Current Fiscal Policy and Expenditure Management in Korea October 9, 2003 Hong-Sang Jung Ministry of Planning and Budget Republic of Korea

Table of Contents Ⅰ. Main Features in Fiscal Policy ……………………………… 3 Ⅱ. Role in economic development …………………………….. 17 Ⅲ. Policies during the crisis period ……………………………. 22 Ⅳ . Future Challenges ………………………………………….. 26

Ⅰ. Main Features in Fiscal Policy Fiscal Balance (consolidated central government) Percent of GDP Consolidated central government balance

. Since Early 80s, fiscal balance has been managed relatively well  Since Early 80s, fiscal balance has been managed relatively well except the crisis period (’97~’99)  Note structural factors : (i) surplus in social security (about 3 percent of GDP in 2002); (ii) privatization proceeds (about 0.2~1.1 percent of GDP a year in ’98~’03)

 National debt + Local government debt Central government debt + Government guaranteed debt Percent of GDP Central government debt

. National debt amounts to about 22 percent of GDP in 2002  National debt amounts to about 22 percent of GDP in 2002. However, this figure increases to about 40 percent if the government guaranteed debt are included  The government guaranteed debt increased sharply just after the economic crisis. The guaranteed debt were used for financial sector restructuring.

Two turning points (1) : early 80s · Fiscal tightening started. Prudent fiscal management (the principle of expenditure within revenue) continued until the economic crisis. · Helped stabilizing the economy. · However, resulted in a shortage of infrastructure and high transportation costs in late 80s. As a response, infrastructure investment increased in late 80s and early 90s, resulting in slight deficits in that period.

Two turning points (2): late 90s (economic crisis) · Fiscal loosening and deficits in ’97~’99 to help the recovery from the economic crisis. Fiscal surplus again after this period. · Expenditure increase first and revenue increase followed. Expenditures to support recovery  economic recovery  revenue increase/ fiscal surplus.

Size of total expenditure and net lending Percent of GDP Total revenue Consolidated central government balance

. Relatively small size of government (Korea 22. 8 percent of GDP  Relatively small size of government (Korea 22.8 percent of GDP in 2002; OECD average 37.3 in 2001). · Size of total expenditure followed fluctuations in that of total revenue. As a result, fiscal balance has remained almost balanced.

Composition of revenue

. Heavily dependent on consumption and property taxes rather than  Heavily dependent on consumption and property taxes rather than income taxes.  Privatization proceeds amounted to 0.2 ~ 1.1 percent of GDP a year in ’98 ~ ’03.

Composition of expenditure (by function)

By function :  Relatively low : social protection, health  Relatively high : economic affairs, defense.

Composition of expenditure (by economic classification)

By economic classification :  Relatively low : income transfer, government consumption, interest payment.  Relatively high : Public investment.

Total expenditure and net lending Ⅱ. Role in economic development Role in economic development : fiscal vs. financial Total expenditure and net lending Percent of GDP M3

. Financial sector played more active role than the fiscal sector in  Financial sector played more active role than the fiscal sector in economic development.  During the economic crisis, fiscal sector played an active role because the financial sector could not perform its role properly.

Main contributions by the fiscal sector  Helped maintain macroeconomic stabilization. Fiscal conservatism and resulting low public debt No excess supply of liquidity by the fiscal sector · Supplied infrastructure for economic development (road and harbor construction, vocational education, etc.). and initiated structural changes (government loans to new technology SMEs, R&D institutions, etc.).

Features for effectiveness  Fiscal policies were implicitly linked to economic plans. Plans had a medium-term (5 years) perspective (until 96s). · Concentrated on high priority areas (esp. economic affairs). Given limited resources, concentration was essential. Strong political leadership and good inter-ministrial cooperation supported this.

Improvement in fiscal management system  Improve rationality : Review committee system for budget compilation. · Flexible apparatus to support important projects(infrastructure construction, housing) : public enterprises, special accounts for earmarked revenues, and extra-budgetary funds. Efforts to improve their efficiency (e.g., appraising system for public enterprises and funds, and auditing). · Efforts to save cost : Preliminary feasibility studies, tightening of project ceiling.

Ⅲ. Policies during the crisis period (’97~’99) Fiscal policies to help the recovery · Supporting the restructuring costs of the financial sector. · Extending social safety net. · Boosting economic growth.

Restructuring the financial sector · KAMCO and KDIC issued bonds (total 97 trillion won) to clean non-performing loans and to add capital to a required level. Banks and other financial institutions could remain credible and functioning because of this restructuring. · Rule of thumb for cost sharing: a half by the financial institutions and the other half by the government. · The government is repaying bonds since 2003 (2 trillion a year in coming 25 years). · In addition, the government took the burden of interest costs.

Extennding social safety net · Unemployment became an important issue. ’96 ’97 ’98 ’99 ’00 ’01 ‘02 Unemployment rate 2.0 2.6 6.8 7.5 6.8 6.2 5.5 · The government increased public works, vocational training, income transfer to low-income earners, unemployment insurance, and loans to unemployed.

Supporting economic growth · Increased credit guarantees and government loans to,especially SMEs (small and medium enterprises). · Increased infrastructure constructions as a stimulus to recovery.

Ⅳ. Future challenges Changes in policy environment · Spending pressure will accelerate : health and welfare costs due to an aging population; costs due to maturing social safety net; uncertain cost of cooperation with North Korea. · Diversified demand and political pressure. Complicated policy demands.

The government plans to · Clearly implement medium-term plans. · Improve budget formulation procedure with a top-down approach. · Strengthen performance management. · Improve transparency by simplifying budget structure.