Economic impact of terrorist strikes

First published in The Korea Herald.


The recent dastardly terrorist attacks in Paris shocked the world, with countries scampering to tighten security in preparation for any eventuality.

Even countries like Korea that have had no terror attacks from Islamic jihadists have gone on high alert, and the administration is tightening measures to make sure that no untoward incident happens.

While the nation’s security, human casualties and material losses are important aspects of these inhumane attacks, what should also be considered is the economic impact of a terrorist strike -- especially on countries like Korea, which are highly dependent on a few sectors.

A study released last month by ratings agency Moody’s shows that terrorist attacks significantly weaken economic activity, with long-lasting effects on the economy.

The study measures the impact of terrorism on a country’s economic growth, investment growth, government expenditure and cost of government borrowing, according to the report “Terrorism Has a Long-lasting Negative Impact on Economic Activity and Government Borrowing Costs.”

“For example, in 2013 the 10 countries most affected by terrorism took an immediate and significant hit to growth, dampening GDP between 0.5 and 0.8 percentage points,” the report noted. “Even worse is that the negative impact continues for years after the attack, taking up to five years for the effects to peter out.”

Investment growth takes an even greater immediate hit, with Moody’s estimating for the same episodes that investment growth declines between 1.3 and 2.1 percentage points.

During the time period studied, terrorism was concentrated in a few countries. For example, more than 60 percent of all incidents in 2013 were in just four countries, with the majority of attacks occurring in Iraq (24 percent) and Pakistan (19 percent).

Terrorist events also materially dampen economic activity and investment in mature economies, the report noted. Moody’s analyzed the economic impact of the Sept. 11, 2001, attacks in the U.S., the 2004 bombings in Spain and the 2005 bombings in the U.K., all of which resulted in significant human casualties and infrastructure damage. In each case, the effect on economic activity and investment was significant and lasted several years.

Moody’s study consisted of a sample of 156 countries between 1994 and 2013.

In another interesting study published in the International Monetary Fund’s Finance & Development journal in June, the authors reach the same conclusion.

“The effects of terrorism can be terrifyingly direct,” it notes. “But terrorism inflicts more than human casualties and material losses. It can also cause serious indirect harm to countries and economies by increasing the costs of economic transactions.”

The article explores the economic burden of terrorism, focusing on three: national income losses and growth-retarding effects, dampened foreign direct investment, and disparate effects on international trade.

It notes that rich, large and diversified economies are better able to withstand the effects of terrorist attacks than small, poor and more specialized economies.

Unfortunately, Korea falls into the specialized category given its dependence on just a few engines of growth.

The article states that specialized economies may not have such resilience. Resources such as labor or capital may either flow from an affected sector to less productive activities within the country or move to another country entirely.

“A terrorist attack against such a nation is likely to impose larger and more lasting macroeconomic costs.”

Increased terrorism in a particular area tends to depress the expected return on capital invested there, which shifts investment elsewhere. This reduces the stock of productive capital and the flow of productivity-enhancing technology to the affected nation.

The authors analyzed 78 developing economies over the period 1984–2008 and found that on average a relatively small increase in a country’s domestic terrorist incidents per 100,000 people sharply reduced net foreign direct investment.

There was a similarly large reduction in net investment when the terrorist incidents originated abroad or involved foreigners or foreign assets in the attacked country.

The study suggests a troubling association between terrorism and foreign direct investment, both of which are crucial for emerging economies.

“It is generally believed that there are higher risks in trading with a nation afflicted by terrorism, which cause an increase in transaction costs and tend to reduce trade.”

Although terrorism may reduce trade in a particular product because it increases transaction costs, its ultimate impact may be either to raise or reduce overall trade.

Terrorism also influences immigration and immigration policy. The traditional gains and losses from the international movement of labor may be magnified by national security considerations rooted in a terrorism response, the authors note.

These above-mentioned studies hold useful lessons for Korea, which is highly dependent on trade, tourism and private consumption to sustain growth.

As recent history has shown, the impact of a local tragedy on consumer sentiment in Korea is huge.

In the aftermath of the Sewol ferry tragedy -- where more than 300 people died when it sank on April 16 last year, most of them students -- the economy suffered when private consumption dropped drastically.

It plunged the country into deep mourning, dragging down economic growth -- the slowest for more than a year -- partly because of sluggish consumption.

Consumer sentiment struggled to recover for months after the incident and the fallout lasted longer than expected.

With consumer sentiment remaining feeble, companies delayed investment due to uncertainty over the economic outlook, further depressing the economy.

More recently, the Middle East respiratory syndrome outbreak in Korea dealt a severe blow to the tourism sector and dampened consumer spending, almost crippling the economy.

Thirty-three people here died from MERS since it was first detected in May, making it the largest outbreak outside the Middle East.

South Korea’s export-led economy, which has been hit by slowing global demand for its goods, together with sluggish consumer demand at home, certainly does not need another tragedy.

It is right of the government to take rigorous steps to prevent terror attacks, even though many may consider it a little over the top. The Korean economy is currently very fragile and the administration is on the right path.

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Take gov’t projections with truckloads of salt

First published in Korea Herald.


A recent media statement issued by the Seoul Metropolitan Government that got wide coverage had me in splits.

According to the note that was issued to mark the 10th anniversary of the Cheonggyecheon Stream Restoration Project -- which removed an elevated freeway and transformed it into a lush walkway through the heart of Seoul -- which was faithfully picked up by all of local media without any question, 190 million tourists annually visit the landmark.

“Some 190 million Koreans and tourists are estimated to have visited the stream since its restoration by former President Lee Myung-bak on Oct. 1, 2005. The number is expected to exceed 200 million by early next year.”

These figures were obviously cooked up by some government official and can be understandable to a certain degree -- making extrapolations based on certain data collected over a few days every year are part and parcel of economic studies. But what took the cake was the detailed breakup of the nationalities of people who visited the stream.

We are told that from 2011 to August this year, 1.8 million tourists from China, 399,000 from Thailand, 256,000 from Japan, 133,000 from Taiwan and the U.S. and 290,000 from the rest of the world visited the stream.

There are no details of how the estimation was arrived at or the methodology used. But that didn’t deter the news from getting wide coverage.

First, keep in mind that the stream is close to 6 km long with 22 bridges and has various entry points. Ordinary residents (including expats) who work in the bustling business district have to cross the stream whenever they leave their office to go for appointments, coffee, lunch or transit back home.

Second, there is no single entry point and entrance gate where one can sit and take count of the number of people visiting -- to extrapolate based on the average of a few days.

Third, since there is no entrance or record keeping, how can one be sure that the person who strolls across the stream is from China, India, North America, Europe or Timbuktu?

But the SMG was confident enough to dish out the numbers and the local media was complacent enough to take it at face value.

The reason I have brought this up is not because I do not trust the government. But I do not blindly trust what the Korean government officials say with regard to economic projections of their pet projects. No one should.

Recently, the government designated Aug. 14, a friday, as a temporary holiday -- since the actual 70th Liberation Day fell on Saturday -- to increase domestic consumption. Finance Minister Choi Kyung-hwan grandly announced that it would increase domestic spending to around 1.3 trillion won ($1.1 billion).

“When this happens, local companies will also earn more and will require more staff. In turn, they’ll need to hire more employees. The holiday will encourage a ‘halo effect’ throughout South Korea,” he said.

Absurd as it was -- one extra day off generating so much economic benefit to pull the country out of its economic misery -- no one questioned him.

The government logic was that it would enhance the people’s nationalism and encourage domestic consumption. With the economy greatly affected by the MERS outbreak and other external factors, it could use a boost -- in the form of a nationwide holiday with plenty of activities and events in store for the public as well as tourists.

No questions asked … the local economic reporters dutifully reported it, and it was taken as gospel.

Same thing happened with the “Korea Black Friday,” which was announced with much fanfare.

Unimaginatively named after the U.S.’ big shopping day after Thanksgiving, the largest-ever sale event -- involving about 26,000 stores encompassing department stores and online shopping malls from Oct. 1 to 14 -- was supposed to “revitalize the economy.” Nothing of that sort has happened.

When it was announced, no questions were asked. All the questions are being raised now when it has proved to be a damp squib and the government is scrambling to dub it a success.

The same goes for the government policies to ease youth unemployment -- the nation’s jobless rate for people between the ages of 15 and 29 came to 8 percent in August, much higher than the headline unemployment rate of 3.4 percent -- by forcing companies to introduce the wage peak system.

The wage peak system advocated by the government calls for people nearing retirement age to accept lower wages with the money saved by this arrangement to be used to hire new employees.

Many companies have announced the launch of this new wage system under pressure, but no one is asking how effective it will be in getting over the main problem -- youth unemployment.

I think it is a knee-jerk reaction and is not the “magic formula” to get the youth jobs. More so, when the announcements by the chaebol are just a headline-grabbing tactic with very little changing on the ground. As was the case with the “shared growth” hyperbole.

This trend is so common -- as observed in my 11 years as a business journalist here -- that one has learned not to go by news reports about economic projections of benefits that policies will achieve.

Not that questions are never raised. The editorial writers do a splendid job doing that and pointing out the lapses. But if local economic news articles have to get credibility, the reporters on the ground need to ask the uncomfortable questions to government officials before parroting their statements -- as they do in other advanced democracies -- without wondering whether they will upset the powers that be.

One can start trusting the government economic projections only when reporters -- not just editorial writers -- start confronting government officials with uncomfortable queries and get their response instead of simply reporting their grand promises.

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Does Korea benefit from FTA with EU?

First published in The Korea Herald.


 July 1 marked the fourth anniversary of the EU-Korea free trade agreement, which entered into force in 2011. It was touted as the first of a new generation of FTAs, going further than any previous agreements in lifting trade barriers. Being also the EU’s first trade deal with an Asian country, Korea was expected to benefit immensely.
The agreement eliminated duties for industrial and agricultural goods in a progressive, step-by-step approach. The majority of import duties were removed already when the FTA entered into force. On July 1, 2016, import duties will be eliminated on all products except for a limited number of agricultural products.
In addition to eliminating duties on nearly all trade in goods, the FTA addresses nontariff barriers to trade with a specific focus on the automotive, pharmaceuticals, medical devices and electronics sectors.
It also creates new opportunities for market access in services and investments, and includes provisions in areas such as competition policy, government procurement, intellectual property rights, transparency in regulation and sustainable development.
All this has definitely had an impact on EU-Korea economic relations, with bilateral trade growing immensely. More European goods are now more visible in stores and many European companies have entered the market. In fact, the EU was the largest investor last year, injecting a total of $6.5 billion, followed by the United States ($3.6 billion), Singapore ($1.7 billion) and China ($1.2 billion).
This would seem to indicate that the deal is a tremendous success. But is it?

Looking back

The Korea-EU FTA reflects the larger trade strategies both sides have pursued from the beginning of the 21st century.

Prior to the mid-2000s, both were reluctant to enter into bilateral FTAs, preferring to conduct trade through the World Trade Organization and through regional preferential trade arrangements. However, they changed track and have been pursuing FTAs aggressively since.

The EU was a pioneer in negotiating preferential trade arrangements and used it to anchor trade relations with neighboring countries, such as members of the European Free Trade Area and as a transition mechanism in trade relations with countries slated to accede to the EU. The EU also employed PTAs to preserve preferential trade relationships with former colonies among developing countries.
The FTA with Korea was part of a new wave of EU FTAs and part of an overall strategy referred to as Global Europe that the European Commission announced in 2006. The strategy was developed to respond to the challenges faced by EU members in a rapidly globalizing economy. An objective of that strategy was to work towards reducing tariff and nontariff barriers in trade and to liberalize markets for foreign investment.
As part of the Global Europe strategy, the EU has engaged in FTA negotiations with the objective that the FTAs are more appropriate vehicles to address more trade complex issues and can serve as building blocks toward a more robust multilateral trading system.
The Global Europe strategy sets down two main criteria for selecting FTA partners: (1) that the partner country offers sufficient market potential and (2) a sufficient level of growth opportunities that would result from the removal of tariff and nontariff barriers as a result of the FTA. Based on these criteria, along with the fact that Korea had negotiated an agreement with the United States, the European Commission identified South Korea as a priority country for an FTA.
As for Korea, for nearly a decade, it was transforming itself into an FTA hub in Northeast Asia. Signing a network of FTAs was a key part of the national economic strategy of President Lee Myung-bak as well as his predecessor Roh Moo-hyun. Both presented FTAs as necessary for advancing Korea’s economic well-being.
Ongoing competitive pressure from Japanese firms, increased competition from Chinese enterprises and the rapid aging of the Korean workforce heightened the sense of urgency to boost national competitiveness.
President Lee set a goal of building a “free trade network” that by 2014 would enable over 70 percent of Korean exports to enjoy duty-free access. He explicitly tried to diversify the composition of Korea’s FTA partners, simultaneously negotiating FTAs with large advanced economies as well as with natural resource-rich developing countries.
The Korea-EU FTA also fit into his goal of creating the “Global Korea” by expanding Korea’s engagement with and presence in the international community.
As a result, negotiations were launched in 2007, and after more than two years of negotiations, both sides finally signed an agreement on October 6, 2010. Both the Korean National Assembly and the EU Parliament have ratified the agreement, and it went into effect on July 1, 2011.
In 2009, the year preceding the official signing of the deal, Korea accounted for 2 percent of EU merchandise exports, ranking 12th as an export market, and accounted for 3 percent of EU merchandise imports, ranking ninth as a source of EU imports.
On the other hand, the much larger EU market of 492 million people with a gross domestic product of $14.4 trillion was much more important to Korea. In 2009, the EU was the second-largest market for Korean merchandise exports, with a 13 percent share of total Korean exports, second to China with its 24 percent share.
The EU was the third-largest source of Korean imports in 2009 with a 10 percent share of Korean merchandise imports behind China with a 17 percent share and Japan with a 15 percent share. In contrast, the United States accounted for 10 percent of Korean exports and 9 percent of Korean imports.
Among the EU member countries, Korea’s largest trading partners were and continue to be Germany, France and the United Kingdom.

Plain statistics


In 2010, a year before the implementation of the FTA, bilateral trade amounted to $92.23 billion, with Korea having a trade surplus -- exports stood at $53.51 billion and imports from EU at $38.72 billion. By 2014, bilateral trade showed a growth of 23.65 percent to reach 114.05 billion. However, everything is not so rosy. Korea now has a trade deficit -- exports of 51.66 billion and imports of 62.39 billion.
This clearly indicates that Korean companies have not been able to take advantage of the deal to the same extent as EU companies.
This trend is also acknowledged by the European Commission in its annual report on the trade deal submitted to the European parliament and Council in March.
It noted that the EU’s share in Korea’s total imports from the world increased from 9 percent before the FTA to 11 percent in the third year of the FTA implementation. Over the same period of time, the EU‘s share in total exports from Korea declined from 11 percent to 9 percent.
In terms of EU exports, the most important categories of products were: “Machinery and appliances,” accounting for almost 34 percent of total EU exports to Korea; followed by “transport equipment,” where exports increased by over 56 percent and represent 16 percent of total EU exports to Korea.
“Chemical products”, where exports increased by 9 percent in the third year of FTA implementation, accounting for over 12 percent of total EU exports.
Other categories of products for which EU exports increased significantly since July 2011 are “mineral products,” “wood” and “pearls and precious metals.”
As far as EU imports from Korea are concerned, the main product categories are: “Machinery and appliances” accounting for 36 percent of EU imports from Korea -- they have declined by 20 percent since the FTA took effect; and “Transport equipment” accounting for 26 percent of total EU imports from Korea, showing fluctuating growth.
Significant increases were noted in plastics, mineral and chemical products.
The report also notes that EU exports of motor vehicles to Korea increased by 90 percent, accounting for 9 percent of total EU exports to Korea. On the other hand, EU imports of motor vehicles from Korea grew by 53 percent. Motor vehicles account for 11 percent of total EU imports from Korea.
EU exports of car parts to Korea increased by 6 percent since the 12-month period before the FTA, whereas EU imports from Korea of car parts increased by over 20 percent. Over the three-year period, the respective imports from the rest of the world increased by merely 3 percent.
That is as far as product classification goes, which clearly indicates that Korea’s exports are not really much diversified.
In fact another set of data also shows some disappointing results. If we look at the figures for the first half of the year starting from 2011, something strange can be seen. Bilateral trade between Korea and EU in the first six months of 2015 is actually less than the first half of 2011, before the trade deal was implemented. In 2011, bilateral trade amounted to 53.64 billion, while it registered 51.64 billion this year.
Taking a closer look, we can see that it is Korean exports to the EU that have drastically gone down, while EU imports into Korea have increased.
This is worrisome for Korean companies, which shows that the economic slump has affected them more than their counterparts in the EU. This certainly needs to be investigated by scholars.
In fact, according to a recent survey of 360 major companies in 18 EU member countries by the Korea Trade-Investment Promotion Agency, more than seven out of 10 European companies are taking advantage of the FTA to promote their business opportunities.
The awareness of the Korea-EU FTA among European companies is far higher than that for the EU’s free trade deals with other countries.
Comparable figures were 35 percent for the EU-South Africa FTA, 34.7 percent for the EU-Mexico FTA, and 28.6 percent for the EU-Chile FTA, the survey showed.
About 34 percent of the respondents said they have increased imports of Korean products since the implementation of the bilateral free trade deal.

More efforts needed

Clearly, the Korean government has its task cut out for it to ensure that the effects of the trade deal benefit both sides. At present it appears to be one-sided.
Moreover, Korea’s exports to the EU are concentrated into a few sectors, such as ships, automobiles and electronics. These three sectors represent almost 60 percent of Korea’s total exports to the EU, in contrast to exports of other countries that are much more diversified. This requires attention.
As noted in a report by the Korea Institute for International Economic Policy, in order to take full advantage of the FTA, it is necessary to not only increase the utilization rate of tariff preferences, but also improve the business environment and productivity and upgrade industrial structures in Korea.
“With more countries committing themselves to comprehensive FTAs with the EU and the U.S. and Korea relocating more of their production bases abroad, it is more likely that exports from domestic production will be replaced by overseas production. As a result, Korea’s relative advantage as an early comer in the FTA is likely to be obsolete. In this context, it is necessary to increase the utilization rate of the FTAs in the short run and to use the FTA as occasions to strengthen industrial competitiveness in the long run,” the KIEP noted.

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Pros and cons of Korea’s minimum wage law

First published in The Korea Herald.

The minimum wage in Korea has been set at 6,030 won ($5.30) for next year after weeks of debate, although the labor unions boycotted the government-led talks on the final day.
Labor union representatives walked out of a meeting of the Minimum Wage Council ― a trilateral committee of employers, employees and labor market experts to set the minimum wage through discussion ― on Wednesday. They were upset with the suggestion that there should be a cap on the increase in the minimum wage. However, the council went ahead and finalized an increase on the following day.

The Minimum Wage Act stipulates that at least one-third of all representatives on the council can decide on the rate if any party refuses to attend the negotiations more than once.
The new rate will be notified by the government on Aug. 5 after taking into consideration all objections to the finalized rate.
In Korea, the minimum wage is the lowest allowable gross wage per hour, regardless of employment status or nationality. There are some exceptions to this rule: Businesses that only employ family members or relatives living in the same residence; domestic service users; and seamen who are governed by the seamen act.
The unions initially demanded a 79 percent rise from the current minimum hourly wage of 5,580 won to 10,000 won, while employers ― represented by the Korea Employers Federation ― were pushing for a freeze. The unions lowered their demand to 8,100 won, and refused to budge from this stance, despite opposition from others on the council.
The minimum wage in Korea was raised by 7.1 percent this year from 5,210 won in 2014 ― it was 600 won in 1989 when the government formed the wage council. The latest hike, therefore, marks an 8.1 percent hike.
For comparison purposes, the minimum wage in the United States is $7.50, Japan $6.40 and the U.K. $10.
The KEF argues that the minimum wage has risen too rapidly and needs to be stabilized, voicing concerns over possible job losses and soaring production costs. On the other hand, the unions maintain that a hike would curb the nation’s income inequality and boost consumer spending.
So, who among them is right?
At face value, the logic of the unions seems right, as minimum wages protect workers from exploitation by employers and reduce poverty. Legal minimum wages are a government’s most direct policy lever for influencing wage levels, especially for workers with a weak bargaining position.
They also serve as a basic labor standard, alongside working-hours regulations and related provisions to ensure basic job-quality standards. And supporting low-wage earners is widely seen as important for promoting inclusive growth.
However, many economists do not think so. They believe that minimum wage laws cause unnecessary hardship for the very people they are supposed to help.

The argument is that while the law can set wages, it cannot guarantee jobs. The experience in most countries with a minimum wage law is that low-skilled workers are often priced out of the labor market. This is because employers typically are not willing to pay a worker more than the value of the additional product that he or she produces.
In fact, there are numerous studies using aggregate time-series data from a variety of countries that have found that minimum wage laws reduce employment.
If employers consider the wage floor too high, Workers whose productivity is valued less than the mandated wage will find jobs only in occupations not covered by the law or with employers willing to break it.
In Korea, we already have seen many highly publicized cases in recent months where nonregular and part-time workers were paid below the mandated wages until a public outcry made them reconsider.
In addition to making jobs hard to find, minimum wage laws may also harm workers by changing how they are compensated by cutting fringe benefits which are an important part of the total compensation package for many low-wage workers.
Studies have also found that the minimum wage increases generally redistribute income among low-income families rather than moving it from those with high incomes to those with low incomes.
As the Organization for Economic Cooperation and Development has noted in a recent policy brief, minimum wages are common but controversial. Currently, 26 out of 34 OECD countries have statutory minimum wages.
“Views differ about whether such support is best provided through minimum wages, or closely related policies, such as government transfers,” it noted.
In recent years, policymakers in many countries have adjusted minimum wages in the context of high and increasingly persistent unemployment, stagnant or even declining average wages and, frequently, falling incomes especially among the poorest families.
“While minimum wages are intended to support low-wage workers, the cost of employing them can be at the heart of concerns that legal minimum might reduce employment, or damage the international competitiveness of domestic firms relying on low-skilled labor,” the brief noted
Further, tax burdens too have to be taken into account.

Even at the very bottom of the wage ladder, taxes and social levies can strongly reduce take-home pay. At the same time, taxes and other mandatory nonwage labor costs also push up the cost of employing minimum-wage workers.
By having an impact on labor costs and workers’ take-home pay, the overall tax burden has implications for how well minimum wages perform at supporting low-wage workers, while avoiding significant job losses.
Given the overwhelming evidence in numerous economic studies, the Korean trade unions should have softened their stringent position and worked out an increase to their satisfaction. By boycotting the talks, they did not do justice to young people and low-skilled workers.
While it is impractical to do away with the minimum wage, given the social realities in Korea, the government should also step in and ease the concerns of businesses.
Some countries have adopted specific measures to reduce the gap between the amounts an employer pays and the take-home pay that the worker receives. To lower employers’ costs, or to reduce risks of employment losses following minimum hikes, some have introduced tax rebates for firms employing minimum wage workers ― something the Korean government should consider.
More importantly, there needs to be efficient coordination between minimum wage policies and other redistribution measures by the government, notably taxes and transfers ― that are lacking in Korea.
These small steps could go a long way in protecting the interests of businesses as well as ordinary workers, given that the economy is struggling to recover and unemployment continues to be a major concern.

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