Implications of Global Recession and Structural Changes for the Korean Economy

We propose the following policy recommendations. First, all our results support the important role played by domestic demand. Both rising inequality and aging population affect Korea's GDP primarily through the private domestic demand channel. In the beginning of the implementation of Chin's Five Year Plan, the external sector is the main driver of boosting an economy. Over time, however, the channel through which domestic demand affects Korea's GDP outweighs external channels such as net export. Second, the policy to address aging population through raising the fertility rate should take into account the trade-off between current employment and investment and the number of future working-aged population. Because production factors, labor and capital, are complementary in general, a decrease in employment would lead to investment slowdown. On the other hand, raising the fertility rate implies an increase in the future working-aged population. Again due to complementarity between production factors, this can boost investment and pick up growth in the future. Therefore, implementation of policies to address aging should be based on the optimal growth of population and take into account the trade-off between its short run and long run effects. Third, a single index for income inequality is limited in fully representing all changes in inequality, and the aggregate effect of rising inequality is better captured by tracking down changes in the entire income distribution instead. Populations within the different income groups might play a different role and the aggregate consequences might depend on the entire income distribution. Instead of targeting a single index for inequality, therefore, policy tools to address rising inequality should be grounded by more sophisticated analysis. Finally, depending on factors such as a country's input-output linkages with other countries, moving up and down in global value chains, and whether a country and its trading partners are growing, a country could either gain or lose from an FTA with a specific country. Given that the gain from trade liberalization may not be bilateral in practice, a careful approach to quantify the effect of trade liberalization should be necessary before the implementation of an FTA with a certain country.