[2022 Roundtable] Kim Heungjong, KIEP President: "2022 Marks the First Year of Global Great Transformation... Communication Between Government and Businesses Is Essential"

Asia Economy Special Ground Roundtable

[Sejong=Asia Economy Reporter Kim Hyunjung] As we enter the third year of the COVID-19 pandemic in 2022, what changes will domestic and international economic and industrial structures undergo? The global economy, having suffered devastating blows to face-to-face service industries and experienced rapid expansion of the non-face-to-face market over the past two years, is sitting on a rollercoaster. Before concerns about deflation (economic recession) have fully subsided, there is now the challenge of resolving inflation (economic overheating) caused by pandemic responses.

Kim Heungjong, President of the Korea Institute for International Economic Policy (KIEP), identified "global transformation" as the keyword surrounding this year's economic situation during a special paper-based discussion with Asia Economy on the 4th, considering the COVID-19 quarantine situation. President Kim stated, "From this year, we will follow a path where mid- to long-term structural improvements become visible," diagnosing it as "the first year of global transformation." He pointed out upcoming risks such as ▲the possibility of passive fiscal responses by governments worldwide ▲delays in supply chain normalization ▲uncertainties in international cooperation, emphasizing the need for proactive government discussions and responses.

▲If you were to name the keyword leading the global economy this year, what would it be?

= Although the COVID-19 pandemic is still ongoing, the economy is in a recovery phase. The most important role in this situation has been played by governments' crisis response policies worldwide. Broadly speaking, these can be called economic stimulus measures, which in the short term support demand maintenance and prevent supply capacity collapse, and in the long term promote policies for economic structural improvements such as digital transformation and green transition. From 2022, these mid- to long-term structural improvements will become visible. It can be called "the first year of global transformation." Such a transformation requires massive investments to build human and physical infrastructure. While investments for transformation inject vitality into the global economy, they also carry uncertainties, and accordingly, various risk factors will persist.

▲Specifically, what risk factors should be considered?

= First is the sustainability of expansionary fiscal policies. To improve structures, countries are setting long-term investment plans for human and physical infrastructure, requiring large-scale proactive government investments to continue for several years. However, since substantial fiscal expenditures have already been made in response to the pandemic, securing budgets for future investments may be difficult. As the post-crisis normalization point becomes visible, concerns about continuous fiscal spending may rise, potentially leading to a shift toward passive responses to structural changes.

Second is the potential delay in smooth functioning of supply chains. The economy needs time to adapt to rapidly changing policy environments alongside the pandemic, and this adaptation delay is causing bottlenecks. Frictions in the energy sector due to green transition policies have already appeared in China, Europe, and elsewhere. While these frictions will likely resolve over time, the adaptation path to policy changes may not proceed as expected. Generally, side effects known as the balloon effect of regulations may occur, with frequent private sector attempts to circumvent new policies and regulations, potentially causing unforeseen problems.

Lastly, there is uncertainty in international cooperation. Achieving global transformation requires coordinated efforts among countries, which may be difficult. For example, stable revenue increases such as tax revenue are necessary for global transformation, which is not a problem for a single country but requires global joint efforts. Although many international agreements have been reached this year since the Biden administration returned to international cooperation, concerns remain about the sustainability of U.S. leadership. At the 26th UN Climate Change Conference of the Parties (COP26), which closed on November 13 last year, some emerging countries' opposition and the absence of leadership from advanced donor countries prevented agreement on phasing out coal power by 2030. In 2022, the U.S. midterm elections will take place, and U.S.-China conflicts will become more sophisticated. Nationalism will continue to act as a negative risk.

▲Additional interest rate hikes are anticipated domestically. With the U.S. tapering acceleration underway, what is your assessment of the impact of these trends on Korea's trade and macroeconomy?

= Compared to global monetary policy trends, among advanced countries, the Bank of Korea has raised its base interest rate proactively. The Bank of Korea's legal duties include price stability and financial stability. It was necessary to respond to overheating in asset markets, including real estate, and the related increase in household debt. While the effect of mitigating capital outflows triggered by the U.S. monetary policy shift was likely considered, the main factor was believed to be alleviating financial imbalances caused by asset market overheating. Concerns about the reoccurrence of taper tantrums as tapering progresses have also been raised. However, from a macro perspective, Korea's external sector stability is considered to be secured to some extent. Foreign exchange reserves reached a record high of $469.2 billion as of the end of October 2021, and since returning to a net creditor position in 2014, domestic investors' foreign financial assets have steadily increased, resulting in external assets exceeding foreign exchange reserves since the end of 2018.

Although there was some regret over the termination of the temporary currency swap with the U.S. at the end of 2021, an agreement was made to use the Federal Reserve's "Standing FIMA Repo Facility" if necessary to partially compensate. Since a significant portion of foreign exchange reserves consists of U.S. and other major countries' government bonds, concerns about effectiveness decline due to forced sales during crises had been raised. Securing a channel to stably procure dollars at a stable interest rate by using held U.S. government bonds as collateral is expected to contribute to maintaining external stability.

▲Global supply chain issues are cited as one of the biggest external risks this year. What government responses are necessary to further strengthen Korea's export trade improvement? Also, how do you assess current responses?

= Amid major countries' active moves to stabilize supply chains by attracting or nurturing production facilities for core industries domestically and strengthening cooperation with allied countries, Korea, with high external dependence, has reached a point where it cannot leave securing stable global supply chains solely to companies. More than ever, communication and cooperation between government and companies are needed.

First, beyond national-level diplomatic and trade policies, it is necessary to establish and implement diplomatic and trade policies at the industrial level. Korea must identify the core supply chains of its major industries and build optimal global networks by industry to enhance stability. While pursuing supply chain diversification strategies to reduce dependence on specific countries, support measures should be prepared to substitute core materials, parts, and equipment with domestic supply whenever possible, simplifying global supply chains to minimize supply chain risks. Trust-building and close cooperation between government and companies are essential, and practical and flexible approaches to various forms of diplomatic and trade policies must be boldly pursued.

Alongside this, Korea's comparative advantage in manufacturing capabilities should be fully utilized during the global supply chain restructuring process. In the past, when global supply chains were built based on efficiency, manufacturing advanced countries pursued optimal strategies focusing on high value-added production stages and outsourcing other processes. Through the COVID-19 pandemic, it became important to maintain at least a minimal production base to respond to crises. However, achieving this goal solely by nurturing domestic companies is not easy, and establishing mass production capabilities for advanced products requires time and investment, with no guarantee of success. Korea has solid manufacturing capabilities in major industries and is regarded as a key partner in countries' supply chain stabilization policies. Korea should fully leverage this position, improve what it has done well, and solidify its status as a production hub in the global supply chain.

Finally, the nation must concentrate its capabilities to lead core technologies of future new industries and secure market dominance through bold investments in new technologies. Over the past 20 years, Korea's global competitiveness in various new industries has been based on high R&D investment relative to GDP. As uncertainties in global supply chains increase, competition among countries to secure competitiveness in advanced fields will intensify. Korea must manage to prevent core technologies and personnel from leaking, encourage and support more aggressive investments in new technology fields, gain technological superiority, and establish a foothold to play an essential role in future global supply chains.

▲The current government plans to apply for membership in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) in April, but membership remains uncertain. What approach and pace do you think are desirable for pursuing membership?

= Since the mid-2010s, bilateral issues have surfaced, and the current government inherited the worst Korea-Japan relations, compounded by Japan's semiconductor material export restrictions in July 2019, making the situation very unfavorable. Hastening membership negotiations at that time could have risked very disadvantageous negotiations. Considering the overall situation, it cannot be said that the opportunity was missed. CPTPP is currently the world's highest-level mega FTA. Through membership, Korea can align its existing systems and regulations with global standards, improving institutional efficiency and transparency, which is expected to have significant and important effects. However, due to the high level of market openness, concerns about some sectors such as agriculture are real, so negotiation strategies must be well prepared, and effective supplementary measures for the agricultural sector must also be established.

▲The government is promoting carbon emission 'net zero' achievement. Opinions are emerging about providing incentives to promoting companies and about related disclosure systems and the role of capital markets. What advice do you have on this?

= Civic groups and international organizations are focusing on ensuring the enforceability of carbon neutrality deadlines and implementation plans set by governments. However, we must consider what will happen if countries worldwide move toward carbon neutrality as promised. Likely, we will need to worry about a shortage of materials essential for carbon neutrality. More specifically, in the transportation sector, batteries for electric vehicles, semiconductors, lightweight metals and materials for vehicle light-weighting; in the energy sector, raw materials for manufacturing solar and wind power generators, materials for expanding electric supply networks, and hydrogen are all essential materials for carbon neutrality. Carbon neutrality will trigger enormous demand for copper, aluminum, hydrogen, lithium, nickel, cobalt, barium, and rare earth elements.

Future strategies of countries moving toward carbon neutrality involve explosive demand for upstream supply chain sectors that extract, refine, and produce intermediate goods of these resources. If upstream sectors are monopolized by specific countries or regions, or if countries possess resources but cannot refine them domestically for environmental reasons, it is conceivable that certain countries might weaponize carbon-neutral resources. Resource weaponization based on resource nationalism, as seen with the oil cartel in the 1970s, could reoccur anytime in the era of carbon neutrality where key materials are unevenly distributed. Preparing for resource weaponization intertwined with carbon neutrality is urgent.

Support for companies responding to the climate crisis is also necessary. Support for innovative technology development and incentives or institutional foundations to discover business models that enhance resource circularity throughout product design, production, and consumption cycles should be established. Future low-carbon technologies depend on current technology innovation investments; the later the investment, the slower the economy's transition to a low-carbon economy, resulting in greater future economic burdens. The government should design systems to create an environment for industries to pursue carbon neutrality. Considering that market-friendly means providing incentives to economic participants rather than unilateral regulations can induce the most cost-effective outcomes is important.