[Chatham House] ⑤ "Economy is Politics... Economic Logic Alone Cannot Solve It"

Is a PF-Triggered Financial Crisis Really Coming?

Editor's NoteAsia Economy's economic and financial think tank, 'Asia Economy Chatham House,' has been launched. On the 1st, at Lotte Hotel in Sogong-dong, Jung-gu, Seoul, an in-depth discussion was held under the theme "Is a Crisis Triggered by Project Financing (PF) Coming? - An In-depth Diagnosis of Korean Finance," featuring Kwak Young-kwon, Executive Director of Meritz Securities; Kim Dong-won, former invited professor at Korea University; Park Jae-ha, former Deputy Director of Korea Institute of Finance; Lim Jin, Director of the Korea Chamber of Commerce and Industry's Sustainable Growth Initiative (SGI); and Cho Won-dong, former Blue House Chief of Economic Policy (in alphabetical order). The participants forecasted that "the current economic recession will not reach the level of the past International Monetary Fund (IMF) foreign exchange crisis." However, opinions diverged on the extent of the government's role in overcoming the crisis. There was a sharp debate between those advocating proactive and aggressive policy responses and those arguing that government intervention might hinder the market's natural structural adjustment. Many also pointed out that preparing for the deepening polarization and super-aged society after 2023 is more urgent than immediate market instability. Asia Economy Chatham House follows the 'Chatham House Rule,' disclosing the list of participants but anonymizing each speaker's remarks. The full discussion will be published in several parts.

On the 1st, participants are sharing their opinions at the 1st Asia Economy Chatham House event titled 'Is a PF Crisis Coming?

◆ Moderator = Lee Jeong-jae, Director and Editorial Advisor of Asia Economy Media School

(Reference)

Is a Financial Crisis Triggered by PF Really Coming?

"Korea Electric Power Corporation, a Bottomless Pit Black Hole, Needs Electricity Rate Hikes"

"Next Year's Economy More L-shaped than V-shaped... Preventing the Worst Is the Best"

Should 'Yeongkkeul' Borrowers Be Rescued? Government Intervention: "Yes vs No" continued

"An Era Where Politics Determines the Economy, It's a Leadership Issue"
"Government Needs Clear Message Management"

<Discussant B> About ten years ago, I thought the same way. 'We need to distinguish between cyclical and structural responses. Overreacting to cyclical issues might cause us to miss structural problems. So, even if some companies collapse and households face difficulties, we should tolerate it to some extent.' However, after observing Korean politics over the past decade, my perspective has changed significantly. I believe economic experts are overlooking political factors too much. "Politics is someone else's business, a foreign country's issue; we just need to talk rationally." But was that really the case? Looking back over the last ten years, politics has influenced everything and, as a result, created new economic problems. Therefore, excluding politics from economic policy means missing something big, in my opinion.

The PF crisis should also be viewed from this perspective. Some say we can just let a few insolvent companies fail, but I think differently. Of course, saying we should save everyone is unreasonable. That's why I believe government message management is crucial. The previous administration's message of "the government will take full responsibility" should not be repeated. Nor is it easy to say, "From now on, those who caused the insolvency should take responsibility." Instead, the government should strongly communicate, "This problem is difficult for these reasons. Therefore, the public must participate in solving it. The government will lead, so please support us." Only then can structural problems be resolved later.

Regarding real estate, if the government sends a message that it will solve the problems of the young generation who borrowed heavily to buy homes during the previous administration, it would be disastrous. The government's role should be limited to normalizing real estate transactions. The current transaction freeze could lead to a sharp drop in housing prices. Slowing the pace to enable a soft landing is important. The best approach is for housing prices not to rise as much as inflation, thus reducing real value. For that, transactions must normalize first. Government policies should align with this trend.

<Discussant A> When German Chancellor Gerhard Schr?der announced 'Agenda 2010' in 2003, Germany's economy was in a very serious state. It was called the 'sick man of Europe.' The reforms were not made because the macroeconomy was good but because it was bad. Schr?der judged that "Germany could no longer continue as it was."

I think we are in the same situation now. Our society and young people's problems cannot continue as they are. Some say the government cannot make structural reform decisions because the economy is difficult, but I disagree. I see it as a matter of political leadership rather than the economy. If the Korean economy cannot sustain itself, political decisions should initiate structural reforms, and I believe it is possible. The issue is leadership will, not the economy.

<Discussant B> The current environment does not allow for purely rational discussions. Schr?der lost power after the reforms. We must consider such difficulties when implementing policies.

<Discussant A> Schr?der mentions this in his autobiography. After announcing the reform agenda, he faced severe attacks from the labor unions, his former supporters. Wherever he went, unions threw eggs at him, making it impossible to appear in public. Ultimately, he lost the election in September 2004. Even then, Schr?der believed that "the sincerity of not being able to continue Germany as it was could persuade the public," despite the risk of losing power.

<Discussant C> However, it is also true that Germany's recovery was not solely due to Schr?der's policies. The European Union's integration shifted many problems onto other European countries.

<Discussant A> So, Chancellor Merkel was quite lucky. Schr?der exposed uncomfortable truths, and energy issues with Russia were also resolved well.

<Discussant C> The current real estate transaction freeze fundamentally results from people's expectations of price declines. In that context, the government cannot say, "Prices will not fall further," can it?

<Discussant B> Still, the government must send messages like, "We will take any necessary measures to prevent a sharp price drop," including such assurances.

On the 1st, attendees are sharing their opinions at the 1st Asia Economy Chatham House event titled 'Is a PF Crisis Coming?

"Delaying Cyclical Response Hinders Structural Response"
"Market Crisis Theories Are Overstated"

<Discussant A> Former Deputy Prime Minister for Economic Affairs Yoon Jeung-hyun often used the phrase 'Chukrokja Bulgyesan (逐鹿者 不見山),' meaning "Those chasing deer cannot see the mountain." In our discussion of structural versus cyclical issues, the structural problem corresponds to the mountain, and the cyclical problem to the deer. But we cannot ignore chasing the deer either... It's a difficult choice. I think the previous administration made the economy difficult for two reasons: one, prioritizing politics over the economy; and two, focusing only on the deer and ignoring the mountain, turning the market into a wasteland. The current Yoon Seok-yeol administration must not repeat the mistakes of the Moon Jae-in administration; otherwise, South Korea will be ruined. Repeating the Moon administration's mistakes is the greatest risk.

<Discussant C> Policy standards should not be set to help companies at the very bottom. Japan is an example. Look at Japan. While the world is raising interest rates sharply, Japan cannot raise even by 0.5%. There are various reasons, but fiscal issues are the biggest. There are too many zombie companies, and raising rates would cause many to go bankrupt. In that sense, our economy must always maintain a sound structure. Carrying too many unsustainable companies will later become a major constraint on fiscal and policy measures.

<Discussant A> Japan's companies are part of the social security system, so there is that aspect.

<Discussant C> Anyway, it is a crucial time for the government to accurately identify and fundamentally solve the core problems our economy faces. I fully agree that 2023 will be important.

<Discussant A> I think the current market crisis theories are exaggerated. On YouTube, six out of ten economists say a crisis is coming, but I see this as a serious problem in economic information delivery. The boom in securities investment YouTube channels may be a reason. Anyway, if we gather here again on December 1 next year, I believe everyone will be much more optimistic than now. We will say, "We did well over the past year." And talking about 2024 will be much more optimistic than discussing 2023 today.

<Discussant C> The government will hopefully implement good policies during the next year.

<Discussant A> That remains to be seen. But we should be cautious about excessive crisis talk as it can become a kind of trauma.

<Discussant B> I sincerely hope so too. I think 2023 will be another turning point in a different way. I expect the U.S. to tolerate inflation above 6%. That means the pace of interest rate hikes will slow and even rate cuts might be considered in the second half of next year. This would allow countries worldwide to significantly reduce real debt. According to The Economist, when inflation rises by 2 percentage points from now, Japan's real debt decreases by about 20 percentage points, and the U.S. by 7-8 percentage points. This means fiscal measures implemented during the COVID-19 response can be withdrawn accordingly. Our reduction might be less, but household debt issues will be somewhat easier to solve. Even without raising tax rates, tax revenues will increase, and real debt will decrease.

Natural tax increases brought by inflation will enhance fiscal capacity to solve structural problems, thereby increasing the government's ability to respond. Therefore, the view that current cyclical responses should be avoided to address structural issues is too simplistic.

<Discussant C> The dilemma the U.S. faces with raising interest rates is similar. Rates go up, but unemployment doesn't decrease, and companies don't fail. Monetary policy is not responding. During the pandemic, government support was enormous, so households received huge amounts, making Americans less shocked by current rate hikes. This is very different from us. Our government's support to households is very small compared to the U.S. Therefore, interest rate hikes must consider this. There is criticism about whether we should take 'big steps' or just 25 basis points, unlike the U.S.'s 'giant steps.' If we took giant steps like the U.S., the impact on our households and economy would be much greater. So, caution is needed. (End)