Current account balance (CAB) of a country is the difference between the country’s savings and investments. A positive CAB measures the country’s savings abroad, while negative CAB measures the domestic investments financed by the savings of the foreigners. It is defined by the sum of the imports (both goods and services), plus the net investments outside the country, minus the exports (both goods and services). All the measurements are done in the domestic currency. It measures the country’s competitive strengths and also indicates the stability of the country’s currency.
In 1970s and early 1980s, there were current account imbalances in Korea just like other countries. The major contributors to this were the concern about misalignment of currencies, unfair trade practices and manipulation of exchange rates, and the country’s fiscal policies. Japanese yen rose rapidly as the dollar declined. South Korea together with other countries like Singapore, Hong Kong, and Taiwan, took advantage of the yen’s appreciation but at the same time failed to open up the market. To-date, the economic relations of Korea and U.S undergo straining due to trade conflicts and macroeconomic policy.
There was large accumulation of current account surpluses in Korea during 1986-88. This resulted from the “three lows”: Low international interest rates, Low oil prices, and Low dollar. As the surpluses started to disappear in 1989, Korea’s current account deteriorated and recorded a deficit of more than three percent of GNP in 1991, in comparison with the surplus of 8.2 percent of GNP in 1988.
Exports and Imports
The movements in Korea’s current balance from 1970 to 2005 were largely fuelled by exports and imports. The oil shocks of 1974 and 1979-80 contributed towards setting back the current account. This is illustrated in the figure above. The two oil shocks were highly associated with drastic fall in trade. Real trade balance (real exports less real imports) in 1985 showed a steady improvement till 1988. The fluctuations in the current account are therefore largely explained by the swings in trade. During 1986-88, the country enjoyed gradual improvements terms of trade and real trade balance. However, during 1989-91, it experienced a drastic and sudden reduction in real trade.
Savings and Investment
Within the period, the country’s current account showed a very strong correlation (positive) with the saving-investment balance of the private sector. The government’s budget was also correlated positively but not as strong as the private savings.
The post 1985 experience presented a lot of changes in the savings and investments. The private saving investment balance reduced the surpluses in the current account. Increase in both land and stock prices promoted investment in construction. Fiscal policy also played a substantial role in reducing the surpluses in the current account. The net savings of the government slightly changed in 1988-90; however, there was a 2% decline in 1991. Another factor was the adjustments of both private savings and investments.
From 1996, there has been a change in composition of the financing of government deficits. Domestic financing of the deficits increased while the resource transfer from abroad dropped. The deficit is currently domestically financed. This deficit has direct negative effect on the availability of credit to the private sector. With the emergence of China, bilateral trade has greatly increased between Korea and China. This trade also contributes greatly to the current account balance.
The South Korean economy had been heralded as a miracle in the early 1990s by World Bank. But, towards the end of 1997, the country fell into another economic crisis. The government had to look for rescue options, of which it opted for a loan from IMF. The loan came with its condition: neoliberal economic policies be imposed on the country’s economy. Various strategies were then laid so as to bring a long lasting solution.
Asia Model strategy stipulated that the industrial sector finances its investments through bank loans instead of bonds and stock. The results were over investments and excessive bank landings. The government had sold its holdings of commercial banks to the public by 1983, so this strategy could not work. The government was unwilling or simply unable to co-ordinate private investments. Establishment of Hanbo Iron & Steel Company was approved by the government in 1993, a time when production facilities where excessive. Later, Hanbo went bankrupt.
Although this strategy contributed to an economic miracle, stable economic growth was not a guarantee. The success of the export-led strategy depended mostly on external factors which the government had no direct control over. The factors included the demand level in the world market, and trade policies. The current account balances since 1970 are closely linked with the export performance.
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