KDI Korea Development Institute

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.

Summary

Policy Study KOR Time Preference Estimation in Korea: Focusing on the Impact of Age

This study systematically analyzes the relationship between time preference and age in South Korea, offering policy implications. It reviews the theoretical foundations of age-specific characteristics of time preference and empirically examines time preferences using survey methodology. Findings reveal that time preferences follow a U-shaped pattern with age, reaching their lowest point in the 45-50 age range. Educational attainment significantly impacts time preferences, with college graduates linked to lower preferences and smoother age-related patterns compared to those with high school education or less. Additionally, life insurance policyholders and groups with high financial literacy demonstrate lower and more stable time preferences. These results suggest the need for targeted life-cycle policies. Contrary to traditional economic theory’s view of time preference as a fixed exogenous variable, this study suggests potential endogenous changes, advocating tailored policy approaches in savings, education, finance, and information provision.

Summary

Policy Study KOR The Impact of Demographic Changes on Productivity

Demographic transitions in South Korea are projected to slow its potential economic growth through declining labor input and lowering total factor productivity (TFP). However, the TFP channel has been relatively underexplored compared to the labor input channel due to data limitations. To address this gap, this study constructs a comprehensive firm-level dataset by combining KISDATA from the NICE Information Service with income tax records from the National Tax Service. The resulting dataset includes information on both firm-level productivity and the age composition of employees, enabling a quantitative analysis of how workforce aging affects TFP.

The analysis reveals five key findings. (1) An inverse U-shaped relationship exists between employee age composition and TFP, peaking at ages 35-49. (2) Among employees aged 50 and older, TFP significantly decreases as their share rises. Relative to the 35-39 reference group, an increasing share of 40-49 year-olds has no statistically significant effect. However, a 1%p increase in the 50-54 share decreases TFP by 0.2%, and a 1%p rise in those aged 55 and above shows a larger 0.5% decline. (3) The negative impact of workforce aging is more pronounced in firms in the Seoul metropolitan area, firms with 50-299 employees, manufacturing and construction sectors, and firms operating over 30 years. (4) Firms with low average education and wage levels, high labor intensity, or low value-added per employee exhibit greater TFP declines due to workforce aging. (5) While strong seniority-based wage systems are associated with an earlier peak in the inverse U-curve, firms with weak seniority wages experience larger TFP declines due to aging.

The findings suggest that overlooking the TFP channel may lead to underestimating the demographic effects on economic growth. Mid-to-long-term population projections indicate that population aging will reduce TFP by an annual average of 0.2% between 2031 and 2041. The persistent downward pressure on productivity should be incorporated into assumptions about the future TFP trajectory.

This study identifies firms most vulnerable to population aging through heterogeneity analyses, offering targeted policy recommendations for South Korea's labor supply strategies. As industries become more labor-intensive, low-skill, and low-wage, their productivity declines are expected to be even steeper from workforce aging. Expanding younger foreign worker inflows in the short term can bolster labor supply, while long-term strategies should enhance productivity in these industries to attract domestic youth. Additionally, as seniority-based wage systems exacerbate the productivity impact of aging, reducing reliance on seniority and expanding task- and performance-based compensation systems is advisable for improving TFP.

Summary

Policy Study KOR Impact of Global Trade Fragmentation on South Korea’s Exports: The U.S-China Trade War and Policy Insights

This study analyzes the effects of the U.S.-China trade war on third-country exports to the U.S. and China, focusing on South Korea. Using tariff change data that occurred during the 2018~19 US-China trade war, it estimates product-level elasticities of substitution, i.e., tariff cross-elasticities, and investigates their determinants across countries, industries, and products. This analysis elucidates the heterogeneous effects of the trade war, informing policies to seize new export opportunities amid ongoing global trade fragmentation.

The results show that Korea’s tariff cross-elasticities toward the U.S., relative to U.S. tariffs on Chinese imports, were generally positive, implying that higher U.S. tariffs tend to boost Korean exports to the U.S. In contrast, the elasticity toward China, relative to Chinese tariffs on U.S. imports, was negative on average, suggesting that increased Chinese tariffs tend to reduce Korea’s exports to China. Comparing predicted and actual export changes reveals a potential underestimation bias in the regression model.

Decomposing the determinants of tariff cross-elasticities into country, industry, and product factors reveals the significance of country-specific elements for exports to the U.S. and China, with industry factors also exhibiting relevance for exports to the U.S. In the case of Korea, tariff elasticities were higher in high-tech, capital-intensive, or export-integrated industries.

Additionally, analysis of Korean manufacturing shows that industries with economies of scale reduced production costs and expanded output during the trade war. Zooming into factors for economies of scale, capital-intensive industries with prior investments saw increased value-added, expanded investment, and lower costs. Export-integrated industries exhibited similar positive outcomes.

Lastly, simulations based on the estimated elasticities project that four U.S.-China tariff scenarios increase Korea’s exports to the U.S. by 0.1% to 7.0%, depending on the extent of U.S. tariff changes on Chinese imports. In a severe scenario where both countries impose roughly 10%p additional tariffs on all bilateral imports, Korea's exports are projected to rise by about 4.7% to the U.S. and 9.1% to China.

These findings inform policy decisions for Korea to navigate global trade changes, such as the U.S.-China trade war, by prioritizing targeted support for high-tech and capital-intensive industries and bolstering investment and export infrastructure to enhance resilience and capture emerging export opportunities.

Summary

Policy Study KOR Transport Policy for Megacity Regions: Insights from Commuting and Travel Patterns

This study employs a network community detection approach to identify megacity regions in South Korea based on commuting and travel flows between municipalities―cities (si), counties (gun), and districts (gu)―and defined boundaries. The analysis finds 16 megacity regions in 2000, 19 in 2005, 16 in 2010, 17 in 2015, and 15 in 2020.

Comparing these findings with the designated metropolitan areas under the Special Act on Metropolitan Area Transport Management, the study proposes revisions to these designations. Specifically, the Busan-Ulsan area should be split into two regions, Busan-Gyeongnam and Ulsan-Pohang-Gyeongju. Additionally, Changnyeong-gun, currently part of the Daegu area, should be reassigned to the Busan-Gyeongnam area, and Gimcheon-si should be incorporated into the Daegu area. For the Gwangju area, expansion could be considered with additional municipalities of Yeongam, Muan, Mokpo, Gokseong, Haenam, Yeonggwang, Gangjin, Jangheung, Wando, and Jindo. The Daejeon area could also consider adding Buyeo, Yeongdong (Chungbuk-do), and Muju (Jeonbuk-do), while Cheongju and Boeun in the existing Daejeon area appear to form a different cluster. Furthermore, given population size and constituent municipalities, the Jeonbuk area―encompassing Jeonju, Wanju, Iksan, Gimje, Gunsan, Jeongeup, Seocheon, Namwon, Buan, Imsil, Gochang, Jinan, Sunchang, and Jangsu―should be recognized as an additional metropolitan area under the Special Act.

This study also identifies anchor and hub cities (nodal points) within each megacity region and proposes a framework for establishing a polycentric spatial structure, a key feature of megacity development. For instance, within the Seoul Metropolitan Area (A), Gangnam and Jung-gu in Seoul serve as major inflow nodes, while Seongnam and Suwon in Gyeonggi-do are major outflow nodes. To support megacity development, it is necessary to build a transport system that connects these nodes with surrounding municipalities.

Among large-scale transport infrastructure projects for megacity development, railway service expansion is identified as the most feasible option, with the greatest potential to reshape the centrality of cities, counties, and districts. Accordingly, this study assesses the impact and sustainability of railway services on the centrality. The findings indicate that, outside the Seoul Metropolitan Area (SMA) and excluding regional metropolitan cities, railway expansion consistently increases inflow degree centrality, reinforcing the crucial role of rail networks in fostering polycentric megacities.

Based on these findings, transport infrastructure recommendations for megacity development are proposed. First, the definition of metropolitan transport under the Special Act should be expanded from 'travel between cities and provinces within a metropolitan area' to travel between cities, counties, and districts that form integrated living and economic areas.' This expansion would provide a legal basis for transport infrastructure provision to support megacity development. Regarding funding mechanisms, the study proposes strengthening the user pays principle, including expanding both the entities responsible for formulating metropolitan transport improvement plans and the entities subject to transport facility charges. In particular, to secure funding for railway construction and capture land value gains around transit-oriented developments (TOD), the study suggests an integrated approach that effectively aligns railway TOD with railway construction projects.

Lastly, an integrated governance framework should be established to coordinate transport projects for megacity development. To that end, it emphasizes the importance of setting shared objectives and consolidating authority and responsibilities within a flexible governance structure.

Summary

Policy Study KOR A Study on the Superior Bargaining Position of Digital Platforms

This report analyzes the superior bargaining position of digital platform companies and their exploitation of this advantage. Two key characteristics underpin this position: (i) their advanced capacity for data collection and utilization compared to traditional firms, and (ii) their role as rule-setters within the marketplaces they have established.

Existing literature identifies three primary sources of their bargaining power: (i) information asymmetry, (ii) demand-side monopoly power, and (iii) hold-up arising from relationship-specific investments. Due to their superior data collection and utilization capabilities, platform firms are better positioned than traditional firms to exploit information asymmetry, thereby abusing their bargaining position. Additionally, the dynamic nature of platform markets often magnifies demand-side monopoly power. Despite a small market share, platforms can still exert significant market influence depending on user behavior. However, hold-up concerns over relationship-specific investments are less pronounced because platforms, which typically offer standardized terms of trade, find it challenging to enforce customized contract terms tailored to individual business users. Under customized contracts, the likelihood and severity of exploitation through hold-ups become most acute.

Theoretical model analysis reveals that platform firms may have incentives to refrain from using even the information they have acquired to capitalize on their superior bargaining position. Regarding relationship-specific investments, the inability to adopt customized contracts can encourage business users to invest despite the absence of a binding commitment mechanism―in sharp contrast with existing studies on relationship-specific investments and investment delays.

In concludion, this analysis highlights several critical issues that must be addressed to improve the short-term effectiveness and long-term consistency of regulatory measures targeting the abuse of superior bargaining positions by platform firms. First, discussions are needed on victim identification and the impact on the trade order. Current legal precedents requiring the identification of specific victims could hinder efforts to regulate the abuse of superior bargaining positions by platforms. For platforms that set rules for a wide range of counterparties, mandating counterparty specification could significantly limit the regulatory scope for addressing the abuse of superior bargaining positions. In the short term, therefore, it is advisable to alleviate the burden of identifying specific counterparties while still requiring evidence of adverse impacts on the trade oreder, consistent with the Geumbo Development precedent. Moreover, given the multi-sidedness of digital platforms, it is important to consider efficiency-enhancing or pro-competitive effects that may arise in adjacent markets or on the opposite side of the platform when examining instances of superior bargaining position abuse. In the long term, it would be preferable to transition toward regulation through competition law enforcement, such as addressing abuses of market-dominant positions. Acts that harm the trade order against unspecified counterparties are inherently subject to competition law. However, the current reliance on market share as a proxy for market dominance should be replaced by direct measure of market power, and legislative reforms, such as amendments to presumptive provisions, may also be necessary. Finally, to deter and promptly detect abuses of superior bargaining positions by platforms, it is essential to establish a dedicated, permanent oversight bodyendowed with the authority to access data or algorithms as needed.

Summary

Policy Study KOR Electricity Market Segmentation with Uncertainty in Demand and Supply

This study examines the structural limitations of Korea’s electricity market amid the growing share of renewable energy and seeks approaches to modify the market structure to facilitate a low-carbon transition. Korea’s electricity market currently functions as a cost-based, day-ahead market, which constrains its ability to manage supply-demand imbalances effectively as renewable energy rises. To address this, the study evaluates the necessity of introducing a capacity market as a forward mechanism, combined with generation-specific segmentation. A capacity market, in particular, is identified as a key tool to provide stable investment incentives for marginal generators, especially as the share of high-volatility resources like renewables increases, thus enhancing supply stability. Additionally, the study highlights the need to adjust capacity prices dynamically according to the market share of renewables and energy storage systems(ESS). In considering policies to support renewables and ESS, the study contrasts fixed-price contracts with dedicated capacity markets. While fixed-price contracts are vital in the short term to encourage market entry, it is equally important, in the long run, to operate the spot market in a technology-neutral manner to alleviate excessive risk burdens on wholesale market buyers. These insights offer policy recommendations to maintain a stable power supply and support the sustainable expansion of renewable energy.

Summary

Policy Study KOR Investor Composition of Government Debtand its Fiscal Implications

This paper estimates the demand for South Korea’s government bonds across investor categories and projects future bond yields in light of the country’s rising debt trajectory. A cross-country analysis shows that public and non-bank sectors have been key drivers of increased foreign investor holdings of Korean government debt during the COVID-19 pandemic. Using sectoral debt holdings data, the paper examines the evolution of marginal holdings of government bonds by each sector and estimates the responsiveness of debt demand to bond yield changes. Over the past decade, domestic banks and public institutions, including the National Pension Service, have reduced their marginal holdings, while private pension and investment fund sectors have increased theirs. These findings highlight the growing importance of non-bank sectors in government debt demand, consistent with the literature (Fang et al., 2022). Foreign investors exhibit the highest demand sensitivity to bond yields, whereas domestic insurance companies show the lowest. Based on sectoral demand estimates, a 10% increase in government debt is estimated to raise bond yields by 43 basis points. By 2030, when Korea’s government debt is expected to reach 2,000 trillion won, bond yields are projected to rise to 4.85%, ceteris paribus. Notably, 60% of the projected yield increase is attributed to the inelastic demand of insurance companies. This underscores the importance of adjusting the investor composition of the government bond market, with a greater share of investors with higher demand elasticity to alleviate pressure on borrowing cost.

Summary

Policy Study KOR Inflation Dynamics and Monetary Policy in an Aging Society: Insights from Consumption Patterns

South Korea, among the world’s fastest-aging nations, is projected to enter a super-aged society ― over 20% of the population aged 65 or older ― by 2025. Age-driven shifts in consumption patterns may significantly affect monetary policy effectiveness. This study analyzes the impact of age-specific consumption patterns on inflation and monetary policy outcomes, deriving policy implications.

Using consumption baskets, this study compares spending patterns across youth (15-34), middle-aged (35-64), and elderly (65+) cohorts. Findings reveal distinct consumption items by age group, with varying price rigidities. The elderly cohort primarily consumes items with frequent price fluctuations, suggesting a high likelihood of greater sensitivity to monetary policy changes.

Employing Jorda's (2005) local projection method, the study finds that tight monetary policy triggers a larger inflation decline among the elderly cohort than among the youth or middle-aged cohorts, reflecting the higher price flexibility of their consumption items.

These findings suggest that aging may diminish monetary policy’s impact on real consumption. To achieve policy objectives, the central bank must design policies that precisely reflect age-specific consumption patterns and price rigidities, with particular attention to the elderly’s consumption structure. In a rapidly aging society, detailed analysis of age-driven inflation responses and tailored policy measures are essential for monetary policy efficacy.

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Reports

2025 Knowledge Exchange Days (KED) Event Successfully Concludes with Vibrant Participation

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