KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Policy Study KOR A Study on Impact of Korea’s Policy Instruments for Battery Electric Vehicles (BEVs) and Fuel Cell Electric Vehicles (FCEVs)

Over the past five years, there has been a swift increase in the registration of clean vehicles, including Battery Electric Vehicles (BEVs) and hydrogen-powered Fuel Cell Electric Vehicles (FCEVs). The total number of registered BEVs and FCEVs reached 1.6% of all vehicles by the end of 2022, driven by various government support policies. In pursuit of its net zero goal, the South Korean government aims to increase the share of BEVs and FCEVs to at least 85% by 2050. The 2023 budget for clean vehicles (3.3 trillion won) accounts for 29.0% of the Ministry of Environment's total budget. Against this backdrop, this study empirically examines the effects of recent deployment policies based on data from newly registered BEVs and FCEVs. Specifically, by compiling datasets of newly registered passenger cars, government subsidy levels, and cumulative charging infrastructure by region from 2019 to 2022, this study conducts regression analyses to determine the impact of regional differences in these variables on the changes in the number of newly registered BEVs and FCEVs, respectively.

The analysis reveals that the price elasticity of newly registered BEVs and FCEVs based on subsidy changes was -1.59 and -2.90, respectively, while the charging infrastructure elasticity was 1.24 and 0.93, respectively. Additionally, the high degree of fiscal independence among local governments and high fuel prices for internal combustion engine vehicles contributed to the increase in new registrations. In the case of EVs, the price elasticity for foreign cars was higher than for domestic cars. Moreover, when analyzing EVs restricted to private use, the price elasticity decreased, and the impact of deploying chargers diminished. Based on the obtained estimates, this study further examines alternative scenarios to evaluate the effectiveness of the EV subsidy policy. It turns out that approximately 27.4% of new registrations over the past four years were attributed to subsidy payments, and that charger installation is more cost-efficient than paying subsidy in terms of government expenditure. Furthermore, a cost-benefit analysis of the subsidy policy indicates that in most scenarios, costs outweigh benefits. However, if carbon emissions from the power sector are zero and the social costs of carbon emissions from internal combustion engine vehicles are high, the benefit-cost ratio (benefit amount ÷ cost amount) increases to 0.97.

Based on the analysis, the main policy implications are as follows. First, as future EV sales must target private use, which is less responsive to price changes, the effectiveness of purchase price support will decrease. Therefore, enhancing charging infrastructure to stimulate demand will become more crucial. From a qualitative standpoint, an effective deployment strategy involves ensuring the proper maintenance, repair, and replacement of previously installed chargers to maintain full functionality and enhance consumer convenience within the charging system. Additionally, enhancing charging infrastructure at mobile hubs such as highway rest stops in line with technological advancements like battery performance improvements would be effective in increasing deployment. For hydrogen cars, the higher price elasticity compared to electric vehicles suggests a greater effect of subsidies on their deployment. However, due to the uncertainty of the eco-friendliness of the hydrogen production process, a promotion strategy considering technological changes is required. Lastly, as the number of clean vehicles continues to grow, reforming the tax system becomes inevitable. This includes an overall reform of the tax structure applied to fossil fuels, alongside comprehensive investigations to secure a competitive advantage for clean vehicles during operation.

Summary

Research Monograph KOR Reforms in Primary and Secondary School Administration and Finance Suitable for a Population-Declining Society

Korea faces inevitable policy shifts due to prolonged demographic declines, affecting not just the primary and secondary school age populations but the overall population as well. This report tackles these shifts by exploring issues to formulate more effective and efficient reform strategies for the administration and finance of education in a shrinking society. It emphasizes the importance of strategically allocating the national budget across various sectors to optimally use limited resources. This requires a national interest perspective, moving beyond sector-specific stakeholders’ gains and losses, and seeking alternatives. The report argues for the necessity of system and policy reform, acknowledging the challenge it poses to entrenched interests but highlighting its importance in addressing our country's challenges through flexible budgeting and efficient execution.

We critique the current method of the total budget calculation for primary and secondary education, which is too rigidly tied to tax revenues, and call for significant reforms in funding allocation to schools. They propose a new method that boosts school autonomy and accountability, allowing educational outcomes to play a role in budget decisions. Moreover, they suggest that operational and project funding managed by provincial education offices should be clearly separated from direct school funding, advocating for rigorous performance evaluations to enhance fiscal efficiency in education. The report offers various recommendations for reforming education finance, aiming to improve both the quality of education and the efficiency of its financing, hoping these policy suggestions will be actively considered.

Chapter 2 evaluates the appropriateness of giving precedence to the primary and secondary education budget over other sectors is evaluated, particularly as public spending on education begins to exceed the OECD average. Through international comparisons and empirical analysis of various factors like the school-age population, GDP per capita, and data from the Programme for International Student Assessment (PISA), it investigates these elements' impact on educational budgeting, priorities, and student outcomes, offering policy recommendations for more effective and efficient resource use.

Chapter 3 consists of three parts. First, we analyze the impacts of changing the method of electing the superintendent of education from election by the school management committee to direct election by residents, focusing on students' educational achievement and health using a difference-in-differences method. Second, we examine the impact of per-pupil public education expenditure on academic achievement in South Korea, employing the method of instrumental variables. Third, we assess the impact of per-pupil public education expenditure on academic achievement in the United States using a state-fixed effects model.

The estimation results indicate that in regions where the direct election of superintendents was first implemented, there was a decrease in the proportion of students scoring in the top tier of the College Scholastic Ability Test, and an increase in the proportion of students in the middle and lower tiers, compared to regions where the direct election had not yet been implemented. No significant changes are observed in students’ health. In South Korea, an increase in per-student expenditure positively affects the academic achievement of elementary school students, although the magnitude of this effect is not substantial. No significant, positive effects are found for middle and high school students. In the United States, there is no significant relationship between per-student educational expenditure by state and the academic achievement of students in 4th, 8th, and 12th grades.

The results suggest a need to strengthen accountability for a range of student outcomes among superintendents of education. They also imply a necessity to adjust how education budgets are allocated in response to the declining school-age population and to enhance the allocative efficiency of these budgets.

In Chapter 4, we study the effect of the current institutional features of the education administration and finance system on the structure of local education finance. Specifically, we focus on changes in school budgets when the overall volume of educational finance increases beyond expectations. For recent years, the local education grant has increased unexpectedly, as the national tax revenue increased and large volumes of supplementary budgets were added due to Covid-19. We analyze how this unexpectedly large surplus of educational funding was distributed and executed. In addition, we investigate how the provincial superintendents, elected at the local election, distributed targeted funding to schools.

Our analysis of the budget and balance data of the school and provincial education offices reveals a behavioral response of the education offices to the current institutional characteristics of educational administration and finance. As the total volume of education funding is uncertain at the beginning of the financial year, they first underestimate the total revenue and expend additional revenue through the supplementary budget. A targeted funding, which the superintendent distributes to the schools autonomously, is a good way to expend such extra revenue. Regression analysis using targeted funding distribution data and local election data shows that superintendents distributed a higher amount of funding per school population to schools in a district where the percentage of votes for the superintendent in the last local election was relatively higher. This implies that the distribution of targeted funding is affected by the political interests faced by the superintendent under the current system of the educational administration and finance system.

Chapter 5 discusses how the main issue with the current funding system for education stems from the provincial education offices' lack of incentive to improve financial efficiency, rooted in a system overly reliant on national and local tax revenues without accountability for fund raising. It suggests the need to revise the budget calculation method due to the projected overabundance of funds, following an analysis that shows maintaining 2022 levels of educational infrastructure could lead to increased expenditure per student but not significantly higher total costs. In addition, it is proposed that a hypothetical criteria for integrating schools to enhance financial efficiency. Lastly, it advocates for abolishing the tax revenue-linked budgeting method and introducing a new support system with ten structural elements aimed at improving educational outcomes and addressing regional decline. The report calls for a unified governance structure for education and further research on the necessity of the elected provincial superintendent system.

Summary

KDI FOCUS Impact of Policy Incentives on Adoption of Electric Vehicles in South Korea

South Korea’s strategies for deploying battery electric vehicles (BEVs) primarily include providing purchase subsidies and expanding charging infrastructure. An empirical analysis of new vehicle registrations from 2019 to 2022 shows that investing in charging facilities is more costeffective than offering purchase incentives for increasing BEV adoption. To achieve a higher share of BEVs, a stronger policy focus on improving the charging network is necessary to stimulate overall demand for BEVs.

- Achieving the target of ‘deploying 4.5 million BEVs and FCEVs by 2030s’ requires a substantial increase in the number of these vehicles, necessitating a comprehensive review of effective policy strategies.

- While Korea has witnessed a consistent increase in the cumulative number of BEVs (and PHEVs), it still lags behind the global average.

- Recent data indicates a deceleration in the growth rate of new BEV registrations.

- Korea’s government policy support to promote the adoption of BEVs and FCEVs primarily comprises purchase subsidies and charging infrastructure installation. Fiscal spending for these measures has increased dramatically, with the related budget accounting for 25.3% of the Ministry of Environment’s total budget in 2023.

- Analysis reveals that a 10% increase in the cumulative number of chargers correlates with a 12.4% rise in new registrations, while a 10% price reduction due to subsidies results in a 15.8% increase in new registrations.

- Also, private vehicles exhibit lower elasticity in response to changes in the number of chargers and in price compared to their government and business counterparts.

- Subsidy-induced adoption accounted for about 27.4% of the 240,000 BEVs eligible for purchase subsidies in 2019~22.

- Analysis suggests that promoting BEV adoption through the expansion of charging infrastructure would be more cost-effective than offering purchase subsidies. Additionally, the direct social benefits derived from BEV subsidies generally fail to outweigh their costs, indicating current subsidy levels may be excessive.

- Future BEV deployment policies should prioritize reinforcing charging infrastructure over providing purchase subsidies. In particular, deploying enough fastchargers at key travel hubs is essential to improve convenience and facilitate long-distance travel.

Summary

KDI FOCUS Korea’s National Pension: Structural Reform Measures

South Korea has been under acute pressure to sustain its National Pension Plan without the risk of fund depletion. Given the looming fiscal threat, this study proposes the introduction of a new pension, a fully-funded system designed to ensure intergenerational equity. This reform aims to guarantee that future generations can receive pension benefits equivalent to the contributions paid and investment returns, without the fear of resource exhaustion. For contributions made prior to the reform, the benefits promised under the existing plan should be honored, while addressing the resultant financial shortfalls of the old pension through separate management and strategic utilization of the general budget to bridge these gaps. This study stresses the urgency of immediate action since the prompt implementation will substantially reduce fiscal stress.

- Under the current scheme, South Korea’s National Pension Fund is projected to be depleted by 2054. As a result, subsequent increases in contribution rates will be prohibitively high for future generations.

- Amid rapid shifts in demographic structure, it is essential to undertake structural reforms and adjust pension parameters to enhance intergenerational equity.

- This study proposes pension reform measures that can keep the expected return rate around one, while approaching this target rate is challenging in Korea, particularly due to the sharp decline in the total fertility rate.

- Provided that the current operation is maintained, increasing the contribution rate from 9% to 18% is likely to result in the reserve fund's complete depletion by around 2080.

- To avoid imposing undue burdens on future generations, adopting a fully-funded “New Pension” system with an expected return rate one is essential.

- With a 15.5% contribution rate, a fully-funded new pension plan will sustain the current average benefit levels for those born in 2006 and later.

- The parallel operation of the old and new pension plans means that the expected return rate gradually declines for each successive birth year, converging to one for those born in 2006 and later.

- To support the adoption of the New Pension, it is necessary to consider measures that ensure the general budget covers the unfunded liabilities of the old pension, estimated at approximately 609 trillion won (26.9% of GDP).

- Since providing general finances early and swiftly minimizes the nominal fiscal burden, it is advisable to initiate fiscal injection before the old pension fund is depleted.

- Delaying the reform of the fully-funded new pension plan by five years is expected to result in an additional 260 trillion won in unfunded liabilities that will need to be covered by the general budget.

- Even though the expected return rate of public pensions is similar to that of private pensions, the necessity of public pensions for social stability is wellrecognized, and worth considering is the fact that Korea’s NPF has recorded somewhat higher returns than private ones.

- With high uncertainties like dramatic demographic changes, bolstering the financial stability of the new pension system requires transitioning from the Defined Benefit (DB) model to the Defined Contribution (DC) model.

- Unlike individual account systems, applying a DCtype pension to age cohorts enables the integration of an income redistribution function.

- In a new DC pension system, it is possible to adjust the income replacement rate through modifications to the contribution rate.

Summary

Policy Study KOR Income Disparities and the Impact of COVID-19

This study analyzes trends in household income distribution in South Korea during the period encompassing the COVID-19 pandemic and the factors influencing the income disparities from two perspectives. First, it examines overall trajectories in household income distributions, focusing on underlying factors with persistent effects, such as population aging, reduction in household sizes, and increase in dual-income households―important household characteristics that influence these trends. Analysis of household income distribution trends through income quintile comparison reveals a widening income gap by market income criteria, notably driven by a decline in market income among lower-income brackets relative to middle and high-income brackets. Particularly, rapid aging and shrinking household size have significantly widened the income gap between the lower-income brackets and the wealthier ones. However, when changes in household characteristics are controlled, the market income gap shows a trend of narrowing. Additionally, the recent increase in the share of dual-income households among those headed by individuals aged 50 and older has markedly narrowed the income disparity based on market income. In contrast, the quintile share ratio based on disposable income has continued to decrease, with much smaller impacts observed from household characteristics, suggesting that income and expenses from public transfers have mitigated the growing income gap caused by changes in household characteristics.

Second, the impact of COVID-19 on income and consumption is investigated by income strata, identifying how the labor income shock during the COVID-19 crisis affected income inequality and the actual household economy. The findings indicate opposing trends in labor income among low-income households: during the crisis in 2020, the growth rate of labor income for low-income households significantly decreased compared to the pre-COVID-19 period, whereas in 2021, it increased substantially, exhibiting a clear recovery trend. The effects of government cash assistance on income, when combined with labor income, varied greatly depending on the nature of the support. Temporary support provided in 2020 in response to COVID-19 significantly compensated for the labor income shock, demonstrating its effectiveness. In contrast, traditional cash support, similarly evaluated in conjunction with labor income, did not significantly alter the outcomes compared to those based solely on labor income, indicating their limited capacity to address the economic difficulties caused by COVID-19. In addition, the analysis of the impact of income shocks on consumption reveals that in 2020, the overall rate of increase in consumer spending decreased significantly for both low and high-income households compared to the period before COVID-19, with different consumption items affected by income strata. The decline in consumption growth rate was particularly noticeable in food, education, and medical expenses for low-income households, and in entertainment, culture, and education expenses for high-income households. Despite the recovery in labor income observed in 2021, the decrease in the growth rates for entertainment, culture, and education expenses continued.

These findings suggest several policy implications. First, as the aging of the population structure intensifies, income disparities based on market income are likely to widen, underscoring the need for future interpretations of income disparity trends to consider these demographic changes. Second, as increasing employment within households represents a crucial pathway to mitigating income disparities, policy support is required to remove barriers to employment, especially in low-income households. Lastly, in response to unforeseen crises like the COVID-19 pandemic, as well as shifts in the labor market landscape, such as pandemic-accelerated technological advancements and climate changes, it is advisable to strengthen the counter-cyclical functions of social safety nets to effectively cope with economic difficulties.

Summary

Policy Study KOR Economic Effects of Sectoral Fiscal Expenditure and Policy Implications

This study presents an agreeable standard among various criteria used for discussions in setting the upper limit on financial resource allocation by sector via economic effect analysis. A dynamic stochastic general equilibrium (DSGE) model estimates fiscal multipliers according to economic character classification. In the DSGE model, economic agents (households, businesses, government, etc.) are equipped with microeconomic foundations for making optimal choices with reasonable future expectations, and macroeconomic variables (consumption, investment, etc.) are linked to fiscal spending. Sectoral fiscal outlays sorted by economic qualities have these multipliers to calculate economic impacts over the past six years, both on average and per input unit.

To summarize the findings of this study, the economic effects range from least to greatest in order of social welfare, national defense, general & local public administration, education, health, environment, and public order & safety. However, the impact on social welfare, general & local public administration, and education is more significant because of the sheer size of the budget increase from the previous year. Accordingly, from most to least, the effect per budget unit can be listed from transportation & logistics, public order & safety, national defense, environment, and agriculture & fisheries to health. In addition, the public order & safety and defense sectors, which have a high proportion of government consumption, show a gradual decrease in economic effects over the medium term. On the other hand, transportation & logistics and environment, with a high proportion of government investment, show an increased impact in the same time frame.

Sorting by economic characteristics per consolidated fiscal balance may lead to heterogeneous economic ripple effects bundled together as one group and making decisions with social and political factors instead of economic ones. Also, even in the presence of limitations in research, like the assumption of a closed economy model, the impact of economic growth estimated in this study can be used as a sensible reference for preparing guidelines for making sectoral priorities for efficient spending or budgeting in line with economic characteristics and deciding fiscal reforms in the order of importance. That is, this study offers key implications for policymaking that, with expenditure ceilings put in force lately, earmarking more funding for budget categories with greater economic knock-on effects and restructuring ineffective budgets can ensure sound fiscal management in response to the expected economic slowdown.

Summary

KDI Policy Forum Can Artificial Intelligence Improve the Effectiveness of Government Support Policies?

■ Despite high hopes for artificial intelligence (AI) to generate powerful innovations across the public sphere backed by its strong prediction skills, Korea has not fully brought the technologies into the public sector in tasks like identifying policy target groups and managing follow-up tasks in line with its policy objectives.

- Recent cases of AI-applied public services in Korea show limited usage, mainly replacing simple repetitive tasks.

- Few leading countries are trying to apply AI-based analysis to select promising policy target groups to effectively achieve policy goals and follow up on the performance of public projects.

- While the existing management system for policy performance is mostly about ex-post assessment of project outcomes, the application of AI technologies signifies a shift to data-driven decision-making that uses ex-ante forecasts of policy effects.

■ An analysis of AI-applied recipient selection of small and medium enterprise (SME) policy support programs demonstrated the efficiency of AI in predicting the performance of beneficiary firms after the program and AI's potential to significantly improve the effectiveness of public support by providing helpful information in screening out unfit SMEs.

- Using firm-level data, this study applies machine learning to various public financing programs (subsidies or loans for SMEs) funded by the Ministry of SMEs and Startups and finds that AI helps predict the growth of recipient firms in the years following policy support.

- The application of AI in identifying fitting recipients likely to achieve intended objectives may increase project effectiveness.

■ In a KDI survey in 2020, respondents pointed out that what hinders transitioning into a system of AI-applied, data-driven policymaking in the public sector are: 1) incomplete standardization and linkage of policy information between governmental ministries and 2) lack of expertise in technology utilization in the public sector.

■ By developing a strategy to propel a transition into data-driven policymaking in the public sector, coordinated national-level efforts must be made to heighten policy effectiveness across different public fields, including education, health care, public safety, national defense, and business support.

- One way to adopt AI technologies in the public sector is by designing a policy to support technology adoption for competent public institutions. Support measures may cover system, data platform, security, organizational consulting, training, etc.

- Detailed strategies are: 1) unifying existing data management systems into one single platform, 2) reorganizing the way government work gets done to enable efficient exchange of policy information, and 3) building a trust-based public-private partnership.

- By examining the policy cycle from planning and implementation to evaluation, it is important to clarify areas for AI to contribute to policy decision-making. Also, the government needs step-by-step strategies toward data-driven policymaking, such as setting clear project objectives, selecting and sharing data, establishing system and security, and promoting operational transparency.

Summary

Research Monograph KOR Reconsideration of Tax and Fiscal Policies after COVID-19

The purpose of the study is to put forth tax and fiscal policies necessary to make worsened fiscal conditions after COVID-19 more constructive and sustainable. We first present the long-term fiscal baseline projections until 2060 and suggest four policy measures that could enhance the future fiscal space of Korea. Then, we analyze the possible positive impact of intangible investment other than R&D on improvements in total factor productivity (TFP), which could result in a natural increase in government revenues through economic growth. Finally, we also empirically evaluate the pros and cons of several types of fiscal rules and suggest rules for spending that could be one plausible alternative considering the current policy environment in Korea. The main findings and policy implications are summarized as follows.

In chapter 2, we present policy measures needed to achieve the long-term fiscal policy goal announced by the Korean government in September 2020, the government debt-to-GDP ratio of 81.1% in 2060. Before delving into specific measures to enhance fiscal space, we look at the baseline debt-to-GDP ratio for 2060, projected at 144.8%. Among three risk factors considered in this study, the failure of discretionary expenditure control was most detrimental to future fiscal conditions. If the discretionary expenditure ratio to GDP is kept at 14.7% until 2060, the debt-to-GDP ratio is expected to add 86.1%p compared to the 2060 baseline.

Even if these risk factors are not realized and remain as the assumption of the baseline outlook, the 2060 debt-to-GDP ratio far exceeds 81.1%, the government's long-term fiscal goal. The analysis finds that the government debt ratio in 2060 could be reduced to 87.6% by reforming local education financial grants, additional control of discretionary expenditures, raising effective tax rates of income and value-added taxes, and reducing tax expenditures.

Over the past two decades, the Korean economy has experienced low economic growth despite the persistent expansion in traditional inputs, capital, and labor. In this circumstance, TFP has come into the spotlight as a new engine to revitalize economic growth, which could enhance government revenues and fiscal sustainability.

In chapter 3, we investigate the determinants of TFP, focusing on the role of intangible assets on firms' productivity. Exploiting firm-level data from Kisvalue, we first estimate the TFP of sample firms by applying Olley-Pakes (1995) method and examine the determinants of TFP. Our findings show that other intangible assets such as patents and copyrights play a more decisive role in improving the productivity of firms rather than R&D investment. This tendency appears to have strengthened after the global financial crisis. Thus, our results indicate that Korean firms have not achieved effective allocation among their investments in intangible assets. In this sense, we suggest the Korean government seriously consider re-designing the institutional system to encourage firms to diversify their investment in intangible assets.

In chapter 4, several empirical analyses were conducted to understand the expected positive and negative effects of the controversial introduction of the fiscal rules to enhance fiscal soundness. An international panel analysis confirmed that introducing such rules could increase fiscal space mainly by reducing the intrinsic interest cost of the existing national debt. On the other hand, it also confirmed concerns that the pro-cyclicality of fiscal spending could increase if fiscal resources were insufficient, especially in developing countries, or if applied excessively multi-layered fiscal discipline. In addition, it was shown that the introduction of the spending rules regulating the total amount of fiscal spending significantly lowered the probability of occurrence of a systematic banking crisis.

In Korea, it is difficult to set realistically achievable national debt and fiscal balance ratios due to rapid changes in demographic and industrial structure. Given this reality, the government needs to prepare reasonable fiscal rules for the growth rate of government spending and the ratio of expenditure to GDP in order to reduce the excessive burden on the national economy due to fiscal uncertainty. Although the current level of the national debt is relatively low, it is desirable to manage its increasing rate by applying reasonable fiscal expenditure rules coupled with the appropriate fiscal balance rules when a rapid increase in national debt raises concern.

Summary

Policy Study KOR Does Fiscal Instability Cause Financial Instability?

This study analyzes the impact of fiscal instability on the soundness of financial institutions. The IMF's long-term fiscal outlook (2021) forecasts Korea's public finances to weaken over the medium to long term. Deteriorating fiscal stability may undermine the soundness of the financial sector by way of the financing channels of government bonds and guarantees. Through an empirical analysis, this study finds that the higher the risk of sovereign default, as measured by credit default swap (CDS) premiums on government bonds, the higher the risk of bank default, as measured by bank bonds CDS premiums. Moreover, this study looks at other countries sharing similar fiscal and financial features as Korea―without reserve currencies, greater banking sector size relative to national revenue, and huge private sector credit that is rapidly expanding― and finds that for such countries, bank default risk is further amplified when sovereign default risk increases.

The analysis results may have two policy implications. Firstly, it is necessary to build up fiscal soundness, and this is an indispensable policy agenda item for the Korean economy to pursue over the longer term. Secondly, the banking sector needs to become less reliant on public finances and more self-sufficient. In case of a bank failure in contingencies, it is desirable to adopt a bail-in system that requires creditors to share the losses to rescue the defaulted financial institutions rather than bail-out, which provides relief at the expense of government revenue.

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