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Summary

Research Monograph KOR Research on Structural Reforms to Enhance Sustainability of the Public Pension System

This study aims to explore structural reform measures for South Korea’s national pension scheme that can ensure both fiscal sustainability and intergenerational equity. Additionally, it seeks to redefine the basic pension system to guarantee an adequate level of retirement income. To achieve these objectives, the paper integrates fiscal projections, based on a new fiscal forecasting model, with analysis from an overlapping generations (OLG) model. Furthermore, it addresses legal issues related to pension reform and examines cases from major countries where social consensus was achieved during the reform process. The paper also discusses the introduction of the Guarantee Pension and various issues facing public pension systems in Korea.

Chapter 2. Reform Measures and Projections for the National Pension System

This chapter examines reform measures for the national pension system and analyzes their fiscal implications. Since its introduction in 1988, the national pension has undergone several reforms, adjusting both the contribution rate and the income replacement rate. However, earlier reforms seem inadequate to secure long-term fiscal sustainability. Therefore, this research has developed a projection model based on models from the National Pension Research Institute and the National Assembly Budget Office to estimate the current financial situation.

The fiscal projection model estimates the revenues and expenditures of the national pension using demographic forecasts, macroeconomic outlooks, and policy variables. According to the projections, its surplus, which stood at 72.1 trillion KRW in 2023, is expected to turn into a deficit by 2040 and further expand to a deficit of 1,005.2 trillion KRW by 2100. Consequently, the pension fund, which was 1,015.8 trillion KRW in 2023, is projected to reach a peak of 1,972.0 trillion KRW in 2039, after which it will gradually decrease to depletion by 2054.

To enhance the sustainability of the national pension, a scenario analysis is conducted, which suggest that raising the contribution rate from 9% to 12% would deplete the fund by 2060. An increase to 15% would extend solvency to 2068, while a rate of 18% would last until 2079. These findings indicate that even with a substantial and challenging increase in contribution rates, the current defined benefit (DB) scheme―which guarantees a benefit ratio over 2 regardless of contributions―would makes it difficult to sustain the fund throughout the projection period. This highlights the challenge of securing intergenerational equity and maintaining the pension fund's solvency solely through contribution rate increases under the current pension structure, which may face resistance from younger generations.

In response, this research proposes a structural reform of the national pension scheme by introducing a reformed defined contribution (DC) system called the "New Pension," while referring to the pre-reform DB system as the "Old Pension." The shortfall in benefits under the Old Pension would be covered by the government budget, allowing all generations to receive at least their principal contributions back (expected benefit ratio of 1).

The proposed DC New Pension would operate as a Cohort Collective Defined Contribution pension system, where individuals within their cohort participate in an insurance scheme to receive a pension benefit amount until death. To this end, a model has been developed to project revenues, expenditures, balance, and reserves under this system. The results indicate that under the cohort-based DC scheme, the pension fund would not be depleted, even with declining birth rates or extended projection periods, as benefits are paid only from the accumulated contributions and investment returns.

However, since the Old Pension inevitably leads to a fiscal deficit, the study also calculates the scale of this deficit. While various methods exist to measure the shortfall of public pensions, this study aligns with the logic of the Old Pension by calculating the benefits corresponding only to contributions made by current beneficiaries and active contributors (closed group method without future accruals). The financial deficit for contributions made up to 2023 is estimated at 609 trillion KRW (in 2023 present value), but if contributions continue until 2028, this deficit is projected to rise by an additional 260 trillion KRW, bringing the total shortall to 869 trillion KRW. This emphasizes the need to implement pension reforms as early as possible to mitigate the fiscal burden on the government budget from the shortfall in the Old Pension fund.

Chapter 3. Reform Measures and Projections for the Basic Pension

This section analyzes the proposed reform measures for the basic pension system and their fiscal implications. Given the high rate of elderly poverty and the substantial coverage gaps in the national pension, this study examines long-term fiscal projections for the basic pension to ensure its sustainability and enhance its effectiveness in reducing poverty. Various reform scenarios are assessed in the context of these projections to guide future policy decisions.

South Korea has one of the highest elderly poverty rates among OECD countries, largely due to the relatively recent introduction of the national pension and the fact that many older adults were unable to enroll. To address this issue, the Basic Old-Age Pension was introduced in 2008 and later restructured into the basic pension system in 2014. Currently, the basic pension provides up to approximately 333,000 KRW per month as of 2023, targeting the bottom 70% of the elderly based on their recognized income.

The current basic pension system operates on a goal coverage rate, distributing pensions to 70% of older adults. However, as the population ages and the standard pension amount increases, the fiscal pressure on the system intensifies. At the same time, as the national pension benefits increase for new retirees and economic conditions improve, the income threshold for basic pension eligibility has been rising annually. Recently, this has resulted in individuals with recognized incomes approaching 100% of the median income qualifying for the basic pension benefits. Consequently, policy discussions have emerged around improving the poverty reduction effect of the basic pension by tightening eligibility criteria, reducing the number of beneficiaries, and increasing the standard pension amount.

In this context, the study conducts fiscal projections for various reform scenarios currently under consideration for the basic pension. One scenario, proposed by Yun Seok-Myung (2023), involves fixing the eligibility threshold at its current level and indexing it to inflation. To estimate the impact of this selective reform measure on the number of beneficiaries, the study projects changes in the distribution of recognized income among future elderly populations using data from the 2014-2021 Fiscal Panel. The projections assume that the current trend in recognized income persists through 2070. The estimated distribution changes are then applied to the basic pension fiscal projection model developed by Shin Kyung-Hye and Kim Hyeong-Soo (2021) to perform the fiscal projections.

The fiscal projections reveal that maintaining the current system would result in total cumulative expenditures of approximately 3,143 trillion KRW between 2023 and 2070. In contrast, a universal expansion scenario, which increases coverage from 70% to 100% of the elderly population and raises the standard pension amount from the inflation-adjusted 333,000 KRW to 400,000 KRW from 2024 onward, would result in total cumulative expenditures of approximately 5,510 trillion KRW over the same period, which is about 75% higher than maintaining the current system. However, under the targeted improvement scenario, where the eligibility threshold is fixed at the 2023 level and indexed to inflation, the proportion of beneficiaries would gradually decrease from 70% to 23% of the elderly population each year. Even with an increase in the standard pension amount to 400,000 KRW from 2024, total expenditure would amount to 2,012 trillion KRW, a reduction of approximately 36% compared to the current system. Notably, the savings generated from reduced expenditures could increase the standard pension amount to 570,000 KRW by 2070.

It is crucial to consider the basic pension reform in conjunction with the national pension system. As the population ages and the national pension system matures, the basic pension should aim to enhance fiscal sustainability and effectiveness in poverty reduction by making eligibility criteria more targeted and increasing the standard pension amount. To achieve these objectives, the national pension must continue to fulfill its role as a public retirement income security system, while further development of the private pension system is necessary to strengthen income security provided by a multi-pillar approach. Ultimately, the basic pension could prioritize supporting the income of relatively economically disadvantaged elderly individuals, while the national pension and private pensions provide income security for those in relatively better economic conditions.

Chapter 4. Analysis of a DC-Type National Pension System Using an Overlapping Generations Model

This chapter analyzes how different age groups and income classes respond to various pension systems and economic environments by employing a heterogeneous agent overlapping generations (OLG) model within a general equilibrium framework. Unlike the financial projection model discussed in the previous chapter―which treats each gender×age×subscription period group as a homogeneous entity and does not account for endogenous changes in macroeconomic variables such as interest rates and wages―this model allows for a deeper and more nuanced analysis.

This study assumes the population structure of 2070 to examine the potential issues that may arise if the defined benefit (DB) pension system is maintained and to compare it with the responses of various age and income groups under a reformed defined contribution (DC) pension system.

In a population structure characterized by advanced aging like that of 2070, the DB pension system would require an increase in the contribution rate from 9% to 18%, yet still necessitate government support, estimated to be as high as 8.8% of GDP. In contrast, transitioning to a DC pension system would significantly reduce the government's fiscal burden and enhance the sustainability of the national pension fund. While overall production and the average living standards of the working-age population would improve under the DC system, the lower income replacement rate might exacerbate disparities. The DC system makes it more challenging to secure adequate retirement income, which could potentially widen the gap in income security between age groups compared to the DB system.

Specifically, in a DC pension system, households are likely to increase savings in preparation for retirement, leading to lower interest rates and higher wage rates, potentially worsening inequality between retirees and the working-age population. To address this, a mixed approach that uses part of the government financial support for the DB system as a supplementary support for the DC framework could be considered, providing economic benefits to both working and retired age groups. When considering a mixed approach, the DC system generally results in higher total production and post-tax income. Additionally, if the fund's rate of return exceeds the nominal growth rate, the pay-as-you-go (PAYG) pension system may become inefficient in the long term, making a DC system with government support potentially more efficient than a DB system.

Chapter 5. Directions for Public Pension System Reform

This chapter examines the legal issues surrounding national pension reforms and analyzes international cases of social consensus achieved during pension reforms in major countries. It also assesses the validity of structural reform measures for public pensions and explores the potential for restructuring the basic pension and introducing supplementary pensions to address the shortcomings of the current system. Finally, the chapter discusses issues related to South Korea’s public pension systems.

Reforming the national pension inevitably requires legislative amendments in line with constitutional principles, such as property rights, the principle of legitimate expectation, and the principle of proportionality. Legal reviews serve as an important reference, particularly Constitutional Court rulings on mandatory pension enrollment and the legality of premium collection. Adjustments to the contribution rate and income replacement rate are key measures for ensuring the financial sustainability of the national pension. While these adjustments may infringe on property rights, legislative actions that minimize the breach of trust and adhere to the principle of proportionality could be permissible within the constitutional framework.

Ideally, pension reform is achieved through broad social consensus, with active involvement from stakeholders to adjust and align various interests toward a collective agreement. However, South Korea may be ill-suited for a social dialogue-based model like Finland’s or a political consensus model like Sweden’s. The country’s low unionization rate, the absence of representative organizations for self-employed and vulnerable workers, the weak tradition of social dialogue in institutions like the Economic and Social Development Commission, and the adversarial nature of the country's two-party political system all pose challenges.

Given these challenges, the government-led consultative approach, as observed in countries like Germany, the UK, and Japan, may offer a more effective pathway for pension reform in South Korea. What is recommended in this paper is the establishment of a Pension Reform Committee composed of a small number of experts, which would be instrumental in objectively analyzing the situation and proposing directions and principles for reform, for the government to consider adopting.

The current DB pension system faces challenges in improving its fiscal sustainability solely through parametric adjustments, such as increasing contribution rates, lowering income replacement rates, or adjusting the pensionable age. These efforts are constrained by optimistic demographic assumptions underpinning policy decisions. Therefore, it is necessary to explore strategies to address potential issues from introducing a funded DC system, including investment return risks, mortality and wage growth projection errors, and income redistribution concerns. Additionally, reforms should prioritize securing retirement income adequacy.

Furthermore, the chapter discusses restructuring the basic pension and introducing the Guarantee Pension. The restructuring of the basic pension aims to protect individuals who fall outside the coverage of the national pension system, with a focus on strengthening retirement security for low-income groups. Drawing lessons from Finland and Sweden, which operate selective basic pension systems, and Canada, which has a universal system, the chapter explores the future direction of South Korea’s basic pension. South Korea should design a system that, like Finland and Sweden, targets a more limited group of beneficiaries for basic and supplementary pensions to ensure minimum retirement income for low-income seniors.

Lastly, the chapter briefly discusses proposals to enhance the national pension system, including increasing National Pension contribution rates, extending the mandatory enrollment period, raising the ceiling on standard monthly income, addressing the issue of income gaps caused by extending the pensionable age, and exploring integration options to improve equity between the national pension and occupational pensions, such as the Government Employees Pension.

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.

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