Korea Special April 2017

Korea

Korea: Moon Jae-in elected president by landslide, government to adopt a larger role in the economy

May 21, 2017

On 10 May, Moon Jae-in was sworn in as President of Korea after winning the snap elections held the previous day. The liberal candidate’s election brings an end to months of political turmoil following the ousting of conservative President Park Geun-hye and signals a shift in fiscal policymaking towards a more expansionary stance. With the KOSPI index rallying to an all-time high shortly after the election, analysts argue Moon’s economic policies will have a positive impact on the ailing domestic economy, giving households the shot in the arm they have long sought. Nonetheless, plenty hurdles lie down the road, with a split National Assembly unlikely to support the president’s ‘big government’ agenda and the details of game-changing reform plans still needing to be thrashed out.

The new administration’s policy priority is job creation through a combination of public-sector hiring—Moon campaigned on a promise to create 810,000 new public sector positions—and incentives to the private sector to increase staffing. In a bid to support the government’s proposals, the finance ministry has already announced that it will set aside an USD 8.8 billion supplementary budget for this year. This is part of Moon’s plan to gradually increase annual fiscal spending growth to 7.0% over the next five years, effectively doubling the current mid-term target of 3.5%.

The government adopting a more active role in the economy will inevitably not come cheap. To prevent fiscal deficits from spiraling out of control, the authorities announced on 15 May that the administration would revise tax codes in the second half of the year. On the campaign trail, Moon had suggested raising the effective corporate tax rate by reducing exemptions and benefits and increasing taxes on wealthy individuals and real estate, but avoided providing further details due to the sensitive nature of the issue.

Contentious tax hikes and higher government debt will face a severe backlash from the Liberal Korea Party, now the main opposition. Moon’s Democratic Party holds 120 of the 300 seats in parliament, while any law needs more than 180 votes to pass. The forming of a coalition among liberal parties could bring the number up to 166, still falling short of the ample majority needed. Against this backdrop, the need for compromise among liberal and conservative factions will likely force Moon to alter some of his original plans.

Another priority for the new administration will be addressing the lack of trickle-down benefits from the chaebols’ economic success and their unhealthy exposure to political influence. The new president has called for a series of measures to restrict the chaebols’ power, including strengthening regulations on holding companies, restricting industrial firms from engaging in financial business and providing more rights to minority shareholders. Recent appointments to key government positions of longtime chaebol reform activists are a further testament to Moon’s corporate reform agenda.

However, the new administration has not yet outlined a concrete agenda to address the challenge of increasing productivity among SMEs. While fair competition, better governance among chaebols—on which SMEs are highly dependent—and short-term government support by means of tax benefits are likely to help their profitability, government backing can only do so much if firms are to compete against global suppliers. The government has also pledged to hike the minimum wage by 55% from current levels by 2020. This will further strain competitiveness among SMEs and has the potential to backfire over the mid- to long-term.

On the foreign policy front, analysts see Moon Jae-in moving away from the hardline stance taken by his predecessors in the conservative field. He leans towards diplomacy with Pyongyang and is widely expected to attempt to defuse tensions with China over the THAAD anti-missile system. Although North Korea has shown no signs of moderation since the election, Moon is expected to keep up a more measured approach towards engaging with his northern neighbor with the goal of denuclearizing the peninsula. At the same time, an improvement in relations with China could revert recent retaliatory measures imposed by the Chinese authorities on Korean exports.

Moon Jae-in will face myriad challenges with a divided National Assembly and a Sino-Korean diplomatic row to handle. And yet the country has some silver linings, including a strong external balance, an improved macroeconomic policy framework and ample public support for a better system of governance. All in all, analysts see the election of Moon as a catalyst for investors to stage a return and for both business and consumer confidence to pick up further. Against this backdrop, FocusEconomics panelists have revised their forecasts for the Korean economy up by 0.1 percentage points from last month’s projections and now expect it to expand by 2.5% in 2017. The economy is seen accelerating to 2.6% growth in 2018.


Author:, Economist

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