 Why Did Korean Domestic Demand Slow Down after the Asian Financial Crisis?Unjung Whang,
Seongman Moon,
Taehyun Ahn,
Su Bin Kim and
Junyup Kim
No 15-1, Policy Analyses from Korea Institute for International Economic Policy Abstract: Economic growth in Korea has slowed down dramatically after the Asian financial crisis of 1997. The average growth rate of real GDP of Korea before the crisis (1981-1996) was 9.3%, while it was reduced to 3.7% during the period (2003-2014) after the credit card lending boom following the financial crisis. Coincidentally, the patterns of domestic demand growth before and after the crisis were similar to the GDP growth: the average growth rate of Korean real domestic demand was 8.8% and -0.3%, in the respective periods. This remarkable decline in both growth rates should not be attributed to the factors that are linked to the short-run economic fluctuations because these phenomena have lasted more then 10 years after the Asian financial crisis. Instead, structural factors related to the domestic market or exports are more likely to induce the significant declines in the growth of these two variables. In this study, we focus on identifying those structural factors that are responsible for the decline in the growth rate of domestic demand after the Asian financial crisis, which may result in the decrease in economic growth. Motivated by observing dramatic changes in the growth rates of the relevant variables such as GDP, domestic demand, investment, and exports, we consider two structural problems that the Korean economy faced after the Asian financial crisis: i) one is the dampened ripple effects of exports on domestic demand and thus on GDP; ii) the other is the decrease in the growth of household disposable income. First, exports can contribute to the economic growth via two channels. One is the direct contribution to the GDP. The other is the indirect contribution to the GDP through the domestic demand (that is, the ripple effect of exports on GDP). As firms export more, they tend to use more production inputs and thus are more likely to increase investment and employment, which results in the increase in domestic demand. In fact, the data reveal that about one third of GDP growth can be accounted for by exports directly in the period of 1981-1996. This implies that two third of GDP growth can be explained by the domestic demand. In contrast, the Korean economic growth after the Asian financial crisis is entirely driven by export growth, that is, the growth of export sector does not boost domestic demand after the crisis. In other words, the ripple effect of export sectors on GDP has significantly dampened after the Asian financial crisis. Furthermore, we found two potential reasons for the dampened ripple effect from the export sector. These reasons are closely related to changes in investment behaviors of large-sized Korean exporting firms before and after the Asian financial crisis: i) the large-sized exporting firms do not invest their earnings from exports any more to create new industries; ii) they tend to use more foreign value added contents for their exports and to increase outward FDI by participating in the Global Value Chains (GVCs). Second, another structural factor that affects the pattern of domestic demand before and after the Asian financial crisis is closely associated with the decrease in the growth of household real disposable income. Its growth rate was 10.3% in the former period (1981-1996), which is higher than the GDP growth rate. Its growth rate, in contrast, was 2.3% after the financial crisis, which is lower than the GDP growth rate. This remarkable decrease in the growth of household income may influence household consumption, and hence economic growth. In fact, the data reveal that the real consumption growth rate was 8.4% in the former period and 2.4% in the latter period, respectively. These patterns of consumption growth rates before and after the crisis were similar to the patterns of both the GDP and the income growth rate. In addition, the decrease in household disposable income is more likely to induce increase in household debts and thus an increase in the burden of debt service. This will Keywords: Economy - Korea; Structure Problem; Ripple Effect; Domestic Demand; Employment; Household Debts (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:ris:kieppa:2015_001 Access Statistics for this paper More papers in Policy Analyses from Korea Institute for International Economic Policy [30147] 3rd Floor Building C Sejong National Research Complex 370 Sicheong-daero Sejong-si, Korea. Contact information at EDIRC. |
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