[Insight & Opinion] Escaping Domestic Demand Slump Requires Urgent Shift in MOEF's Perspective

Retail Sales Fall for Third Consecutive Year, Signaling Domestic Demand Crisis
Key Economic Forecasts and Diagnoses Missed the Mark
Fundamental Solutions Needed to Reduce Household Debt

The domestic demand slump is severe. According to Statistics Korea, last year, South Korea's retail sales index recorded a minus 2.2% compared to the previous year, marking a decline for the third consecutive year following -0.3% in 2022 and -1.5% in 2023. This is an unprecedented situation since the statistics began. The increasing magnitude of the decline raises fears that our economy might be following the path of Japan, which is enduring not just a lost 3 years but a lost 30 years. Despite the worsening problem, the determination of the economic authorities in charge of the national budget is weak, and their response is surprisingly inadequate.

First, the Ministry of Economy and Finance (MOEF) has largely failed in basic key economic forecasts and diagnoses. During the pandemic, the then Deputy Prime Minister for Economy strongly rejected calls to stimulate domestic demand, citing poor government finances, which was shocking. I strongly criticized MOEF’s shortsightedness in failing to foresee the impending domestic demand slump in my editorial titled “Disaster Relief Funds as Antibiotics for Economic Recovery” published on July 1, 2021.

However, a few months later, even more shocking news emerged. Contrary to the Deputy Prime Minister’s complaints, tax revenues in 2021 exceeded the plan by about 60 trillion won, resulting in a surplus. To use an analogy, MOEF was like a commander who failed to distribute rations to troops going into battle despite the granary being full of rice. If the surplus tax revenues had been well utilized to actively stimulate domestic demand at that time, the current situation could have been much better. For some reason, MOEF has continued to fail in distribution due to annual tax revenue forecast errors amounting to tens of trillions of won. Over the past three years, it has repeatedly issued overly optimistic forecasts, among many serious diagnostic errors.

Since the diagnosis is flawed, appropriate economic prescriptions are hardly forthcoming. How MOEF analyzes the causes of the domestic demand slump makes me doubt my own eyes and ears. For years, I have warned in editorials such as “Household Debt Fear Spreading Like Wildfire” (March 4, 2021) that household debt, which has grown too large relative to the economy’s size, would severely erode effective demand and cause a domestic demand slump. That warning has become reality, yet over the past three years, various government housing finance support measures have offset the effects of rising benchmark interest rates, keeping South Korea’s household debt-to-GDP ratio at the highest level in the world.

Recently, the Bank of Korea released an interesting statistic: the top 20% income households hold about 78% of total household debt and about 94% of total mortgage loans. To interpret roughly, over many years, the Bank of Korea has injected money to stimulate the economy, but a significant portion of that money has been used for housing speculation by high-income earners. In such a situation where high-income earners’ income does not translate into consumption and investment, expecting a bright future becomes even more difficult.

To escape the lost 3 years of domestic demand stagnation, a fundamental change in MOEF is urgently needed. It is important to understand why advanced countries like the U.S. and the U.K. have focused on reducing household debt, including cutting back on housing finance support, even amid severe economic recessions following the global financial crisis. Trying to curb consumption sluggishness caused by household debt with policies that increase household debt is like trying to cover skin troubles caused by toxic cosmetics with more makeup. If a proper diagnosis is made and sincere solutions are implemented, the questionable failures in distribution?whether intentional or accidental?will naturally disappear.

Seo Junsik, Professor of Economics, Soongsil University