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Opinion pieces on business & economic issues

KWAK Soo-Jong

Warning from the Invisible Hand

KWAK Soo-Jong

Sept. 7, 2005

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Is South Korea's economy finally on the road to recovery from weak domestic demand?

No, not quite yet, judging by the slow recovery of consumption and flat consumer prices. The best economic scenario envisages high growth with low consumer price increase. That, of course, has a flip-side: low growth with low price hikes. Since Korea's case in recent years belongs to the latter category, concerns have risen that it could be following in the footsteps of Japan's decade-long recession, which was marked by zero growth and flat prices.

Korea's consumer price index, based on the weighted average of 516 products and services, has remained fairly stable at 2.0% in August over a year ago. This relative stability came despite the skyrocketing cost of energy from rising international oil prices. The consumer index for daily necessities, based on the average change in consumer prices of 156 items essential for livelihood, has hovered around 2.8% in the same period.

Given this low movement on the price front, economists across the nation are revising their forecast for GDP growth this year downward, from the initial estimate of 5.0% to as low as 3.8% today, mainly because of the slow recovery in domestic demand that accounts for two-thirds of national income. As for the government, it still insists that recovery of demand is just around the corner, but such assurances, as far as the average person on the street is concerned, is nothing but far-fetched.

Some analysts even complain that interest rates as low as 3.25% have not been sufficient enough to prompt more corporate investment. Even the fact that the long-festering problem of consumer debt is finally on the road to resolution, has failed to loosen up the purse strings of average consumers. The current level of private consumption hovers lower than the annual average growth of 3.5% for the past ten years.

Equally worrisome is the Korean economy's inability to respond more flexibly to the challenge of changing demographics - the economic impact from the ageing population and falling birth rate. Then there is the serious issue of the widening gap between different income brackets. Affluent people from the higher income groups have taken to an ostentatious overseas spending spree, exacerbating the already lackluster economy.

Just to appreciate the magnitude of this sort of spending: it is estimated that a small number of wealthy individuals have spent approximately 10 trillion Won abroad on pleasure trips or expensive medical care over the last year. Think how much Korea's economy would have benefited if this scale of spending had taken place domestically.

This is an astonishing amount of money; it is equivalent to about 1.25% of Korea's GDP in 2004. Think it over: each 1% rise in GDP triggers about 0.74% increase in consumer price. Suppose that the entirety of 10 trillion Won had been channeled into domestic consumption, however unlikely this might sound, it would have had the effect of jacking up consumer price by 0.93%. Conversely, every 1% jump in consumer price brings about a 1.2% increase in GDP growth.

So goes our reasoning. Under this kind of a virtuous cycle, macroeconomic variables such as domestic demand, consumer prices, and economic growth all work harmoniously like a precision machine. But the recent trend of flat consumer prices, in the long run, cannot but show a stagnant domestic demand. And a weak domestic demand, in turn, is foreshadowed by declining consumer prices. This is what is happening in Korea today.

Today, leading indicators like the consumer sentiment index and consumer expectation index all point southward. They amount to a red flag warning us that the worst is yet to come: a long-running recession.

It's an "invisible hand" of the market warning us. The problem is that Korea is in denial, ignoring the coming danger.

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