The Korea Herald


[EDITORIAL] Fiscal discipline

By 류근하

Published : Aug. 13, 2016 - 01:00

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[THE INVESTOR] The government is pushing to enact a law aimed at preventing the national debt from rising too rapidly. The move is well advised, as fiscal principles need to be set in stone if they are to be strictly followed.

A draft bill disclosed by the Finance Ministry proposes to make it a rule for the central government to keep its debt below 45 percent of gross domestic product.

It also proposes to set the ceiling for annual budget deficit at 3 percent of GDP.

The ministry’s proposal also includes the pay-as-you-go rule, also known as PAYGO, which obliges the government or lawmakers to submit funding plans when they introduce bills that require fiscal spending for implementation.

Korea’s national debt as a percentage of GDP cannot be seen as high compared with other countries of the Organization for Economic Cooperation and Development.

Yet it has been rising rapidly in recent years. It stood at 28 percent of GDP in 2008 but jumped to 35.9 percent by 2014 and is expected to reach 40.1 percent this year.

In an assessment of the long-term fiscal outlook, the ministry forecasts central government debt would rise to 62.4 percent of GDP in 2060 even when the structure of government spending is consistently reformed.

The ministry warns the debt ratio could surge to above 90 percent if new mandatory spending programs are created amid a slowdown in economic growth.

This possibility cannot be ruled out in light of the nation’s rapid population aging and a low birthrate. The number of economically active people is set to decrease from next year after peaking at 36 million this year.

Furthermore, the Korean economy has already entered a low-growth phase, with its potential growth rate having dropped to the lower part of the 3 percent range.

Despite the slowing growth of the economy, welfare spending has been increasing at an alarmingly fast pace. Political parties have provided fuel to the rapid welfare expansion by coming up with populist programs aimed at buying off voters with taxpayers’ money.

Under these circumstances, it is necessary to put in place legally binding arrangements that could put the brakes on an excessively rapid expansion in government spending.

A couple of years ago, the Finance Ministry announced a set of fiscal rules as concerns were raised over Korea’s fiscal conditions. Yet the rules have not been strictly followed as they were not compulsory. In this regard, the proposed legislation is a step in the right direction.

Yet while strict fiscal rules are needed to keep public finances in good shape, overly strict ones could have negative effects on the economy. For instance, the 3 percent deficit rule, if it should be followed under any circumstances, could prevent the government from increasing fiscal spending sufficiently when the economic situation gets worse.

To avoid such a possibility, the draft bill allows the government to take expansionary measures above the limit in extraordinary cases such as a sudden economic slump or natural disasters.

The proposed legislation needs to be enacted promptly to establish fiscal discipline. Yet some legislators may not welcome it as it will introduce the PAYGO rule.

Currently, lawmakers need not submit financing plans even when they introduce costly bills. This tends to encourage lawmakers to propose bills without any regard to their effect on public finances. But this practice needs to be changed and lawmakers should also act in a fiscally responsible way.