Public%20Finance%20and%20Economic%20Development

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Public Finance and Economic Development

• May 2005
• Youngsun Koh
• Korea Development Institute

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The Role of Fiscal Policy in Economic Development

• Traditionally, three roles are assigned to fiscal
  policy
• Reallocating the resources in the economy with
  the provision of public goods in the hope of
  correcting market failures.
• Redistributing income and wealth with the tax and
  benefit system and also with the public education
  and other services.
• Stabilizing the macro-economy in the short and
  long term.
• A counter-cyclical fiscal policy, if implemented
  appropriately, can help to smooth out the
  short-term business-cycle fluctuations.
• Fiscal policy can contribute to a stable,
  long-term output growth with low inflation by
  maintaining sound budgetary positions and
  limiting the growth of public debt.

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Budget Surplus/DeficitKorea
OECD
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Budget Balance
Fiscal consolidation in the early 1980s restored
the budget balance to a sustainable path. The
recent economic crisis had a severe
but short-lived impact on the balance.
Note Consolidated central government.
Note General government. Source
Ministry of Finance and Economy.
Source OECD.
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Spending Growth
Fiscal consolidation in the 1980s took the form
of expenditure restraint rather than revenue
increase.
Growth of Real Expenditure and Revenue
Note Real values were obtained by deflating
nominal values with GDP deflator. Source
Ministry of Finance and Economy.
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Government LiabilitiesKorea
OECD
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Government Liabilities
The debt-to-GDP ratio declined steadily since the
early 1980s but increased rapidly after the
crisis. When government guarantees are included,
the ratio stood at 33 at the end of 2003.
Note Central government.
Source Ministry of Finance and
Economy. Note General
government, at the end of 2003.
Source OECD.
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Debt / GDP Ratio
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Government Liabilities
During the early days of government-led economic
growth, foreign borrowings played a crucial role
in providing the funds for public and private
investment.
Source 1953-90, Korea Development Institute
1991-2003, Ministry of Planning and Budget.
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Size of Spending
Expenditure and net lending as of GDP declined
throughout the 1980s and then rose in the 1990s.
It peaked in 1998 as a result of the expansionary
fiscal policy during the crisis.
Expenditure and Net Lending and Revenue
Source Ministry of Finance and Economy.
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Size of Spending
The total government spending corresponds to
23.0 of GDP, much lower than in other countries.
But the difference is mostly due to smaller
social benefits in Korea.
General Government Expenditures
Source OECD
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Tax and Social Security Burden
The increase in spending has been accompanied by
an increase in tax and social security burdens.
Tax Burden and Social Security BurdenKorea

OECD
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Sectoral Allocation of Spending
Economic affairs has taken the largest share in
total spending. The spending on social protection
is on the rise after the recent crisis.
Trends of Expenditure and Net Lending
  ( of total expenditure and net lending)
Sources Ministry of Finance and Economy.
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Spending on Economic Affairs
Spending on economic affairs corresponds to 6 of
GDP, far higher than those in advanced countries.
Spending on Economic Affairs
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Government Lending Outstanding
Stock of Loans
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Government Lending
The spending on economic affairs often takes the
form of lending.
Note Net lending new loans -
repayments. Sources Ministry of Finance and
Economy.
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Coping with the Crisis of 1997
During 1998-2002, the government made loans to
Korea Deposit Insurance Corporation (KDIC) and
Korea Asset Management Corporation (KAMCO) in
the amount of interest payment on the
restructuring bonds issued by these
corporations. The government also provided
guarantees on these bonds. In 2002, the
government announced a plan to take up the
obligation on part of the bonds (49 trillion
won) and transform them into treasury bonds. The
rest will be repaid by KDIC and KAMCO. In 2003,
13 trillion won was spent on the transformation.
The figure for 2004-2006 is 12 trillion won each
year. In addition, the government expanded the
welfare programs significantly to help the poor
and the unemployed.
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Assessment

• Overall, fiscal policy in Korea has carried out
  its roles successfully
• Resource allocation The emphasis was placed on
  promoting the economic growth with large spending
  on education, infrastructure, and other public
  goods.
• Income distribution After the crisis, spending
  on social protection is increasing rapidly, and
  is expected to increase further in coming years.
• Stabilization The prudent management of fiscal
  policy contributed to a sound budgetary position
  and a low debt-to-GDP ratio.
• But the short-term stabilization has been limited
  due to the small sizes of tax revenues and
  welfare spending.

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Assessment
The Korean economy recorded an average growth
rate of around 8. The inflation was reduced
drastically in the early 1980s and declined
further after the crisis of 1997.
Output Growth and Inflation
Source Bank of Korea.
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Assessment
Korea is also known as a country with a
relatively equitable distribution of income, even
though the inequality rose significantly after
the crisis.
Gini Coefficient
Source Hyun (2003) and Yoo (2004).
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Challenges
Government spending has been on a rising trend
since the mid-1990s, and the proportion of
mandatory spending is rising, calling for a
conscious effort to restrain the spending growth.
Expenditure Growth
Source Ministry of Finance and Economy.
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Challenges
The extensive government lending activity appears
to be playing a substitutive, rather than
complementary, role to commercial banks. Direct
support to private agents, including the
government lending, should be scaled down to
augment the complementarity.
Loans by
Financial AssetsCommercial Banks
/ GDP
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Public Sector Employment
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Challenges
On the other hand, the government should increase
its efforts in the provision of basic public
services such as public security, judicial
services, promotion of competitive business
practices, statistical services, and so on.