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Savings And Investment Imbalances
Savings and investment imbalances mirror the overall trend in the current account. In Korea, the saving-investment imbalance emerged only after the Asian financial crisis. Before the crisis, Korea's investment was generally larger than its savings (Figure 7 [ PDF 19.2KB | 1 page ]), resulting in current account deficits. Indeed, in the 20 years before the crisis, the current account had surpluses in only five years: from 1986 to 89, and in 1993 (Figure 8 [ PDF 80.6KB | 1 page ]). In 2008, Korea's current account once again turned negative.
Between 1998 and 2007, Korea had a current account surplus which reflected savings surpassing investment; however, this surplus began to decrease as savings declined and investment stagnated.
3.1 Stagnating investment
Gross investment in Korea slipped from 37.8% of GDP in 1996 to 25.0% in 1998, reflecting the harsh impact of the Asian financial crisis on the economy. In 1998, corporate investment as a share of GDP fell by nearly 10.0 percentage points from its pre-crisis rate of 25.0% (Figure 9 [ PDF 80.9KB | 1 page ]). It continued to hover below 20.0% of GDP until 2007. By 2008, private investment had returned to pre-crisis levels, reflecting the restructuring of firms and the economy in response to the Asian financial crisis. In 2009, however, the gross investment rate fell again, as the adverse effects of the global financial crisis filtered through the economy.
The Asian Development Outlook 2009 (ADB 2009) has identified a number of factors which may have depressed investments after the Asian financial crisis. First, post-crisis restructuring and reform, including the working out of pre-crisis investment excesses, may have slowed down investment. Prior to the crisis, investment generally exceeded savings in Korea—a trend which was not unique to Korea. However, compared to the other crisis-affected economies—Indonesia, Philippines, and Thailand—the gap between Korea's investment and savings rates was relatively small before 1997 (Figure 7). Therefore, the significance of pre-crisis overinvestment in Korea remains an open question.
Second, the Asian financial crisis may have heightened the risks facing regional investors, causing them to shy away from further investment in the region. Using the risk ratings of the Economist Intelligence Unit (EIU), Figure 10 [ PDF 78.1KB | 1 page ] shows that Korea's overall risk score increased rapidly during the Asian financial crisis, reflecting heightened risks in the country's economic policy, structure, and liquidity. By the first quarter of 2005, the overall risk score had reverted to its 1997 level; investment rates have since remained steady as risk scores have stabilized. The EIU revised its rating methodology in the second quarter of 2006, and up until the third quarter of 2008, classified Korea as low risk (minor adjustments have been made in the ratings for Korea since the end of 2008). This may have contributed to the pick up in investment in 2008, which could very well have continued had the global financial crisis not erupted.
Third, shortcomings in the investment climate may have weakened investment during the post-crisis period. While Korea's overall ranking in the World Bank Doing Business Surveys is high compared to many other Asian countries, it figures relatively low in specific areas of the survey. In particular, out of about 180 countries, Korea ranks below 50 on starting a business, employing workers, registering property, and protecting investors. This could be a valid reason for slower investment, post-crisis.
Fourth, in recent years, the capital intensity of East Asian products has declined as industry structures have shifted to more skill- and knowledge-intensive sectors, such as information technology products and services. This industry upgrading has also contributed to weaker investment demand (Lee and Mckibbin 2007).
Fifth, since the marginal product of capital has been declining, it has become difficult to guarantee a higher rate of profit for physical capital investment. Since the 1990s, Korea's average product of capital—which is proportional to the marginal product of capital if a Cobb-Douglas production function is assumed—has been lower than that of the US (Figure 11 [ PDF 17.2KB | 1 page ]). This implies that the decline in investment is not only a short-term problem, but also a structural one that has persisted for many years.
Sixth, increasing openness in the People's Republic of China (PRC) has made it an attractive investment destination, particularly because of its large and cheap labor force and huge market potential. This may have shifted investment away from other Asian economies, including Korea. Figure 12 [ PDF 78.5KB | 1 page ] shows net inflows of foreign direct investment (FDI) to Korea and the PRC since 1998. Immediately after the Asian financial crisis, net FDI flows to Korea rapidly increased until about 2000, perhaps due to the large number of mergers and acquisitions as firms consolidated in the post-crisis period. In contrast, FDI inflows to the PRC remained somewhat stable (barring seasonality factors) during the same period. Since 2006, however, net FDI inflows to Korea have slowed, while flows to the PRC have continued to grow rapidly. Nonetheless, it is possible that the FDI boom in the PRC may be unrelated to the FDI decline in Korea, given differences in the industrial structure of the two economies. Further analysis is required to determine whether the influx of FDI to the PRC is hurting FDI inflows to Korea.
3.2 Declining savings
The decline in gross investment rates has been accompanied by a similar drop in gross savings rates, which fell from 36.6% in 1998 to 30.7% in 2008 due to a dramatic decrease in personal savings. Personal savings collapsed from 18.5% of GDP in 1998, to about 5% between 2006 and 2008; the net personal savings rate5 was roughly 2.5% in 2008 (Figure 13 [ PDF 16.7KB | 1 page ]). In contrast, corporate savings rose steadily and government savings remained robust in the same period. As such, Korea's surplus has consisted mainly of corporate and public savings.
This trend notwithstanding, aggregate private savings in Korea have remained durable due to a number of factors. First, rapid economic expansion and income growth in Korea has been accompanied by an increase in savings.6 Figure 14 [ PDF 77.8KB | 1 page ] and Figure 15 [ PDF 79.8KB | 1 page ] plot Korea's savings rate and per capita GDP from 1970 to 2008. Although the relationship between per capita GDP growth and savings rates is not very evident from Figure 14, Figure 15 clearly shows that the savings rate has increased along with per capita income, albeit at a decreasing rate. In fact, the savings rate has been declining slowly since 2004.
Second, increased risk and uncertainty seem to have increased precautionary savings by firms. In the aftermath of the Asian financial crisis, Korean corporations seem to have learned the lessons of excessive leverage, consequently cutting back on spending and setting aside more funds for future use. Indeed, the leverage ratios of Korean firms have declined dramatically post-crisis. Total borrowings and bonds payable of manufacturing firms reached 50.1% of total assets in 1998; by 2008, this ratio had fallen to about 26.3% of total assets. Debt ratios (defined as the ratio of total liabilities to stockholders' equity) of manufacturing firms have also declined substantially, from over 300% to about 100% in the same period. This could explain the rising corporate savings rate.
Third, demographic transition may have influenced individuals' motives to save. The life-cycle hypothesis posits that individuals save during their working years and spend their savings after retirement. A high old-age dependency ratio implies that the number of dissavers is rising relative to the number of savers, thus reducing aggregate savings. Meanwhile, a high youth dependency ratio implies that the working-age population has to support a growing number of young children, thus reducing their capacity to save. Higher dependency ratios also hurt public savings. Spending for social services for the youth and the elderly, coupled with a lower tax base due to a smaller workforce, implies a reduction in public savings. Korea's population is rapidly ageing, with the mean age at 37.5 years in 2009, up nearly 5 years over the 10-year period from 1999 (Figure 16 [ PDF 82.4KB | 1 page ]). However, while the old-age dependency ratio has been rising, the youth dependency ratio has been declining, so that the overall dependency rate has remained relatively stable over the last 15 years. The dependency rate was constant between 1999 and 2004, but has since declined slowly. According to the life-cycle hypothesis, savings rates should rise as dependency rates fall. However, this has not been the case for Korea since 2004. This may be because the rising old-age dependency ratio has had a much larger impact on savings rates than the decreasing youth dependency ratio, as found in Kim and Lee (2007).
A fourth factor which may have influenced savings in Korea is the level of financial development, the impact of which can go both ways (ADB 2009). The traditional view suggests that more developed financial sectors induce higher savings by creating deeper and more sophisticated financial systems. The alternative view sees them reducing the precautionary motive for saving. The relationship between financial development and savings in Korea remains unclear.
Is Korea therefore saving “too much” or investing “too little”? The preceding discussion has been unable to provide strong evidence of oversaving or underinvestment. More rigorous econometric analysis is needed to categorically explain savings and investment behavior in the country. From 1998 up until 2008, Korea's savings have been higher than investment. While both the savings and investment rates have not returned to pre-crisis levels reached in 1996, investment seems to be lagging savings, suggesting ample room for a future rise in investment. Increasing investment will raise productive capacity, allowing the economy to grow faster in succeeding periods. However, to get a clearer view of the underlying causes of Korea's external imbalances, a closer look at domestic distortions and structural problems is necessary.
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