Introduction

The state of the world's current account imbalances still poses the risk of sparking another financial crisis. Prior to the current global economic turmoil, there was widespread concern that a “disorderly unwinding” of growing global imbalances would lead to a crisis. In the end, these imbalances did not directly cause the financial crisis that unraveled in 2008. Instead, the primary causes were inadequate financial market regulation and lax monetary policy in industrialized countries, particularly in the United States (US). Such an environment encouraged overspending in the US, which was financed by excess saving from other parts of the world.

The current global turmoil is nevertheless underpinned by global current account imbalances, for which Asia is partly responsible. Indeed, Asia's aggregate current account surpluses have been rising sharply since 2003. The region therefore has a responsibility to reduce its share of the global imbalance and lessen the risk of another economic crisis. Addressing the issue of Asia's current account imbalances, however, requires a better understanding of the causes.

Global imbalances have been mainly driven by the large current account deficits of the US, and the corresponding surpluses in the rest of the world, including developing Asia (Figure 1 [ PDF 82.3KB | 1 page ]). Asia's current account surpluses increased rapidly after the 1997–1998 Asian financial crisis, as a result of declining domestic demand. Investment rates fell sharply in the crisis-hit economies as well as in the region's newly industrialized economies (Lee and McKibbin 2007).

External imbalances are not just an external problem, and should not be judged solely by their size. In open economies, current account imbalances can naturally emerge from country-specific macroeconomic and financial factors; as long as the imbalances reflect economic fundamentals, these cannot be considered “bad”. However, current account imbalances can also result from internal microeconomic imbalances, or domestic distortions caused by market inefficiencies or public policies (Blanchard and Milesi-Ferretti 2009). The domestic saving-investment imbalance, as well as policies on export orientation, exchange rates, and reserve management, can all have an impact on external imbalances. These internal factors suggest that exchange rate adjustments alone will not bring about balanced growth. Rather, a structural approach would be needed to address the fundamental source of imbalances.

This paper focuses on the experience of the Republic of Korea (henceforth Korea), and assesses the underlying reasons for the country's current account imbalances. Korea was hit hard by the global crisis, yet its contribution to the global imbalance problem has been relatively small, even insignificant. Korea's net exports averaged a mere 1.1% of gross domestic product (GDP) from 2005 to 2008, and while its foreign exchange reserves did increase from US$52.0 billion (14.6% of GDP) in 1998 to US$200.5 billion (21.5% of GDP) in 2008 (Figure 2 [ PDF 17.4KB | 1 page ]), this still accounted for only 2.9% of total global reserves in 2008.

This paper is organized as follows: Section 2 presents Korea's current account imbalances, focusing on trends, determinants, and composition. Sections 3 to 5 focus on the different factors which have contributed to Korea's external imbalance problem, i.e., savings and investment imbalances, export-led growth, and internal imbalances between manufacturing and services. Section 6 lays out the policy agenda for rebalancing the country's growth.

Download this Paper [ PDF 626.3KB| 31 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.