(THE KOREA HERALD/ASIA NEWS NETWORK) - The Korea Development Institute (KDI) has advised the government to shift its policy focus from short-term solutions aimed at stimulating the economy to long-term measures geared toward bolstering Korea's growth potential.
What the state-run think tank recommends in its latest economic outlook report is a departure from what is called "Choinomics," an expansionary policy the government has pursued since last year under Finance Minister Choi Kyung Hwan.
Under Mr Choi, one of President Park Geun Hye's most trusted aides, the government has sought to stimulate the economy through a set of expansionary measures.
For instance, it eased regulations on mortgages to boost the sagging property market and the construction industry, and expanded fiscal spending by unleashing a US$39 billion (S$55 billion) fiscal stimulus package.
The central bank also lowered interest rates in line with Mr Choi's policy initiatives.
These measures served their purposes to some degree. They contributed to the recovery of domestic consumption. Increased consumer spending led economic growth this year offset the drag produced by sluggish exports. Without the stimulus measures, Korea's economic growth would have been much lower than the estimated 2.6 percent this year.
But the KDI recommends that the government wind up its expansionary financial and fiscal initiatives, as they would make the Korean economy more vulnerable to external shocks at a time when the global economy faces growing uncertainty.
Specifically, it advised the government to lower the debt-to-income ratio, which was raised from 50 per cent to 60 per cent in July last year to help people take out more loans to finance their home purchases.
The loosened DTI provided a much-needed boost to the property market and home builders, but at the same time it sent household debt through the roof.
Korea's household credit reached a fresh record of 1,166.4 trillion won (S$1.39 trillion), more than 60 million won per household, as of end-September. The sharp growth in household debt is cause for concern as the United States is set to start raising interest rates.
People who purchased homes with mortgages could get in trouble if interest rates go up in Korea following the shift in US monetary policy. If they are forced to give up their newly purchased homes due to increased debt repayment burdens, construction companies could be driven into bankruptcy. This could shake the nation's financial system as banks have extended huge loans to home builders.
The KDI said the government should now put more emphasis on keeping Korea's financial system sound rather than on buoying the construction industry.
Policymakers need to heed this advice and study ways to curb household debt without dampening the property market. They are advised to help borrowers switch their bullet loans to long-term amortising ones.
In a bullet loan, the borrower only pays interest each month to repay the entire principal at the end of the loan term, while an amortising loan is a loan where the principal is paid down over the life of the loan.
In a similar vein, the think tank urged the government to keep national debt under control. As a result of increased government spending under Choinomics, Korea's ratio of public debt to gross domestic product shot up, threatening to break through the 40 per cent mark for the first time next year.
The KDI report advises the government to undertake fiscal reforms to reduce its budget deficit, expand the taxation base by closing tax loopholes, and introduce fiscal rules to contain pressures to overspend.
Recommending fiscal moderation, the think tank notes that Korea should learn from Japan's lost decades. Since the burst of the real estate bubble in 1991, the Japanese government has sought to spend its way out of recession. But this strategy failed, only leaving the Japanese government's finances in tatters.
The think tank's key message is that there is little room left for the government to use short-term stimulus measures to boost the economy.
Therefore, it is time for policymakers to implement more fundamental measures, however painful they may be, that can rectify the structural problems of the Korean economy and put it on a long-term growth path.
The to-do list will include swift and bold corporate restructuring to weed out zombie companies, enhancing labor market flexibility, lowering entry barriers to major service industries, and improving the business environment through deregulation.
As one key factor behind Korea's shrinking growth potential is its rapid population aging and low fertility rate, Korea also needs to come up with more effective measures to address this problem.
Policymakers cannot tackle these problems without full cooperation from lawmakers. The ruling and opposition parties need to put aside their partisan interests and pool their wisdom to meet national challenges.