Can fiscal stimulus solve job problems?

By Kim Hyeongwoo

Mr. Moon Jae-in won South Korea's presidential election on May 9th by a landslide. His 17 percentage-point lead over the runner-up, Mr. Hong Jun-pyo, was the biggest winning margin ever in the history of presidential elections in Korea, which is even more impressive because he won the election in a field of 13 candidates. His victory clearly reflects the Korean people's desperate wish for a change in politics and economic system.

The new president is facing many economic challenges that include the deteriorating conditions and a slowdown in economic growth. For instance, the Korean labor market suffers from rising youth unemployment, long working hours, and discrimination against contract workers.

President Moon says that economic policies in the past focused mainly on improving business conditions for big companies (i.e., chaebol), hoping that they would hire more people and provide better benefits for workers. Looking at the current state of the economy, he argues these policies clearly failed.

Instead, Moon tries to revert the order of policy propagation channels. He says that his administration will first invest in people, not companies. The new government will create more jobs and enhance the quality and the security of existing jobs. By improving labor market conditions, the Korean economy's economic fundamentals will be strengthened, which will spur economic growth in Korea.

With such a vision in mind, Moon proposed a huge stimulus package. The new administration is pushing for a 10 trillion Korean won ($8.85 billion) supplementary budget for this year and plans to increase government spending at a 7% rate in the next five years. More specifically, he aims to create 810,000 jobs at public agencies during his term and will convert contract (temporary) job positions to permanent jobs beginning in the public sector to enhance job security.

The idea behind these proposals is that the government should play an active role in promoting the economy when both consumption and investment fall during economic downturns. When private spending decreases, corporate profits naturally fall, forcing the economy to go deeper into a recession. To prevent this, the government may implement expansionary fiscal policies, which may come in the form of increased government spending and/or tax cuts.

It seems that the new government is not very interested in tax cuts. Actually, Moon implies that we might have to raise taxes if necessary. That is, his stimulus package will be carried out by increasing government spending.

Government spending includes: (1) government purchases of goods and services from the private sector; (2) government value added as compensation of public sector employees.

Stimulus policies in the past were mostly centered on ways to increase government purchases from the private sector to help business grow. On the other hand, Moon seems to focus more on increases in government value added programs because President Moon clearly indicated that the requested supplementary budget will be used to create jobs in the public sector, if approved.

This strategy surely will help improve labor market conditions. It is likely to increase the total employment when the public sector hires from targeted groups of unemployed workers such as youth workers or retirees. Also, stronger demand for labor will help raise market wages not only in the public sector but also in the private sector.

However, we may have to question ourselves whether the plan is effective and sustainable. The size of the public sector is typically a small fraction of that of the private sector. Therefore, this strategy may have a clear limitation unless it is supplemented by the growth in private sector employment, which many not happen under the current proposed plans. For instance, if the new government puts enormous pressure on the business sector to convert contract job positions to permanent ones, job availability in the private sector is likely to decrease because firms must reduce employment as average labor cost rises.

Furthermore, Moon's economic strategies are likely to increase fiscal deficits substantially unless his plans successfully spur economic growth, thus greatly expanding the tax base. If it fails, I am afraid his plans will become unsustainable.

We all want great success for the new government. We have observed beautiful changes in many areas of Korea under Moon's regime. But finding a solution to current economic challenges requires more than a great leadership of the government. I hope President Moon's economic strategies will improve the labor market and stimulate the Korean economy. For that, I believe that Moon's government will have to seriously consider additional policy actions that provide appropriate and sufficient help for the companies in the private sector.

Dr. Kim Hyeongwoo is a professor of economics at Auburn University. He received his Ph.D. from The Ohio State University and his B.A. and M.A. from Seoul National University. He has published over 25 SSCI journal articles since 2009 in the areas of macroeconomics, financial economics and economic forecasting. He can be reached at gmmkim@gmail.com.