KDI Korea Development Institute

Summary

Policy Study KOR On City Size Distribution: Determinants, Spatial Policies, and Welfare

This study employs a quantitative spatial general equilibrium model to estimate the determinants of city size distribution in South Korea and quantify the effects of regional policies, evaluating the optimality of its current population distribution.

Defining 161 cities and counties nationwide as cities and analyzing data from 2005 to 2019, the study finds that differentials in total factor productivity (TFP) drove up the population share of the Seoul Metropolitan Area (SMA), while amenities and urban accommodation costs worked in the opposite direction. In particular, the TFP decline among non-SMA manufacturing cities, such as Geoje, Gumi, and Ulsan, during the 2010s accelerated concentration in the SMA. Although regional development initiatives in this period, including innovation cities and Sejong City, improved local infrastructure and supported moderate population growth, weak TFP gains limited their impact on alleviating SMA concentration.

Counterfactual policy experiments that designate seven non-SMA cities as regional hubs reveal that restoring the SMA population share to its 2000 level would require substantial improvements in TFP and urban accommodation costs. The upper bound of policy costs justifiable without welfare loss is limited, and even with such investments, the SMA would still account for nearly half the national population. The optimal spatial policy analysis further suggests that efficient utilization of agglomeration economies favors population concentration in major cities across the country. With population reallocating not only to Seoul but also to major non-SMA cities, such as Busan, Daegu, and Gwangju, the SMA concentration may not rise beyond its 2019 level.

These findings offer three policy implications. First, for regional development policies to be effective, they must include measures that boost regional productivity. Second, even under optimistic scenarios, reducing the SMA share below 40% remains challenging, suggesting that policy goals should be realistic and strategically focused. Third, to prevent further SMA concentration, proactive spatial restructuring through the development of regional hub cities could provide a path forward consistent with the Pareto optimum.

Summary

Policy Study KOR The Role of Invoicing Currency in International Trade: Determinants and Implications

This study examines the determinants of invoicing currency choice in South Korea’s international trade and analyzes how exchange rates affect trade outcomes across invoicing currencies. Using Korean product-level customs data, it documents distinctive patterns in Korea’s invoicing currency composition and identifies key factors shaping firm-level currency choices for exports.

These factors include the invoicing currency composition of imported intermediate goods, firm-level foreign-currency debt ratios, past invoicing practices, export market share, foreign exchange market size, invoicing currencies of competitors, and exchange rate volatility.

The results show that the degree of exchange rate pass-through varies significantly by invoicing currency, leading to meaningful differences in export volumes. Building on these findings, the study investigates the impact of recent exchange rate movements on Korea’s exports and demonstrates that the dominance of the U.S. dollar as invoicing currency imposes significant constraints on Korean export performance.

This study provides an updated and comprehensive overview of Korea’s invoicing currency patterns in trade, offering rich implications regarding the determinants and consequences of invoicing currency choice. The findings are expected to inform ongoing policy discussions on the revision of the Foreign Exchange Transactions Act, the internationalization of the Korean won, and broader initiatives aimed at advancing Korea’s foreign exchange market.

Summary

Policy Study KOR Income Support in Response to Labor Market Shocks: Korea‘s Basic Livelihood Security System

This study examines how labor market conditions and labor policy changes affect benefit receipt under Korea’s National Basic Livelihood Security (NBLS) system. Given the substantial coverage gaps in employment insurance, NBLS serves as the last-resort safety net for low-income individuals who are able to work. Assessing its responsiveness to economic shocks and policy changes is essential for evaluating the effectiveness and limitations of the current income support system.

First, the study analyzes the responsiveness of NBLS benefit receipt and expenditures to key labor market indicators, such as the unemployment rate and the employment rate. The results show that, overall, NBLS has not exhibited meaningful counter-cyclical responsiveness to labor market fluctuations. Although a modest increase in benefit responsiveness to the unemployment rate is observed following the 2015 reform, responsiveness remains broadly limited ― even during the COVID-19 period. However, in contrast to the weak correlation with the aggregate employment rate, declines in the employment rate of middle-aged unpaid family workers show a clear association with increases in NBLS receipt. These findings suggest that NBLS has limited responsiveness to labor market fluctuations among the working population, though it appears responsive for specific vulnerable groups such as unpaid family workers.

Second, the study examines the effects of minimum wage increases ― a key labor policy targeting vulnerable workers ― on NBLS benefit receipt. The analysis shows that sharp minimum wage hikes increased both overall NBLS receipt and livelihood benefit receipt, particularly among middle-aged individuals. Monthly analyses that control for other NBLS reform effects also confirm that minimum wage increases raised benefit receipt among the working-age population. Moreover, this increase was driven primarily by new entrants to NBLS rather than by a slowdown in exits.

These findings align with the earlier results showing that NBLS receipt is particularly responsive to labor market shocks among certain vulnerable groups, such as middle-aged unpaid family workers. Previous studies have shown that minimum wage increases reduce employment rates among vulnerable groups in the labor market, including the self-employed and unpaid family workers. Taken together, the analysis suggests that employment shocks experienced by unpaid family workers may constitute a key channel through which NBLS benefit uptake rises ― particularly among the middle-aged population.

This paper emphasizes the importance of establishing and strengthening an income support system that is responsive to labor market dynamics, especially in light of anticipated structural changes and labor policy reforms. Moreover, because labor and welfare policies often target overlapping populations and interact in practice, it is essential to carefully consider these interconnections in the design and implementation of related policies.

Summary

Research Monograph KOR Monetary Policy Transmission to the Korean Bond Market

This study quantitatively examines the transmission channels through which domestic and external monetary policy shocks affect the yields of Korean Treasury Bonds (KTBs). To this end, it proposes a new methodology that decomposes long-term KTB yields into expected policy rate paths and term premia and analyzes the interaction between monetary policy and the government bond market through this decomposition. Specifically, the study develops and estimates a four-factor linear term structure model that incorporates gradual structural changes in the level of the KTB yield curve. A comparison with the conventional three-factor model shows that the proposed four-factor model is statistically superior.

The estimation results indicate that, when yields are decomposed into trend and cyclical components, cyclical fluctuations account for a larger share of yield variation at shorter maturities, whereas trend components dominate at longer maturities. The expected policy rate path is extracted from the estimated term premia, suggesting that policy rates are expected to remain broadly stable in the near term and decline gradually thereafter. Analysis of the interaction between monetary policy and the bond market shows that policy rate shocks significantly raise expected policy rates, while shocks to expected policy rates also lead to increases in the actual policy rate. This implies a high degree of mutual credibility between the central bank and the government bond market.

Using this decomposition, the study examines the effects of domestic and U.S. monetary policy shocks on KTB yields. Domestic monetary policy shocks generate significant spillovers across the entire yield curve, from short- to long-term maturities. Short-term yields respond mainly through changes in the expected policy rate path, whereas long-term yields respond more strongly through adjustments in term premia. In contrast, U.S. federal funds rate shocks do not exert statistically significant effects on KTB yields. However, U.S. forward guidance and quantitative easing shocks exert meaningful impacts. Quantitative easing shocks produce larger short-term effects, while forward guidance shocks exhibit greater persistence. Nevertheless, these spillovers are considerably shorter-lived than those from domestic monetary policy shocks, highlighting the relative independence of Korea’s monetary policy.

The study also analyzes the Korean corporate bond market in the context of domestic and external monetary policy. Although the corporate bond market has expanded steadily in terms of outstanding issuance, secondary market liquidity remains limited, with turnover ratios substantially lower than those in the government bond market and trading concentrated in financial bonds. U.S. monetary tightening is found to reduce corporate bond trading volumes and widen credit spreads, with a 25 bp increase in the U.S. policy rate leading to an immediate spread widening of 11―13 bp. Over a horizon of one to three months, corporate bond spreads increase by 28―56 bp. Domestic monetary policy shocks also have significant effects on corporate bond yields, with particularly pronounced responses in lower-rated (BBB-) bonds. By contrast, firm-level financial conditions do not appear to systematically influence the sensitivity of corporate bond yields to U.S. monetary policy shocks, likely reflecting a flight-to-quality behavior during tightening episodes.

Summary

Policy Study KOR Structural Analysis and Policy Implications of Dependence on Private Tutoring

In South Korea, education functions as a powerful mechanism for social mobility, with academic capital from prestigious universities acting as a decisive determinant of career trajectories and earnings. This dynamic has fostered intense educational fervor and the development of a large market for private tutoring, often referred to as shadow education. Compounded by a narrowing path to success, private tutoring has transformed from an optional supplement into a perceived necessity, deepening educational inequality and generating social tension.

This study empirically analyzes the causal pathway through which an excessively competitive environment induces parental competitive pressure, defined as expectations for success and anxiety, and how this pressure, in turn, leads to increased investment in private tutoring. The analysis ultimately explores the structural roots of this dependence.

A historical review reveals that regulatory measures on private tutoring in Korea have shifted since the 1960s from stringent regulation to liberalization and then to management and supplementation within the public education system. Nevertheless, a severely constrained opportunity structure, marked by restricted access to quality employment and top-tier universities, continues to fuel parental anxiety and competitiveness, compelling substantial spending on supplementary education.

The analysis confirms that investment in private tutoring rises significantly as competitive pressure on parents increases. Notably, this increase occurs primarily through higher spending rather than additional hours. This pattern suggests that, given children's time constraints, highly pressured parents strategically prioritize quality over quantity in private tutoring. Furthermore, the impact of parental competitive pressure on investment varies across family backgrounds, indicating that dependence on private tutoring reflects an interplay between socio-structural factors (competitive pressure) and household resources (income and education levels), which reproduces educational inequality across generations.

In conclusion, dependence on private tutoring is not simply the result of shortcomings in the education system but a structural phenomenon amplified by status competition within a success-oriented society. Since these structural factors drive parental competitive pressure, piecemeal policy interventions, such as regulating private tutoring or reducing reliance on it, are unlikely to be effective. The path forward requires recognizing this dependence as a reflection of broader socioeconomic dynamics and shifting policy focus toward addressing the root causes of parental competitive pressure.

Summary

Research Monograph KOR North Korea-Russia Alignment: Impacts on the North Korean Economy and Implications

This study conducts a multifaceted analysis of the evolving relationship between North Korea and Russia following the Russia Ukraine war, employing objective data and rigorous quantitative methodologies. Using big data based indicators that quantify interstate relations, the study first examines trends in North Korea Russia relations over the past decade. The analysis shows that bilateral relations deteriorated sharply after 2016, when Russia, as a permanent member of the UN Security Council, joined international sanctions against North Korea. Relations began to recover gradually after 2018, as North Korea pursued summit diplomacy and sought re-engagement with the global community. In 2020, this recovery was again disrupted when North Korea sealed its borders, citing COVID-19 preventive measures. This trajectory reversed once more following Russia’s invasion of Ukraine in 2022, ushering in a swift alignment of strategic interests and closer bilateral ties that brought cooperation to a level unprecedented in recent history.

The study next examines North Korea Russia external economic relations through a data-driven lens. North Korea’s foreign trade structure remains heavily oriented toward China, with Russia accounting for only a marginal share. Nevertheless, Russia continues to serve as a key supplier of strategic goods, including petroleum products and power generation equipment. Russian investment in North Korea has been largely confined to transportation and logistics infrastructure, and Russian firms have generally maintained a cautious stance due to high political risks and the burden of international sanctions. However, the outbreak of the Russia Ukraine war has altered this dynamic. Russia’s acute labor shortages have coincided with North Korea’s need to secure foreign currency, and there are indications that the overseas dispatch of North Korean workers has continued despite the sanctions environment. In the tourism sector, while North Korea has sought to attract Russian tourists, foreign currency earnings remain negligible, suggesting that the economic spillover effects from tourism cooperation are likely to remain marginal.

Furthermore, the study empirically evaluates the impact of North Korea Russia military cooperation on the North Korean economy. Combining the Korea Institute for Industrial Economics and Trade (KIET)’s North Korean Industry and Enterprise Database with satellite nighttime light imagery and jangmadang(market) exchange rate and price data, the analysis finds that production activity increased significantly in regions centered on heavy industry and military-related industries following the strengthening of military cooperation. In particular, nighttime light intensity rose sharply for firms producing artillery shells and small arms, directly related to the Russia Ukraine war. In contrast, industrial activity in light industries, including food processing, declined, indicating an intensifying pattern of unbalanced, military-centered growth. This trend is also corroborated by the Bank of Korea’s estimates of North Korea’s economic growth rates. Since 2023, heavy and chemical industries have shown notably strong growth, while light industries have remained stagnant. These findings suggest that while military cooperation has bolstered productivity in specific sectors, especially military and heavy industries, these gains have not extended to the civilian economy. Moreover, given recent spikes in exchange rates and prices, it remains debatable whether Russian supplies of food and petroleum products have improved general living standards. Overall, the post-cooperation growth of the North Korean economy appears structurally skewed toward the military sector rather than a broad-based industrial recovery.

These findings offer several policy implications. North Korea is widely viewed as one of the primary beneficiaries of the Russia Ukraine war. Although the specific goods and quantities North Korea has received in exchange for military supplies and troop deployments remain unclear, the exchange has likely had a positive impact on the North Korean economy. This study demonstrates that heavy and chemical industries, including munitions factories, have been the principal beneficiaries of the deepening alignment. However, the expansion of military supplies to Russia warrants close attention, as it may induce broader changes to North Korea’s industrial structure and technological capabilities that extend beyond simple military cooperation. While increased munitions production stimulates core heavy industrial sectors, including metals, machinery, chemicals, and electronics―potentially catalyzing civilian industries and improving household welfare to some extent―the domestic markets are mired in severe instability, marked by soaring prices, exchange rate volatility, and intensified state control following the COVID-19 pandemic. This appears to have exacerbated the polarization between the formal sector, which reaps the rewards from closer ties, and the marginalized informal sector. Should the Russia Ukraine war end, the munitions-driven special demand of Russia will subside. If the North Korean regime maintains its strict control over jangmadangs(markets) after the boom, the economic hardships facing the North Korean population are likely to intensify.

Summary

Research Monograph KOR The Impact of Increased Government Bond Issuance and Policy Directions

This study analyzes the repercussions of the sharp increase in government bond issuance following the economic crisis induced by COVID-19. The surge in the issuance of government bonds in South Korea was substantial, driven by the need for financial resources to support expansive fiscal policies in response to the pandemic. As government bond issuance rises, so does the yield on government bonds. Given that the demand in the financial market comprises households, businesses, the government, and external sectors, the increased issuance not only affects government bond yields but also leads to a rise in interest rates faced by households and businesses.

Conversely, the study explores the impact of government bond buy-backs on yield changes, offering a direction opposite to that of increased issuance. Utilizing a dynamic Nelson-Siegel model with macro factors, including macroeconomic variables, the study estimates changes in the yield curve resulting from both increased issuance and buy-backs. Empirical analysis reveals that a 1 trillion KRW increase in government bond issuance leads to a 2.5 to 2.9 basis points rise in yields, particularly pronounced in the medium to long-term maturities. Conversely, a 1 trillion KRW increase in government bond buy-backs results in a 1.9 to 2.1 basis points decrease in yields, with a more significant impact on medium to long-term maturities with relatively less demand.

Moving on to domestic demand factors, the study examines the influence of macroprudential regulations on government bond yields. Specifically, it analyzes the impact of restrictions on securities firms' participation in the call market and banking sector liquidity regulations, such as the Liquidity Coverage Ratio (LCR). These regulations, introduced to maintain stability in financial systems post-global financial crisis, have direct and indirect effects on government bond demand, consequently influencing market interest rates and resource allocation.

The analysis indicates that restricting securities firms' call market participation to below 25% of equity leads to a substantial increase in securities firms' participation in the repo market. Consequently, the demand for government bonds by securities firms increases, resulting in a yield decrease of approximately 10.8 to 12.5 basis points. Similarly, the phased introduction of LCR regulations leads to increased demand for government bonds by banks, contributing to a yield decrease of around 6.1 to 7.3 basis points. These findings underscore the importance of considering the ripple effects on financial markets through government bond demand when adjusting the intensity of financial stability regulations.

Lastly, the study examines the impact of external uncertainties, represented by global volatility (VIX), on foreign capital flows and exchange rates. Traditionally, an increase in VIX corresponds to capital outflows and currency depreciation. However, recent observations indicate a decrease in the magnitude of these effects, suggesting a shift in the behavior of foreign investors in government bonds. The study concludes by highlighting the need to consider the potential effects on financial markets through government bond demand when adjusting or introducing financial stability regulations in the future.

Summary

Research Monograph KOR Drivers of Part-time Work Growth and Policy Recommendations

This study examines the causes of part-time work growth in South Korea over the past decade and offers policy insights. Chapter 2 analyzes 2012-2022 data from the Additional Survey by Type of Employment of Economically Active Population Survey and the Survey of Labor Conditions by Employment Type, identifying when and which types of part-time workers increased. The growth, notable during 2016-2019, was primarily driven by older workers, part-time workers with extremely short hours (under 15 hours weekly), and service sector employees. It proposes three hypotheses: (1) workforce composition shifts, including aging and service sector expansion; (2) the adoption of a nonlinear labor cost schedule with a significant discontinuity at 15 hours per week; and (3) the minimum wage increases in 2018-2019.

Chapter 3 employs DiNardo et al.’s (1996) decomposition methodology to assess the contribution of workforce composition changes to part-time work growth. Findings reveal limited explanatory power, as within-group part-time trends dominate and declining youth employment offsets rising elderly employment, suggesting institutional and policy factors as primary drivers.

Chapter 4 analyzes the growth of extremely short-hour work driven by institutional factors affecting labor demand, focusing on a nonlinear labor cost schedule with a significant discontinuity at 15 hours per week (or 60 hours per month). Enhanced compliance with this institutional structure in the 2010s, measured by industry-level variations in social insurance enrollment rates for workers with 60-99 monthly hours, strongly correlates with the growth of part-time workers with very short hours, particularly among new hires.

Chapter 5 conducts an event-study analysis with a continuous treatment variable of the effects of the 2018-2019 minimum wage increases on working hours distribution, finding substantial wage increases for low-wage workers but no clear causal link to the growth of part-time workers with very short hours, which follows the pre-2017 trend. Evidence suggests that this growth likely stems from sustained improvement in compliance with the nonlinear labor cost schedule analyzed in Chapter 4 rather than minimum wage increases.

Chapter 6 concludes with a summary of empirical findings and offers policy recommendations to reduce discontinuities in the nonlinear labor cost schedule at 15 hours per week. Focusing on the Weekly Holiday Allowance, it outlines institutional reform directions and addresses implementation challenges.

Summary

Policy Study KOR The Macroeconomic Effects of Social Welfare Reform in South Korea

This study examines the macroeconomic and welfare impacts of replacing South Korea’s targeted income support programs with a universal income support system. A life-cycle overlapping generations (OLG) model with heterogeneous households is constructed to reflect existing programs, such as basic livelihood assistance, child allowances, earned income credits, and public pensions, and to incorporate institutional features and household-level income distribution, including joint household labor decisions.

Simulations of five policy scenarios show that universal benefit increases aggregate output but reduces social welfare due to weaker safety net effectiveness. Program impacts vary, suggesting well-designed targeted schemes may outperform universal income support. Findings also highlight the importance of aligning income support policies with household needs while ensuring fiscal sustainability.

Summary

Policy Study KOR A Study on Strategic Procurement

Around the world, public procurement is increasingly being designed to serve broader social objectives ― such as supporting disadvantaged groups or promoting innovation ― alongside its traditional economic goals. This trend is also gaining momentum in Korea. In this paper, we refer to the use of procurement to achieve these secondary aims as “strategic public procurement” and explore its potential benefits and costs. Specifically, we conduct an empirical analysis of strategic procurement practices that prioritize certain companies or products, with a focus on Korea’s purchase target ratio system. Our findings suggest that procurement aimed at fostering innovation can be economically effective, whereas evidence supporting procurement targeted at disadvantaged groups is less consistent.

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