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January 2020, No. 93


Foreign Trade

Exports; the Jewel of South Korean Economy


South Korea has an export oriented economy and its export accounts for more than 50% of GDP.


To analyze the current economic environment and economic growth in South Korea, it may be useful to cite examples on some people’s assumption about zero inflation. Many people analyzing economic issues using their general information, praising the advantages of Japan’s past and its export potentials and the very positive impression Japan economy has left on the people speak about the benefits of zero inflation as well as zero and negative interest rates. While all of these figures indicate the recession and economic problems that have occurred in Japan, they typically occur in countries where a significant portion of their GDP is dependent on exports. The same line of thinking seems to exist in some media. Some media in Iran assess positively the decline in Korean inflation to zero point, but is this really a favorable economic phenomenon? Will the slowdown in inflation, which is predicted to be negative for a short time, benefit the economy and lead to economic growth in the country?

Prices in South Korea have not changed since August last year. Prices of food and non-alcoholic beverages declined by 4.1 percent in September, faster than a 3.3 percent decrease in the prior month. It was the second yearly fall in the sub-index since July 2016 and the steepest since February 1987, amid a slump in cost of fresh foods (-15.3 percent vs. -13.9 percent in August), namely vegetables (-21.4 percent vs. -17.9 percent).

Meanwhile, prices decreased less for transportation (-1.6 percent vs. -1.9 percent); and communication (-1.8 percent vs. -2.2 percent) and rose at a faster pace for health (1.1 percent vs. 0.9 percent); and alcoholic beverages & tobacco (1.1 percent vs. 0.8 percent). 

While low inflation indicates macroeconomic stability, the decline in inflation in Korea does not reflect stability.

The decline in inflation in Korea is primarily attributable to the projected economic downturn expected in early 2019. Also lower inflation and lower risk-free interest rates of about two percent is the main reason for the decline in exports that happened because of overall lower demand in Korea. 

EXPORTS


Whenever inflation in Japan was below zero percent, it’s exports also declined during the same period.


Exports from South Korea plunged 11.7 percent year-on-year to USD 44.70 billion in September 2019, worse than market expectations of 11.2 percent fall and following an upwardly revised 13.8 percent drop in the prior month. This marked the tenth straight month of yearly decline in overseas sales, amid deteriorating external conditions, including the US-China trade dispute. Exports of semiconductors and petrochemicals decreased while those of automobiles, ships, and bio-health products increased. Among major trade partners, exports to China went down 21.8 percent; those to the US dropped 2.2 percent; and to Japan fell 5.9 percent.

South Korea has an export oriented economy and its export accounts for more than 50% of GDP. The country exports mainly machinery and transport equipment (59 percent of total exports) such as: electrical machinery, apparatus, appliances and electrical parts (18 percent); road vehicles (13 percent); telecommunications, sound recording; reproducing apparatus and equipment (8 percent). Other exports include: petroleum, petroleum products, related materials (6 percent); iron, steel (4 percent) and plastics (4 percent). Major export partners are China (26 percent of total exports), the United States (13 percent) Hong Kong (6 percent), Vietnam, Japan (5 percent each) and Singapore (3 percent).

Integrated circuits / microassemblies are the highest value export products in Korea, valued at $ 109.8 billion in 2018. For example, Samsung and SK Hynix account for 70% of the global market share of available dynamic memory (DRAM). 

INFLATION

The Bank of Korea predicts that inflation will remain below zero for some time. In the case of negative inflation and financial markets, the price (opportunity cost) of holding money is the amount of profit that can be made if it is converted into another financial asset. Financial gains include three risk-free interest rates, risk coverage and inflation. We should know that eliminating inflation or negative inflation reduces the cost of keeping money. While money is the most liquid asset possible and can be used directly in transactions, we must also reduce the interest rate without inflation.

Another point to consider is that the risk coverage of financial assets may be lower than the risk assessed by investors due to trade war and probable disputes.

These issues ultimately lead to the justification and attraction of lowered inflation for holding money against financial assets such as stocks or other investment items, which would cause a further recession as the investment declines.

If you take a look at Bank of Korea’s statements, the bank’s target for 2019 is to achieve a 2% inflation rate. The bank has kept interest rates at 1.5% in its meetings. The reason is that the pace of domestic economic growth in Korea is slow, and uncertainties have been raised about predicting the path of growth. The reason for these uncertainties is the increase in trade disputes between the United States and China. For this reason, the bank has said that it will make the next decisions in light of current events and a careful review of macroeconomic conditions.

The Bank of Korea also said in a statement that as inflation dropped to zero, it would reduce the price of petroleum products and agricultural products, livestock and fisheries. Given the foregoing, inflation is projected to fall below zero for some time, then to rise next year and to increase by one percent from its lowest level.

A look at the recession in Japan shows that the country is in recession with a sharp decline in inflation and a decline in its export power.

Whenever inflation in Japan was below zero percent, it’s exports also declined during the same period. This means that the inability of the monetary and financial arm of the country to withstand the recession has caused great instability in the country. Between 2007 and 2010, when exports fell sharply, we saw a sharp decline in inflation. Also, in 2013 and 2016, when there is a decline in exports, we see inflation below zero. The Bank of Japan maintained its short-term interest rate unchanged at 0.1 percent in June. Policymakers in the country also said they would take remedial measures if the bank fails to meet the two-percent inflation target set. The average interest rate in Japan was 2.76 percent from 1972 to 2019, reaching a negative 0.1 percent in January 2016, and so far.

We should not confuse ‘forms’ and ‘functions’ with each other in economics. Economics is a universal science. We should know that in function the aim is to create macroeconomic stability, but in terms of form, low inflation with little fluctuations indicate macroeconomic stability. As shown, it should be noted that recent events in Korea and inflation near zero or negative indicate macro instability and the inability of Korea’s monetary and financial arm to cope with the recession. And the origin of the recession has also been a negative global shock to demand for Korean exports.

 

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