[Insight & Opinion] New Administration's Economic Measures and the Fiscal Trap

20 Trillion Won Supplementary Budget and Consumption Coupons Issued
Concerns Over Policy Effectiveness and Fiscal Soundness
Economic Research Institutes Warn of a "Fiscal Trap"

The new administration has announced a supplementary budget plan that includes a total of 20.2 trillion won in fiscal expenditure, such as distributing 10 trillion won worth of consumption coupons to all citizens. Given that the new government repeatedly heard about the hardships faced by small business owners and the general public during the presidential election campaign and promised countermeasures, there is no doubt that the government is in a position where it must take action.

The average quarter-on-quarter growth rate of real final household consumption expenditure in the last quarter was 0.15%, indicating that household consumption has virtually stagnated at a serious level. In particular, for the self-employed, who account for a quarter of the population's livelihood, the retail sales index for restaurants and related businesses as of April has not even recovered to the level of April 2019, five years ago, showing a severe slump. Meanwhile, the number of business operators in the National Tax Service's list of the top 100 daily life industries has increased by nearly 30% compared to five years ago, further aggravating the difficulties.

However, despite such political justification, several points need to be considered in terms of policy appropriateness. The first is the issue of effectiveness. The Ministry of Economy and Finance expects that this supplementary budget will raise this year's GDP growth rate by 0.1 percentage points, and particularly anticipates a boost in consumption through the distribution of consumption coupons worth between 150,000 won and 500,000 won per person.

Unfortunately, however, Japan's three rounds of local currency distribution are evaluated as having failed to stimulate the economy. In a situation where there is no optimistic expectation that the future will improve, government-issued consumption coupons tend to substitute for existing spending, especially among low-income groups, which means that the actual effect on increasing consumption is likely to be smaller than expected.

Secondly, due to a lack of tax revenue, an additional 19.8 trillion won must be raised through new government bond issuance to fund the supplementary budget. Financing through government bonds entails another problem, as it separates the beneficiaries and the bearers of government spending by generation. Thirdly, there is a need to be wary of the possibility that, as global economic conditions are likely to deteriorate for a prolonged period, political demands for fiscal measures to boost domestic demand may recur repeatedly.

The National Assembly Budget Office has already pointed out that, due to 253 bills passed by the National Assembly last year, there is no plan to secure the 53 trillion won in fiscal resources required over the next five years, as tax revenue is expected to decrease by 24 trillion won and fiscal expenditure to increase by 29 trillion won. In particular, according to the medium-term fiscal outlook, during President Lee Jaemyung's term from 2025 to 2029, the managed fiscal balance is projected to show a deficit of 442 trillion won, national debt is expected to increase by 496 trillion won, and the national debt-to-GDP ratio is forecast to rise by 7.7 percentage points.

What is noteworthy is that, rather than echoing the vision of the new administration, recent economic research institutes are expressing deep concerns about the Korean economy. The Bank of Korea, through several research reports on the issue of declining growth rates, has raised the need for structural reform to enhance growth potential. Last month, the Korea Development Institute pointed out in its "Potential Growth Rate Outlook" report that "as a decline in the potential growth rate is expected to worsen fiscal soundness, care must be taken to prevent chronic fiscal deficits caused by repeated economic stimulus measures."

In short, research institutes are warning that the new administration, in its rush to boost growth rates, risks falling into a so-called "fiscal trap" by habitually resorting to supplementary budgets and accelerating the chronic accumulation of fiscal deficits. They warn that the result will be a long-term tragedy of prolonged low growth and stagnation. Therefore, the new government must pay close attention to balancing short-term fiscal flexibility with long-term fiscal soundness, and must especially resist the temptation to raise growth rates through fiscal expenditure.

Kim Dongwon, former visiting professor at Korea University