[Insight & Opinion] Solutions to the Domestic Demand Slump

As the domestic demand slump deepens, the number of self-employed business failures is increasing. The closure rate is rising, and more than 40% of self-employed individuals are reportedly considering closing their businesses within three years due to the domestic demand slump and rising costs. If the domestic demand slump continues, there are concerns that financial insolvency will increase as it spreads not only to small and medium-sized merchants but also to large corporations in sectors such as construction. Urgent measures from policy authorities are needed.

First, consumption capacity must be increased. The reason consumption, which accounts for a large portion of domestic demand, is not increasing is that disposable income has decreased due to rising taxes and living expenses. In reality, living costs have significantly increased due to interest burdens from high interest rates, high rent, increases in heating and electricity bills, and rising food purchase costs caused by high inflation. On top of this, taxes such as property tax have also risen, reducing real income and disposable income not only for the lower-income groups but also for the middle class. Of course, if the growth rate is high, consumption can increase even if living costs rise, as long as income growth outpaces the increase in living expenses. However, with low growth causing income stagnation and living costs rising, consumption and jobs decrease, leading the Korean economy into a vicious cycle of domestic demand slump.

To increase consumption capacity, it is necessary to lower interest rates to reduce interest burdens and implement expansionary fiscal policies. Additionally, policies to reduce living costs are also important. Increases in electricity and heating bills should be postponed until domestic demand recovers, and to stabilize housing prices, transportation infrastructure should be expanded from suburban areas to city centers where jobs are located to disperse housing demand in urban areas. Furthermore, measures such as expanding imports and improving distribution structures are needed to stabilize agricultural product prices. Tax reduction policies are also important. Raising taxes to secure fiscal soundness reduces disposable income, which decreases consumption and worsens the domestic demand slump, while also slowing growth and reducing tax revenue. During periods of domestic demand slump, policy authorities should first restore domestic demand through tax cuts. When domestic demand increases, tax revenue can also increase.

Policies to increase the growth rate are also necessary. This is because low growth leads to fewer jobs and lower income growth rates, which reduce consumption. The Korean economy was able to increase its growth rate by increasing exports to China when China had a high growth rate but lower technological capabilities. However, now that China’s technological capabilities have surpassed Korea’s and the trade balance with China has turned into a deficit, there are concerns that low growth will continue. Low growth leads to job and consumption decreases, and eventually, as the exchange rate rises, the Korean economy may falter at the threshold of becoming a developed country. In fact, youth unemployment rates are already rising, and middle-aged individuals are experiencing worsening financial hardship after early retirement.

To increase the growth rate, new industries must be fostered to enhance export competitiveness. Policy authorities should establish new industry policies, and the political sector must promptly prepare support systems for fostering new industries. Structural reform of the labor market is also essential. With the current rigid labor system, companies are likely to move overseas. In a digitalized open economy, tax and labor systems that do not meet global standards will reduce domestic corporate investment. As overseas direct investment increases and domestic jobs decrease, growth slowdown and domestic demand slump will continue as they do now. Policy authorities and labor groups must recognize the changed open economic environment and structurally reform the labor market to meet global standards. Otherwise, companies will move overseas, domestic jobs will further decrease, and the pain of low growth will intensify.

The Korean economy is falling into the trap of domestic demand slump. It could experience a long-term slump like Japan. To escape the trap of domestic demand slump and low growth, the correct policy choices by policy authorities are urgently needed.

Jungsik Kim, Professor Emeritus, Department of Economics, Yonsei University