Having said that, on the bright side, the continuous reform and opening-up of China’s economy may help the country transition into a more sustainable and market-driven economy. The government has already started implementing many financial-sector reforms, which are only going to increase this year.

The Chinese economy grew at 7.3 percent during the third quarter of 2014 compared with a year ago, slightly exceeding expectations.

South Africa for its part is battling strikes, higher interest rates, rising inflation and weak demand, which will weigh down its economy. The risk of strikes will remain high, exacerbated by the political power of the trade unions and high unemployment. Sound fiscal and monetary policies, and infrastructure investment may facilitate overall activity, and economic growth could gradually pick up pace.

Last year, a prolonged strike in the platinum sector and other labor actions disrupted the mining and auto sectors. This has hurt business confidence and the impact is still being felt, although economists think growth has a good chance of rebounding.

The GDP in South Africa expanded 1.4 percent in the third quarter of 2014 over the previous quarter.

Recently President Jacob Zuma said that through Operation Phakisa, the country is poised to reach the ambitious economic growth target of 5 percent by 2019. Operation Phakisa focuses on unlocking growth and new jobs in the country’s ocean economy.


A mixed bag

Coming to the ASEAN heavyweights now.

The World Bank has projected that Thailand will generate the lowest economic growth in the region next year because of structural problems in the export sector and unresolved political issues. Domestic demand in Thailand remains weak despite the government’s efforts to boost growth by increasing budget spending. In addition, tourism is being negatively affected by the imposition of martial law, which is not expected to be lifted any time soon. Recently, the government declared that democratic elections, which were originally planned for late-2015, will be postponed to early 2016 as the new constitution will not be ready in time.

Southeast Asia’s second-largest economy grew 1.1 percent in the third quarter of 2014, from the previous three months, and 0.6 percent from a year earlier.

On the bright side, military rule could improve political stability and it is expected that big infrastructure projects will lead to a slight uptick in economic growth this year.

Malaysia is likely to remain on a sustainable growth path. On Dec. 1, fuel subsidies were officially dropped and prices are now linked to global rates. This is the latest in a series of moves designed to trim the fiscal deficit, and comes just months before a new goods and services tax will be introduced.

Malaysia’s economy posted growth of 5.6 percent in the third quarter of 2014 from the corresponding period a year ago, slowing down from the 6.2 percent in Q1 and 6.5 percent in Q2.

Experts have noted that while the government is showing strong commitment to improving its financial standing, there is concern that these measures will put a damper on private consumption in the following year. Weak demand for Malaysia’s commodity exports and falling oil export revenues due to the current global price slump also pose an important risk to growth in the near term.

In Indonesia, the new government led by President Joko Widodo increased the price of subsidized fuel by one-third recently, in a bold move that bodes well for efforts to reduce the fiscal and current-account deficits. It will also free up public funds for infrastructure development and expanded welfare services.

Indonesia’s gross domestic product grew 5.01 percent in the third quarter of 2014 from a year earlier, its slowest in five years.

Future growth will largely depend on whether the country’s new government is able to push through policy reforms. These include boosting infrastructure development, improving regulatory certainties in doing business and reducing the country’s poorly targeted energy subsidy spending.

A tepid and uneven global recovery tempered Singapore’s economic growth last year, which was also affected by the government’s push to reduce a politically unpopular reliance on foreign workers. That has led to a tight labor market and raised business costs. In addition, Singapore saw its fourth antigovernment rally in less than two years, in an indication that Singaporeans are becoming more politically engaged.

The country’s economy expanded by 2.4 percent in the third quarter of 2014, unchanged from the previous quarter.

According to economists, externally oriented sectors such as the manufacturing and transport and storage sectors are likely to slow while growth in the construction sector will continue to be weighed down. However domestically oriented sectors like business services are likely to remain resilient.


Bright Down Under

Australian Prime Minister Tony Abbott has successfully repealed carbon and mining taxes and has concluded free-trade agreements with Japan, South Korea and China. Despite fiscal tightening, the economy is expected to strengthen as mineral export volumes rise and consumers regain confidence.

Australia’s economy, though, grew at a slower-than-expected pace in the third quarter of 2014, at 2.7 percent, underscoring growing concerns about its outlook and calls for the central bank to undertake easing measures.

According to economists, macroeconomic policies are appropriate for the current juncture while long-term prosperity depends on ensuring that structural settings boost all forms of economic activity and promote broad-based productivity growth.

At the same time, lower commodity prices could weigh on profits and wages, while also reducing both company taxes at the federal government level and royalties at the state level. This would in turn constrain consumer spending and business investment, and lead to an extended period of weaker-than-usual growth in public demand. On the whole, however, the prospects are bright.

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Millennium Development Goals: Not there yet

First published in The Korea Herald.

The New Year is significant when it comes to the issue of sustainable economic growth and the promises made by world leaders 14 years ago that have not been fully kept.

World leaders, in adopting the United Nations Millennium Declaration in 2000, pledged to create a more equitable world by 2015. However, today, more than ever before, it seems that the wealthiest individuals have become wealthier while the relative situation of people living in poverty has improved little.

Disparities in education, health and other dimensions of human development still remain large despite marked progress in reducing the gaps. Various social groups suffer disproportionately from income poverty and inadequate access to quality services and, generally, disparities between these groups and the rest of the population have increased over time.

The implications of rising inequality for social and economic development are many. There is growing evidence and recognition of the powerful and corrosive effects of inequality on economic growth, poverty reduction, social and economic stability, and socially sustainable development.

The many adverse consequences of inequality affect the well-being not only of those at the bottom of the income distribution, but also those at the top. Specifically, inequality leads to a less stable, less efficient economic system that stifles economic growth and the participation of all members of society in the labor market.

According to a new report by the OECD, the situation is so bad now that global income inequality has returned to levels recorded in the 1820s ― when the Industrial Revolution produced sizable wealth gaps between the rich and poor.

The study uses historical data from eight world regions to examine 10 individual dimensions of well-being, tracking them over time and space, then pulls them together in a new composite indicator. The dimensions covered reflect a broad range of material and nonmaterial aspects: per capita GDP, real wages, educational attainment, life expectancy, height, personal security, political institutions, environmental quality, income inequality and gender inequality.

It reveals that great strides have been made in some areas, such as literacy, life expectancy and gender inequality, but while income inequality, as measured by pretax household income among individuals within a country, fell between the end of the 19th century until around 1970, it began to rise markedly at that point, perhaps in response to globalization.

Another OECD report suggests that reducing income inequality would boost economic growth. It found that countries where income inequality is decreasing grow faster than those with rising inequality.

“The single biggest impact on growth is the widening gap between the lower middle class and poor households compared to the rest of society. Education is the key: A lack of investment in education by the poor is the main factor behind inequality hurting growth.”

Rising inequality is estimated to have hold back growth in Mexico and New Zealand by more than 10 percentage points over the past two decades up to the Great Recession. In Italy, the United Kingdom and the United States, the cumulative growth rate would have been 6-9 percentage points higher had income disparities not widened, and inequality also reduced growth in Sweden, Finland and Norway, although at low levels. On the other hand, greater equality helped increase GDP per capita in Spain, France and Ireland prior to the crisis.

The impact of inequality on growth stems from the gap between the bottom 40 percent and

the rest of society, not just the poorest 10 percent. Anti-poverty programs will not be enough. Cash transfers and increasing access to public services, such as high-quality education, training and health care, are an essential social investment to create greater equality of opportunities in the long run.

The report also found no evidence that redistributive policies, such as taxes and social benefits, harm economic growth, provided these policies are designed, targeted and implemented well.

So is the situation really that bad?

Over the past 14 years, since the adoption of the Millennium Development Goals, the U.N. has stated that there has been important progress, with some targets already having been met well ahead of the 2015 deadline.

The MDGs are the world’s time-bound and quantified targets for addressing extreme poverty in its many dimensions ― income poverty, hunger, disease, lack of adequate shelter and exclusion ― while promoting gender equality, education and environmental sustainability. They are also basic human rights ― the rights of each person on the planet to health, education, shelter and security.

They are eight goals that all 191 U.N. member states have agreed to try to achieve by the year 2015: eradicating extreme poverty and hunger; universal primary education; promoting gender equality; reducing child mortality; improving maternal health; combating HIV/AIDS, malaria and other diseases; ensuring environmental sustainability; and developing a global partnership for development.

The 2014 MDG report notes that several targets have been met. According to it, the world has reduced extreme poverty by half, efforts in the fight against malaria and tuberculosis have shown results, access to an improved drinking water source became a reality for 2.3 billion people, disparities in primary school enrolment between boys and girls are being eliminated in all developing regions and the political participation of women has continued to increase. It also states that development assistance rebounded, the trading system stayed favorable for developing countries and their debt burdens remained low.

Having said that, while claiming that substantial progress has been made in most areas, it also agrees that much more effort is needed to reach the set targets.

Major trends that threaten environmental sustainability continue, also, more efforts are also needed to decrease chronic undernutrition among young children, reduce maternal mortality and improve sanitation. None of these goals can be achieved in the last year left for the MDGs.

Continued progress toward the goals in the remaining year is therefore essential to providing a solid foundation for the post-2015 development agenda.

The opportunities that 2015 presents for bringing the countries and people of the world together to decide and embark on new pathways forward are historic and unprecedented. These decisions will determine the global course of action to end poverty, promote prosperity and well-being for all, protect the environment and address climate change.

The actions made this year are expected to result in new sustainable development goals to follow the eight MDGs. This post-2015 development agenda is expected to tackle many issues, including ending poverty and hunger, improving health and education, making cities more sustainable, combating climate change, and protecting oceans and forests.

Governments are in the midst of negotiating, and civil society, young people, businesses and others are also having their say in this global conversation. World leaders are expected to adopt the agenda at the Special Summit on Sustainable Development in New York in September 2015.

Hopefully, there will be speedier progress in 2015.

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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.

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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.

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Korean mortgages reveal tactical shift

First published in The Korea Herald.

A lot has been written in recent months about Korea’s soaring household debt and its implications for the economy. Many experts seem to agree that the country is staring at a catastrophe waiting to happen, and call for the debt to be reined in if the country has to strengthen its economic fundamentals.

Bank of Korea Governor Lee Ju-yeol is also of the view that efforts need to be made to control the growth of household debt, as it may dampen consumer spending ― even though the central bank’s decision to cut interest rates in August and October has indirectly promoted its growth.

In the face of all this, Finance Minister Choi Kyung-hwan has stated that an increase in household debt would have a “limited” impact on the economy and the focus should be on reinvigorating the sluggish economy.

As of end-September, the latest Bank of Korea data showed that outstanding credit to households by financial institutions, including commercial lenders, insurers and financial agencies, stood at 1,060.3 trillion won ($960 billion), with total loans registering 1,002.9 trillion won, of which mortgage loans alone accounted for a whopping 445.2 trillion won. If you add up mortgage loans by Korea Housing Finance Corporation and the National Housing Fund, it amounts to 480.9 trillion won.

Not surprisingly, experts have come out against the government decision to relax the real estate policies, which has led to a rise in household loans, saying that it is like adding fuel to fire.

In end-July, the government lowered hurdles for property purchases, as part of a stimulus package aimed at spurring economic growth, which fell in the second quarter to the slowest pace since early last year, loosening caps that were imposed in the mid-2000s when the property market was booming.

It reset the loan-to-value ratio, a gauge of loan size to the underlying collateral, to a uniform 70 percent, from between 50 and 85 percent depending on region; and at the same time, the debt-to-income ratio, which measures a borrower’s ability to repay, became 60 percent across the country, as against 50-65 percent previously.

To top off these measures, it also announced real estate deregulation measures, which included easing reconstruction of old apartments and lessening the supply of new homes.

Critics say the government’s policies will actually increase household debt in the long term and stifle domestic demand, as they encourage households to stack up higher debts. When delinquency rates rise and housing prices fall, it will trigger distressed sales for repayments, which will apply additional downward pressure on asset prices, creating a vicious cycle leading to debt deflation.

As of now, it is too soon to predict the impact of these measures, but the household loans are certainly not expected to decline anytime in the near future.

Many economists are concerned that the massive household debt problems will negatively and significantly affect economic growth, with many doubting the effectiveness of countermeasures, as excessive borrowing could discourage spending.

It could of course be a nonissue if Korea acts quickly to boost economic growth and makes household income rise faster than debt, which is what the government is trying to do.

Amid all this noise the financial regulator, the Financial Services Commission, has underplayed the doubts, saying that the quality of debt is improving. It cited the shift in the type of institutions from which people are borrowing. Those who previously would have had no other choice than to borrow from nonbanking financial companies at higher interest rates have mostly changed course to apply for loans at banks due to the relaxed regulations. That lowers the financial burden of interest payments, reducing the overall risk of defaults.

Is this really the case?

Let us take a look at the household credit data that was released by the BOK on Nov. 25. If we look at the two-month period before the housing mortgage rules were eased and two months after, there seems to some movement in that direction.

In June-July bank lending to households was 6.5 trillion won while nonbank lending was 5.1 trillion won. In the August-September period, banking lending was higher at 9.3 trillion won, while nonbank lending was lower at 2.6 trillion won. In other words, bank lending grew by 43 percent and nonbank lending fell by 49 percent. There is merit to what the FSC has been saying, something that has been lost in the din raised by critics.

Moreover, even the case of debt deflation that the experts are concerned about is not happening. Recent data shows that housing prices have been increasing since the new rules came into force.

The Land Ministry has noted that the number of home transactions reached an eight-year high of 108,721 in October, spiking 20.4 percent from a year earlier. Also reflecting an apparent recovery in the real estate market, the number of groundbreakings for housing construction jumped 53.9 percent on-year to 60,085 last month.

As they say, there are two sides to every coin. There is no doubt that the government should keep a watch on the growth in household debt and step in immediately when there are signs of a problem. But clearly as of now, one should not jump to conclusions just on the basis of the absolute figures for household loans.

I think it is premature to suggest that Korea is staring at a crisis. The household debt issue should be considered in the context of the households’ ability to repay.

With the tactical shift in housing loans from the insecure nonbanking sector to the more secure banking sector, there seems to be less risk of widespread default.

The biggest risk is a sharp fall in residential property prices. Korean households have more than 80 percent of their assets in real estate. It is expected that the recovery of the real estate market will boost domestic demand and household income, which may eventually solve many fundamental problems.

In any case, the country has the means and experience to deal with a banking crisis. The saving grace: history has endowed Korea with a legacy of distortions in its credit system, which has taken time and a few crises to resolve. Today, its financial system is more mature and less prone to such crises than before.

Also, basic tools to manage household debt are already in place ― for example, the “Measures to Enable Soft-Landing of Household Debt” (June 2011) and “Measures to Promote Structural Soundness of Household Debt” (February 2014).

This is not to suggest that there will not be a problem. But we should be confident that the government will adequately manage the risk factors, if any, of household debt.

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Win-win regional trade pact choices for Korea

First published in The Korea Herald.

After dillydallying for several years, China has thrown the cat among the pigeons by aggressively pushing for the Free Trade Area of the Asia-Pacific at the recently concluded APEC summit in Beijing.

Threatened by China’s urgency, the United States, which has been driving its own Trans-Pacific Partnership minus China, was seen making backroom maneuvers to dilute any reference to the FTAAP in the Leaders’ Declaration. It did manage to take out the deadline of 2025 that was in the draft and what was finally released had no real specifics, except that a collective feasibility study will be concluded by 2016. 

The final declaration noted: “we decide to accelerate our efforts on realizing the FTAAP on the basis of the conclusion of the ongoing pathways, and affirm our commitment to the eventual realization of the FTAAP as early as possible by building on ongoing regional undertakings, which will contribute significantly to regional economic integration, sustained growth and common prosperity in the Asia-Pacific region.”

The idea of creating the FTAAP has been discussed for many years at the annual APEC gatherings, but it is only recently that China has stepped up diplomatic efforts. It would not be wrong to say that it wants to assert its economic clout and neutralize the U.S.’ efforts to forge the TPP in its own backyard.

“Having reached an important consensus on starting the FTAAP process ... What we should do now is translate the consensus into action,” Chinese President Xi Jinping said in his speech at the opening session of the summit on Nov. 11.

Just a day earlier, U.S. President Barack Obama expressed his desire to make the TPP a reality. “We’re going to keep on working to get it done,” he said, describing it as “the model for trade in the 21st century.”

While the two countries battle it out for influence, another regional trade agreement is slowly making progress ― the Regional Comprehensive Economic Partnership.

The three RTAs ― the FTAAP, TTP and RCEP ― are all focused on the Asia-Pacific region. 

APEC ― comprised of 21 member states including China and the U.S. ― first formally began discussing the concept of the FTAAP at the 2006 Hanoi summit, although proposals for such an agreement have been around for a long time. In 2010, APEC leaders issued its “Pathways to FTAAP,” and instructed members to take concrete steps toward the realization of the RTA.

Over the past several years, members have discussed a broad range of issues relevant to the prospects for the deal, conducted analytical work, addressed a number of next-generation trade and investment issues, and undertaken sectoral initiatives. However, China was not really keen to push ahead with the deal.

Sensing this, in November 2011 the U.S and eight other countries (Brunei, Chile, New Zealand, Singapore, the U.S., Australia, Peru and Vietnam) formally announced the TPP, which is intended to “enhance trade and investment among the partner countries, to promote innovation, economic growth and development, and to support the creation and retention of jobs.”

Malaysia officially joined in October 2010, Canada and Mexico in October 2012, and Japan in July 2013.

So far 20 formal rounds of TPP negotiations have been held. However, the members have been unable to reach a consensus on a number of contentious issues like intellectual property and the liberalization of agricultural markets. Adding to this, the U.S. could not make forward progress because of political difficulties at home regarding the passage of a Trade Promotion Authority by Congress. Perhaps this is why China is suddenly showing interest in the FTAAP.

As for the RCEP, it is a proposed trade deal between 10 ASEAN member states: Brunei, Myanmar, Cambodia, Indonesia, Laos, Malaysia, the Philippines, Singapore, Thailand, Vietnam, Australia, China, India, Japan, Korea and New Zealand.

It was announced at the 19th ASEAN Summit in November 2011, and negotiations began a year later, aimed at concluding talks by end-2015. The sixth round of negotiations are due to take place in New Delhi in the first week of December. It remains to be seen whether the negotiations will be successful and the targeted deadline reached, which at present seems unlikely. 

So, where does that leave Korea in the grand scheme of things?

It is already a part of the FTAAP and RCEP, and has also expressed its interest in joining the TPP. While the two largest economies fight it out for dominance, Korea can gain by participating in all three RTAs. Even if one of them falls by the wayside, it has nothing to lose. Being an export-driven economy, it has already been actively pursuing FTAs with its biggest trading partners, and has made quite a few notable achievements.

It makes sense for Korea to ask to join the TPP as soon as possible, instead of sitting on the fence because of its bilateral issues with Japan. The country can pursue the TPP side by side with other RTAs since they are mostly complementary and will only reinforce each other.

Come to think of it, all three RTAs are quite different in scope. Experts have noted that the TPP deal is likely to be much more substantial in terms of depth of prospective trade liberalization and rule-making obligations compared to the other two. It includes stipulations for labor and environmental protection, intellectual property protection and rules for state-owned enterprises.

Compared to the TPP, the standards and degree of liberalization sought in the RCEP are low. The founding document states: “individual and diverse circumstances” of its members, and provisions on labor rights, intellectual property, SOEs and other behind-the-border issues will either be left out or only lightly addressed.”

However, the RCEP could produce significant economic results. The members represent 49 percent of the world’s population and account for 30 percent of world GDP. It also makes up 29 percent of world trade and 26 percent of world FDI inflows. 

Also, according to a recent study, the FTAAP would result in income gains of about $2 trillion, or nearly 2 percent of the world’s GDP in 2025. The biggest winners would be China, the U.S., Japan, Russia and Korea.

Whichever of these deals is wrapped up first will be the foundation for the next deal and finally the total economic integration of the Asia-Pacific region. Either way it is a win-win situation for Korea.

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Shady projections on Korea-China FTA

First published in The Korea Herald.

Now that the dust has settled, and the free trade deal between Korea and China has been sealed, it is time to look at the validity of various claims being made on its economic impact once it is implemented sometime next year.

I am not referring to the merits or demerits of the FTA and the bruises to the agricultural sector, but to the economic projections that are being thrown around by the government officials.

There is no denying the high expectations for the trade deal compared to the FTAs with the U.S. and the European Union, since China is Korea’s largest trading partner, with a massive market. Moreover, it is bang next door, and offers a definite advantage compared to other economic blocs.

Under the deal, Korea will eliminate its tariffs on 79 percent of all products, or 9,690 items, imported from China within 10 years following the implementation of the deal. China, meanwhile, will eliminate its import duties on 71 percent, or 5,846 products, shipped from Korea over the same period.

On the face of it, this is an opportunity not to be missed. For this reason, the government ― which rushed to wrap up the deal, ignoring the side effects ― went to town after the announcement in Beijing on the sidelines of the APEC summit.

The Ministry of Trade, Industry and Energy immediately rushed in to state that the FTA was “expected to help boost the countries’ annual bilateral trade to $300 billion in 2015. This will mark a 39.5 percent hike from $215.1 billion in 2012. It will help bring Korea’s per capita income to over $30,000.” The ministry also said that as a result of the deal Korea’s gross domestic product would go up by 2-3 percent in the short term.

Reading this, I wondered on what basis the projections were made, and that got me digging. In the past 10 years since I settled in Seoul ― and, coincidentally, since Korea started along the path to becoming an FTA juggernaut ― these types of projections have been made by the government after every deal is inked.

From Korea’s first FTA with Chile to its latest with China, government officials have always highlighted the supposed impact on GDP, trade and per capita income. This was done when eight other FTA were implemented in the past decade ― including with major economies such as the United States, the European Union, India and ASEAN ― and even when FTAs with Colombia, Australia and Canada were concluded recently.

I have noticed a pattern in these “official economic projections.” All of them are from the joint feasibility studies that were conducted before the respective FTA negotiations began.

It is the Korean government’s usual practice to carry out a joint study with a candidate country to examine the feasibility of an FTA before it starts negotiations. The joint study ― normally done by the state-run Korea Institute for International Economic Policy and an institute from the partner country ― examines such issues as the economic effect of the FTA, sectorwise impact, the scope and coverage, and negotiating modalities.

When the joint study ends with the conclusion that the proposed FTA will bring benefits, a public hearing is held and then negotiations with the partner country commence. It takes several years for the negotiations to be completed and then many more months or years till they are finally ratified by the National Assembly and enforced.

The process for the Korea-China FTA started in November 2004 when former Chinese President Hu Jintao and former Korean President Roh Moo-hyun declared the launch of an unofficial feasibility study. Completed in 2006, this study concluded that the FTA would be mutually beneficial and a win-win for both countries.

In November 2006, both the countries then decided to upgrade the unofficial study to a joint study made by government, business and academia, which concluded in May 2010. After a public hearing in February 2012, official negotiations started and were wrapped up after 14 rounds in November 2014.

In other words, there was gap of four years since the report of the joint study was published and the deal was announced by President Park Geun-hye in Beijing on Nov. 10.

But that is not all. Interestingly, the joint study report ― a comprehensive and detailed 170 page analysis of the impact on various sectors and trade mechanisms ― did not use its own estimation based on any economic model to talk about the overall impact on the economy vis-a-vis GDP, bilateral trade and per capita income. It instead refered to the economic projections made by the earlier unofficial study conducted by the Development of Research Center of China and KIEP that was published in 2006. Moreover, the first analysis used the 2001 statistical database, which at that time was the latest updated version of the Global Trade Analysis Project model, to derive these projections.

I have no issue with the use of the GTAP model, which aggregates different levels of sectoral and regional details, but the date of the estimates and the statistics used raise a lot of questions about the validity of the projections being made today. More so because it shields a whopping 10 percent of all goods exchanged between the two sides from tariff abolition, the result of negotiators simply throwing out contentious items as they rushed to seal the deal.

While being gung ho about the FTA, the government relied on 13-year-old data and an 8-year-old analysis to make the claim about the economic impact. One can only take their assertions with a bucket load of salt.

We will have to wait for a more recent analysis by KIEP or any other reputed academic institution to gauge the actual economic impact of the agreement on the Korean economy. Even then, there are other economic variables and global economic situations that could come into play.

It is safer to keep the government macroeconomic projections on the deal at an arm’s length and concentrate on the sectorwise costs and benefits. Especially since there are still many hurdles to cross before the deal is ratified by the National Assembly and finally implemented.

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Doing business in Korea ― going beyond ranking

First published in The Korea Herald.

A World Bank report released last week ranked South Korea as having the fifth-best business environment among 189 countries this year. Commendably, the country also topped the Group of 20 emerging and advanced countries and came in third among Organization for Economic Cooperation and Development member countries.

Between June 2013 and June 2014, “Doing Business 2015: Going Beyond Efficiency,” which measures 189 economies worldwide, documented 230 business reforms, with 145 aimed at reducing the complexity and cost of complying with business regulations, and 85 reforms aimed at strengthening legal institutions.

Only Singapore, New Zealand, Hong Kong and Denmark ranked higher than South Korea.

Not surprisingly, the Finance Ministry was elated. In an official statement, it noted that this is two notches above its rank in the previous year. What is more, all the Korean media outlets picked it up and highlighted it, without crosschecking.

The rank actually remains the same, after adjustment, the World Bank has noted. But that is just a minor issue, and we cannot really fault the Finance Ministry for glossing over the fact.

A closer look at the data, which the ministry has also ignored, suggests that not everything is as rosy as it is made out to be. The ministry has attributed this rank to “improvements in regulations and the system for starting a business, granting construction permits and protecting minor investors.”

This is not entirely true, if we take a look at what the data actually shows.

The factors that are scrutinized to compile the ranking include starting a business, dealing with construction permits, getting electricity, registering property, getting credit, protecting minority investors, paying taxes, trading across borders, enforcing contracts and resolving insolvency.

The World Bank data reveals that South Korea has slipped in many of these parameters. In starting a business, South Korea’s rank slid from 16th to 17th this year; for registering property, it slipped from 78th to 79th; for getting credit, it dropped six notches from 30th to 36th; and in paying taxes, it slipped from 24th to 25th.

The country’s rank is stagnant is other parameters such as dealing with construction permits, trading across borders, enforcing contracts and resolving insolvency.

There is one parameter in which South Korea has shown improvement, and that is protecting minority investors. Its rank has climbed from 26th to 21st, but the country still has a long way to go.

It is only in providing electricity to businesses that South Korea is ranked first, and for that, the government can be proud.

These numbers beg the question: Has the situation really improved on the ground for investors wanting to start a business in South Korea? The figures speak for themselves.

The Finance Ministry said the improved ranking in business environment could have a “positive” impact on luring more foreign investment.

In the first half of 2014, South Korea’s FDI recorded historic highs for amounts declared and received. The amount declared was $10.33 billion, with annualized growth of 29.2 percent from $8 billion in the same period of 2013. The amount received was $7.2 billion, rising 55.9 percent from $4.62 billion on-year.

However, foreign investors do not just look at the overall rank when they explore opportunities here. They also get into the nitty gritty of all the issues outlined in the World Bank report, as well as the country’s labor market regulations.

If the government is serious about luring more investment and competing in Asia for investors, it has much left to do in terms of improving the business environment and raising South Korea’s rank in all the parameters.

As the World Bank has noted, a high overall ranking does mean that the government has created a regulatory environment conducive to operating a business. However, it added, “While this ranking tells much about the business environment in an economy, it does not tell the whole story. The ranking on the ease of doing business, and the underlying indicators, do not measure all aspects that matter to firms and investors or that affect the competitiveness of the economy.”

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Should South Korea join China-led AIIB?

First published in The Korea Herald.

South Korea, Australia and Indonesia were conspicuous by their absence in Beijing on Oct. 24, when China, India and 19 other countries signed a memorandum of understanding to launch the Asian Infrastructure Investment Bank ― set to become one of the Asia-Pacific’s biggest lenders in the years to come.

While there is still time for the three countries to make a decision ― the AIIB will be operational only next year ― and they are keeping their options open, there is a real danger that they may not enjoy the same clout as they would have if they had joined the other Asian countries in Beijing. The case is more so for South Korea, whose economy is closely linked to other emerging Asian economies.

The Finance Ministry has officially stated that it has been speaking with China to request further consideration over details such as the AIIB’s governance and operational principles.

“We have continued to demand rationality in areas such as governance and safeguard issues, and there’s no reason not to join it,” Finance Minister Choi Kyung-hwan was quoted as saying.
Obviously, Korea is still in a dilemma on what sort of strategic choices it has to make as China and India together challenge the international economic order led by the U.S. and its Western allies.
Did South Korea do the right thing by refusing to commit itself immediately as a founding member?

On the surface ― there have been numerous media reports ― the three countries gave in to pressure from the U.S., which has raised questions about “the need for another funding agency to rival the World Bank and Asian Development Bank” as also concerns on “its governance, environmental standards and debt sustainability.”

Among the Asian countries, Japan has also kept its distance, but has not raised any eyebrows as was widely expected. It possesses the most influential and powerful voting power over the decision making of the $175 billion ADB along with the U.S., and is not rushed to support a new “rival” on the block.

Since its establishment in 1966, the ADB has played a clear complementary role to the World Bank in aiding infrastructure development and poverty alleviation in the region. Its main role is to make money available to member countries so they can implement their own development programs and provide working-level assistance in carrying them out.

In 2013, the ADB approved $10.19 billion in loans and $142 million in equity investments, and raised $12 billion in long- and medium-term funds.

However, if one looks at the shareholding pattern of the organization, it becomes clear that apart from Japan, the U.S. and its Western allies, the remaining emerging economies in Asia have very little say in the running of the organization that is meant for them. The ADB was modeled closely after the World Bank, and has a similar weighted voting system where votes are distributed in proportion to each member’s capital subscriptions.

As of December 2013, Japan had the highest percentage of shares at 15.7 percent with a voting share of 12.8 percent, followed by the U.S. with 15.6 percent (12.7 percent vote) and China, India, Australia, Canada, Indonesia, and Korea each with 5-6.5 percent of shares and a 4-5.5 percent vote. The European Union member states, if taken as a single block ― though they vote independently ― have a share of 14.4 percent with a voting share of 15.7 percent.

Since the ADB’s early days, critics have charged that Japan, the U.S. and its Western allies have extensive influence over lending, policy and staffing decisions. There is a feeling that these decisions are not always in the best interest of the other Asian countries.

It was therefore natural for China to push for the proposed $100 billion AIIB. After initial reluctance, India too has joined, along with Singapore and other regional heavyweights.

By becoming a founding member and having a greater stake in the organization, Korea could easily raise its economic clout in the region. The AIIB should not be seen as a rival to the ADB, but as a complementary organization.

As per the ADB’s estimates, developing Asian economies need to invest $8 trillion to 2020 just to keep pace with expected infrastructure needs, of which only a tiny portion is provided by the existing multilateral lenders. As such, the AIIB will be able to bridge the gap to a certain extent.

There is clearly room for a new development bank, specialized in financing large-scale economic infrastructure on commercial terms. The ADB does have the expertise to lend a lot more for infrastructure, but has moved in a different direction, focusing more on concessional lending and knowledge sharing with low-income countries, with the main goal being poverty alleviation. That leaves an important niche to be filled by the new organization.

It will also be more effective if the countries that are affected by its lending policies actually have a greater say in how it is run.

The MOU said authorized capital of the bank would be $100 billion and that the AIIB would be formally established by the end of 2015 with its headquarters in Beijing. China is set to be its largest shareholder with a stake of up to 50 percent, the remaining coming from other countries and the private sector.

If Korea has concerns about its governance, it should become a member and try to fix it. Not becoming a founding member of something like this could be a tactical blunder. This is the opportunity to grab a big stake and voting powers, before it is too late.

In any case, in a speech to delegates after the inauguration, Chinese President Xi Jinping promised the best practices. “For the AIIB, its operation needs to follow multilateral rules and procedures. We have also to learn from the World Bank and the Asian Development Bank and other existing multilateral development institutions in their good practices and useful experiences,” he said.

Refusing to take part in an effort to help Asian countries fix their infrastructure will only end up putting Korea in a very poor light ― particularly since, in the initial stages of development, it borrowed heavily from the ADB to shore up its own infrastructure.

Korea needs to continue to develop its relationship with broader Asia and be seen as a part of the development push instead of bowing to U.S. pressure. Moreover, joining the AIIB is in no way indicative of Korea’s stand on political issues in the region.

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