Invest KOREA

World Economic Forecast

Since late 2016, the global economy has been showing signs of investment-led recovery. As a result of the adjustments in facilities/equipment and production since 2010, the world’s overproduction has significantly gone down, while inventories have contracted. The recent rise in demand was caused by companies that have once again been investing in facilities/equipment and inventories, as product prices rise due to adjustments in supply. Investment in construction and corporate facilities has been leading the economic recovery. With asset prices rising fueled by the low interest rates of eased currency policies, housing construction in major countries are seeing increased activity. In the United States, investment in housing has somewhat slowed down in 2017 due to the trend of rising interest rates, but in the euro zone and in major countries such as Japan and China, investment in construction has played an important role in economic growth last year.

World Economic Growth Rates by Demand Sector

(YOY, %)

Note: Weighted average of the growth rate of consumption, investment, and government spending in 33 major countries, assuming national accounts have unchanged
Source: Datastream, LG Economic Research Institute

While many expect the world economy in 2018 to be better, there are also factors that will weaken the economy. With upstream and downstream economic factors coexisting, the economy is expected to maintain a basic growth rate similar to 2017. That the global economy hit bottom and is beginning to recover means economic circulation is taking place. The improving profitability of companies, and the resulting increase in investment will eventually bring about higher employment rates and wages, and lead consumption. The rise in consumption, in turn, could lead to the expansion of production, employment and investment, putting the economy into a virtuous circle. The problem of the current state of recovery is that consumption has only a minor influence on the economy. As wages fail to rise despite greater employment, the purchasing power of households is not strong, and this is a major factor restricting consumption. Next year, there seems to be some room for wages to go up. However, employment is expected to be unable to quickly rise, as it had this year. Europe’s unemployment rate is still high, with room for additional employment expansion, but in the United States, where the unemployment rate has gone down to near 4 percent levels, and Japan, which is suffering from a labor shortage, it seems the lack of workers will restrict growth.

In terms of economic policies, one positive side is that fiscal expansion policies are to be expected. It is highly likely that the Trump administration’s plans to cut taxes and invest in infrastructure will pass through the legislative process, and take effect starting in 2018. In particular, the significantly lower corporate tax rates will act as a positive factor for corporate investments. However, except for the United States, other countries do not have plenty of room for fiscal expansion. It will be difficult for the euro zone to reach an agreement among the countries on fiscal expansion, and even Japan, which has set out for a large-scale supplementary budget in 2017, will find it difficult to further expand government spending.

In contrast, with regards to monetary policies, as the United States pushes forward with quantitative austerity measures and interest rate hikes, and as Europe also sets out to reduce quantitative easing, the global trend of austerity is expected to grow stronger. This trend is expected to have a negative effect on consumption, investment, and, in particular, real estate prices. This will thereby become a factor that restricts the upward trend of investment in construction. From an economic policy perspective, it seems the downward trend caused by monetary austerity will be greater than the upward trend fueled by fiscal expansion.

A look at the trends of each country also shows that developing countries will continue on their paths to growth, while advanced countries are expected to slow down. Of the major economies, Russia and Brazil have started to grow, and India is expected to maintain its upward economic trend, but the euro zone and Japan will peak before falling somewhat.

World Economic Growth Rate and Investment’s Contribution on Growth (%, %p)

In summary, the global economic growth rate is expected to rise from 3.1 percent in 2016 to 3.6 percent in 2017, and maintain the 3.6 percent level this year as well. Neither does the economic outlook seem bright from the perspective of companies. This is because the growth in demand has slowed down, the increase in investment this year is expected to raise the pressure of competition, and there are concerns that production costs will go up as higher interest rates lead to slightly higher wages.

Korea’s Economic Forecast

In Korea, the trend of investment-led growth that started in 2015 has continued throughout 2017. If earlier growth was led by construction investments, in 2017 investment in facilities have shown a higher rate of growth. And while recovery based on investment led growth is a global trend, in the case of Korea, the growth was more heavily dependent on investments than in other countries. For the past two years, the contribution of investment on growth exceeded 50 percent, and is expected to approach 80 percent this year. In 2017 Korea is expected to return to 3 percent growth after along interval.

Korea’s economic recovery was heavily influenced by rising prices in the semiconductor and other electronic parts industries. Amid the expansion of demand for memories in preparation for the Fourth Industrial Revolution, the supply capacity has not increased due to the restructuring that took place in the semiconductor industry, causing prices of semiconductors—a major Korean export item—to surge. This led to a rise in exports and greater investment in facilities. The dominating view is that the semiconductor boom will last until the first half of this year, but the situation will become uncertain starting the second half, when China is expected to increase its supply. Also, being unable to shift the focus from particular items, such as semiconductors and IT devices, it seems the rise in facilities investment will slow down.

Exports, too, are expected to slow down in monetary terms. In 2017 Korean exports, based on customs data, increased by over 17 percent, showing the strongest growth in five years. Semiconductor exports, rising by over 50 percent due to the increase in unit prices, led exports in all sectors, while steel, refined oil and chemical exports also enjoyed a good year due to rising prices. This year, however, the synergistic effect of rising export prices is expected to mostly disappear. While there is room for semiconductor prices to rise further, steel, display and other items that saw an increase in global prices have already started to see their unit prices fall in the latter half of last year, and petroleum goods prices are also expected to stop rising. Moreover, the United States maintaining its protectionist stance and the recent trend of the strong won are expected to have a negative influence onKorea’s exports at different times.

Investment in construction, which led the Korean economy for the past three years, is expected to gradually lose its vitality. The surge in construction projects that began in 2015 led to the high growth rate for housing investments and they are near completion. In contrast, concerns about the oversupply of housing and the government’s supply control policies are causing a decline in the initiation of new construction projects. For a while, the number of housing units that started construction had remained significantly higher than the number of housing units that completed construction, but the trend has been reversed last year. Investment in civil engineering will also slow down. The government has decided to refrain from expanding new social overhead capital (SOC) construction projects and existing investment plans, and plans to significantly reduce next year’s SOC budget. In particular, with the budget for transportation infrastructure including roads, railways and air routes, having been cut by over KRW 4 trillion (USD 3.68 billion), new investments in related sectors are expected to decrease.

In line with global trends, Korea will also display signs of consumption-led growth this year. Until now, consumption has rapidly declined, causing a long period of lackluster consumption despite the rise in actual income. In 2016, the average scale of consumption dropped to a record low—even lower than during the 1997 financial crisis—so many expect there is little room for additional decline. Moreover, considering how consumer sentiment has started to recover last year, it appears that the propensity to consume will stop going down. Even the government’s income-led growth policies, which aim to expand fiscal spending, raise the minimum wage, increase public employment and lower real living expenses, focus on strengthening the consumption sector. Raising the minimum wage could have a negative effect on the production and investment of companies and independent businesses, but considering the effect of the expansion of fiscal spending, the income-led growth policies are expected to have a positive effect on the growth of the domestic economy in 2018.

However, considering the immense contribution of investments to growth, the rise in consumption will not be able to completely offset the effects of the investment slowdown. Unlike investment which widely fluctuates based on the state of the economy, consumption is characteristically inclined to change by small increments. As such, the economy is predicted to undergo a two percent growth—a rate slightly lower than that of 2017.

As growth slows, it seems prices will also be stabilized. As agricultural prices surged due to unusual weather conditions such as drought followed by heavy rain, the growth rate of consumer prices exceeded 2 percent, but recently fell to 1.3 percent. This year, while consumption-led growth will act as a factor that raises prices in the services sector, it is thought that the overall pressure on total demand will not be significant because of the slowdown in growth.

With the domestic economy growing at an increasingly slower pace and prices stabilizing, the base rate will be increased gradually. As the growth of household debt slows down due to the government’s micro-regulatory measures, it seems the Bank of Korea’s concerns on interest rate hikes will focus less on the its effect on reducing debt, and more on the quickly increasing interest burden on households. Upon raising the interest rate late last year, two more interest rate hikes are expected to take place this year. With the United States quickly raising interest rates, there is a growing possibility that the benchmark interest rates of the United States and Korea will be reversed. However, because Korea’s foreign exchange markets have improved their level of soundness, it seems there will not be a considerable outflow of funds in the short term.

By Lee Geun-tae
Senior Research Fellow, LG Economic Research Institute / gtlee@lgeri.com