External debt and the growth of the Korean economy

Abstract

The objective of this study is to analyze the growth effects of Korea's external borrowing with emphasis on the demand side and the heterogeneous nature of long-term and short-term borrowing. This study put forth the following research hypotheses; 1) Korea's external borrowing, considered in the disaggregated term, has had positive growth effects on real GNP, and 2) those positive effects have been large enough to compensate for the cost of external borrowing. In order test the hypotheses, an econometric model was set up consisting of 16 s1lllultaneoulS equations (8 behavioral equations and 8 identities). The model was fitted to annual time-series data for the Korean economy from 1961 to 1931. The main empirical findings obtained through several historical policy simulations are summarized as follows: 1) Long-term debt has the largest income growth effect during the first seven simulation years and short-term debt has nearly as great income-augmenting effect as long-term debt. 2) However, more than 60 percent of the net increase in income with an increase in long-term or short-term borrowing is accounted for by a net increase in private consumption. In addition, the next largest income-augmenting source is a net increase in trade balance, and, in contrast, a net increase in investment turns out to be the least important source of income growth. trade balance, it is found that the impact is imparted mainly through export expansion in the case of long-term borrowing but through import substitution in the case of short-term borrowing. 4) Being fueled by their effect on trade balance, both long-term and short-term debt are found to have a strong positive monetary expansion effect. 5) through a comparative analysis of the results of policy simulations starting in 1965 and those in 1975, it is found that the income-augmenting effect of long-term and short-term debt has been nearly halved since the middle of the 1970s with a drastic decrease in their positive impact on private consumption and the trade balance. 6) The empir1.oal ev1.dence on the benefits and cost analysis of external debt, based on the s1.mulat1.on results, indicates that an increase in long-term or short-term borrowing creates far greater income benefits than the cost of borrowing and, however, t'a1.ls to generate enough foreign exchange to pay interest and repay the principal on the old debt. These findings supports that the major concern with respect to Korea's external debt is not the solvency problem but the liquidity problem.