## 2. Social Spending Gap ## Source details **Canonical URL:** [2. Social Spending Gap](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp12250.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp12250.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp12250.pdf.json) --- ### Introduction - Korea faces two intertwined challenges: sustaining economic growth amid rapid population aging and ameliorating income inequality. - Social spending encompasses programs in healthcare, education, and social safety nets (pensions and income support for working-age and elderly populations). - Well-designed social spending policies can catalyze virtuous cycles: improved income equality can boost growth, and stronger growth can reduce inequality. ### Social Spending and Economic Growth - Historical growth slowdown: - Korea converged toward advanced-economy income levels but potential growth slowed from 7 percent in 1995 to around 4 percent by 2010 (OECD, 2012). - Three channels through which social spending can promote longer-term growth: - Challenge 1 — Increasing labor market participation: - Female labor force participation for ages 25–54 was 62 percent in 2010 (third lowest in the OECD). - Increasing female participation mitigates demographic decline in the labor force. - Challenge 2 — Reducing labor market dualism: - Elevated and rising share of non-regular workers (temporary workers a major source of income inequality). - Women are over-represented: 42 percent of female employees are in non-regular employment versus 28 percent of males. - Non-regular workers face low wages, unstable employment, low employment protection, and weak social safety net coverage. - Low firm-based and low public spending on training (one of the lowest in the OECD) reduces productivity and wages in services. - Challenge 3 — Boosting productivity in the services sector: - Services are much smaller and markedly less productive than manufacturing (Figure 5). - Nearly 85 percent of GDP growth in high-income countries over the past 25 years came from services (McKinsey, 2010). - Making services a second engine of growth is required for further convergence. ### How Social Spending Can Promote Sustainable Growth - Education: - Universal primary and secondary access historically contributed to growth and social mobility. - Equity issues remain: low investment in pre-primary education and heavy reliance on private tutoring. - Pre-primary education spending was 0.2 percent of GDP in 2008 (second lowest in the OECD). - Vocational training and career consultation outside firms: - Could enhance employment prospects of non-regular workers and facilitate transition to regular status. - Could allow reduction in employment protection for regular workers while supporting training and mobility to improve resilience. - Early childhood education and care (ECEC): - High returns by boosting later achievement and supporting female labor market participation after childbirth. - Greater ECEC investment would underpin future productivity gains and increase labor supply. - Model-based simulations (general equilibrium model): - Social spending encouraging labor market reforms reduces duality, increases labor supply (especially female participation), and raises potential output. - Table 1 (row F, bottom panel): a less rigid and more competitive labor market could boost potential output by around 1 percent every year over the next decade. - Specific illustration: a decrease in the wage markup from 25 percent to 2 percent could boost potential output by 1.1 percent per year over the next decade (Table 1, row F, η=1). ### Social Spending and Inclusive Growth - Trends in inequality and poverty: - After the late-1990s recession, income inequality rose; relative poverty rate was 15 percent in 2008 (seventh highest in the OECD). - More recently, Gini coefficient, relative poverty ratio, and LH ratio trends have stabilized or reversed; unemployment returned to low levels compared with OECD average. - Recent expansion in social spending: - Public social spending tripled its share of GDP to 7.6 percent in 2007 from 2.8 percent in 1990. - Despite the increase, deterioration in income distribution persisted for much of the last decade. - Cross-country comparison: - In 2007 Korea had the second lowest level of public social spending in the OECD (Figure 10). - Korea was below OECD average in health care, pensions, and income support to the working-age population. - Adjusted social spending gap: - Simple comparison: social spending gap of about 11.7 percentage points of GDP between Korea and the OECD average in 2007. - When controlling for unemployment rate, per capita income, and dependency ratio, regression analysis suggests the gap narrows to about 3.4 percentage points (Table 2). - Quantile regressions controlling for outliers suggest an even smaller gap (Table 2). - Targeting and program-specific findings: - Government cash benefits are poorly targeted: only a quarter of cash benefits go to the poorest quintile (OECD, 2012). - Projected aging costs: population ageing alone is projected to increase expenditures in the form of pensions, health care, and long-term care by almost 11 percent of GDP over the next 50 years (Feyzioglu, Skaarup, and Syed, 2008). - Basic Livelihood Security System (BLSP): - Provides cash and in-kind benefits but covers only 3 percent of the population — scope for better targeting and relaxed eligibility to cover more in need. - Basic Old-Age Pension System: - Introduced in 2008; around 70 percent of the elderly receive the benefit, which is set at only 5 percent of the average wage. - About 40 percent of the elderly have income below the minimum cost of living (Bae, 2011); a larger and more targeted benefit is recommended. - Earned Income Tax Credit (EITC): - Reduces taxes or provides a refund and raises take-home pay at the low end. - Expanding the number of recipients and benefit amounts would improve income distribution and make VAT increases more equitable. ### Policy Implications - Pace and sequencing: - Social spending increases should be incremental because: - Near-term fiscal consolidation limits resources for major expansions. - Long-term population aging will strain the budget. - There are limits to reallocating non-age-related outlays; scaling back social spending later is difficult. - Revenue and tax policy considerations: - Some revenue measures to offset aging costs may negatively affect growth potential. - Pro-growth tax policy to finance expanded social programs should limit increases in the tax wedge on labor income and keep low corporate tax rates. - Given Korea’s relatively low VAT rate, VAT increases could be combined with an expanded EITC to preserve equity and support growth. ### Conclusion - There is an opportunity to gradually enhance social spending to promote more inclusive and sustainable growth. - Any increases should be incremental and accompanied by strengthened revenue performance over the medium term (including base broadening). - Prioritize spending that increases labor market participation, reduces labor market duality, and boosts productivity (especially in services). - A combination of targeted social spending policies can reduce income inequality and boost potential growth over the longer term. ### Appendix: Model Overview (summary) - The general equilibrium model captures labor market duality via a CES aggregation of differentiated labor inputs and a markup determined by the elasticity of substitution among labor inputs. - Firms: - Linear production with labor inputs augmented by total factor productivity, and monopolistic competition in labor markets leads to wage markups. - Households: - Maximize lifetime utility over consumption and labor effort; each household sets a nominal wage for its differentiated labor input. - Key steady-state relationships: - Production function, household budget constraint, real wage link to total factor productivity, and real wage equaling marginal rate of substitution augmented by a markup. - Calibration and simulation findings: - Elasticity of substitution parameter (ߣ) typically in the 7 to 9 range in related studies, implying a wage markup of around 15 percent. - Reducing labor market rigidity (increasing ߣ and thereby reducing markups) yields efficiency gains, higher labor supply (notably female participation), and higher potential output. - Example simulation: decreasing wage markups from 25 percent to 2 percent could increase potential output by 10.7 percent in the long run (row [B]), which could imply about a 1.1 percent per year increase over a decade if realized over that period (row [F], η=1). *Source: _wp12250 - 2. Social Spending Gap (IMF PDF).* ### References ............................................................................................................. ### _wp12250 - References ### Figures - 1. Real GDP Growth .............................................................................................................3 - 2. Population Projections ......................................................................................................4 - 3 Female Labor Force Participation Rates ...........................................................................4 - 4. OECD: Temporary Employment ......................................................................................4 - 5. Service Sector Productivity Relative to Manufacturing in 2007 ......................................5 - 6. OECD: Gini Coefficients and Relative Poverty Rates .....................................................8 - 7. Income Inequality Indicators ............................................................................................9 - 8. Unemployment Rates ........................................................................................................9 - 9 Social Spending Trends ....................................................................................................9 - 10. OECD: Social Spending in 2007 ....................................................................................10 - 11. OECD: Social Spending Categories in 2007 ..................................................................11 - 12. Selected Indicators Influencing the Social Spending Gap ..............................................13 ### Tables - 1. Output Gains From Social Spending-Induced Labor Market Reforms ............................7 *Source: _wp12250 - References (page listing of figures and tables).* ### 2. Social Spending Gap ................................................................................................. ### 2. Social Spending Gap ### Introduction - Korea faces two intertwined challenges: sustaining economic growth amid rapid population aging and ameliorating income inequality. - Social spending encompasses programs in healthcare, education, and social safety nets (pensions and income support for working-age and elderly populations). - Well-designed social spending policies can catalyze virtuous cycles: improved income equality can boost growth, and stronger growth can reduce inequality. ### Social Spending and Economic Growth - Korea converged toward advanced-economy income levels but potential growth slowed from 7 percent in 1995 to around 4 percent by 2010 (OECD, 2012). - Social spending can promote longer-term growth by addressing three challenges: - Challenge 1 — Increasing labor market participation: - Female labor force participation for ages 25–54 was 62 percent in 2010 (third lowest in the OECD). - Increasing female participation mitigates demographic decline in the labor force. - Challenge 2 — Reducing labor market dualism: - Elevated and rising share of non-regular workers (temporary workers a major source of income inequality). - Women are over-represented: 42 percent of female employees are in non-regular employment versus 28 percent of males. - Non-regular workers face low wages, unstable employment, low employment protection, and weak social safety net coverage. - Low firm-based and low public spending on training (one of the lowest in the OECD) reduces productivity and wages in services. - Challenge 3 — Boosting productivity in the services sector: - Services are much smaller and markedly less productive than manufacturing (Figure 5). - Nearly 85 percent of GDP growth in high-income countries over the past 25 years came from services (McKinsey, 2010). - Making services a second engine of growth is required for further convergence. ### How Social Spending Can Promote Sustainable Growth - Education: - Universal primary and secondary access historically contributed to growth and social mobility. - Equity issues remain: low investment in pre-primary education and heavy reliance on private tutoring. - Pre-primary education spending was 0.2 percent of GDP in 2008 (second lowest in the OECD). - Vocational training and career consultation outside firms could: - Enhance employment prospects of non-regular workers and facilitate transition to regular status. - Reduce employment protection for regular workers while supporting training and mobility to improve resilience. - Early childhood education and care (ECEC): - High returns by boosting later achievement and supporting female labor market participation after childbirth. - Greater ECEC investment would underpin future productivity gains and increase labor supply. - Model-based simulations (general equilibrium model): - Social spending encouraging labor market reforms reduces duality, increases labor supply (especially female participation), and raises potential output. - Table 1 (row F, bottom panel): a less rigid and more competitive labor market could boost potential output by around 1 percent every year over the next decade. - Specific illustration: a decrease in the wage markup from 25 percent to 2 percent could boost potential output by 1.1 percent per year over the next decade (Table 1, row F, η=1). ### Social Spending and Inclusive Growth - Historical and recent inequality indicators: - After the late-1990s recession, income inequality rose; relative poverty rate was 15 percent in 2008 (seventh highest in the OECD). - More recently, Gini coefficient, relative poverty ratio, and LH ratio trends have stabilized or reversed; unemployment returned to low levels compared with OECD average. - Recent expansion in social spending: - Public social spending tripled its share of GDP to 7.6 percent in 2007 from 2.8 percent in 1990. - Despite the increase, deterioration in income distribution persisted for much of the last decade. - Cross-country comparison: - In 2007 Korea had the second lowest level of public social spending in the OECD (Figure 10). - Korea was below OECD average in health care, pensions, and income support to the working-age population. - Adjusted social spending gap: - Simple comparison: social spending gap of about 11.7 percentage points of GDP between Korea and the OECD average in 2007. - When controlling for unemployment rate, per capita income, and dependency ratio, regression analysis suggests the gap narrows to about 3.4 percentage points (Table 2). - Quantile regressions controlling for outliers suggest an even smaller gap (Table 2). - Targeting and program-specific findings: - Government cash benefits are poorly targeted: only a quarter of cash benefits go to the poorest quintile (OECD, 2012). - Projected aging costs: population ageing alone is projected to increase expenditures in the form of pensions, health care, and long-term care by almost 11 percent of GDP over the next 50 years (Feyzioglu, Skaarup, and Syed, 2008). - Basic Livelihood Security System (BLSP): - Provides cash and in-kind benefits but covers only 3 percent of the population — scope for better targeting and relaxed eligibility to cover more in need. - Basic Old-Age Pension System: - Introduced in 2008; around 70 percent of the elderly receive the benefit, which is set at only 5 percent of the average wage. - About 40 percent of the elderly have income below the minimum cost of living (Bae, 2011); a larger and more targeted benefit is recommended. - Earned Income Tax Credit (EITC): - Reduces taxes or provides a refund and raises take-home pay at the low end. - Expanding the number of recipients and benefit amounts would improve income distribution and make VAT increases more equitable. ### Policy Implications - Pace and sequencing: - Social spending increases should be incremental because: - Near-term fiscal consolidation limits resources for major expansions. - Long-term population aging will strain the budget. - There are limits to reallocating non-age-related outlays; scaling back social spending later is difficult. - Revenue and tax policy considerations: - Some revenue measures to offset aging costs may negatively affect growth potential. - Pro-growth tax policy to finance expanded social programs should limit increases in the tax wedge on labor income and keep low corporate tax rates. - Given Korea’s relatively low VAT rate, VAT increases could be combined with an expanded EITC to preserve equity and support growth. ### Conclusion - There is an opportunity to gradually enhance social spending to promote more inclusive and sustainable growth. - Any increases should be incremental and accompanied by strengthened revenue performance over the medium term (including base broadening). - Prioritize spending that increases labor market participation, reduces labor market duality, and boosts productivity (especially in services). - A combination of targeted social spending policies can reduce income inequality and boost potential growth over the longer term. ### Appendix: Model Overview (summary) - The general equilibrium model captures labor market duality via a CES aggregation of differentiated labor inputs and a markup determined by the elasticity of substitution among labor inputs. - Firms: linear production with labor inputs augmented by total factor productivity, and monopolistic competition in labor markets leads to wage markups. - Households: maximize lifetime utility over consumption and labor effort; each household sets a nominal wage for its differentiated labor input. - Key steady-state relationships: production function, household budget constraint, real wage link to total factor productivity, and real wage equaling marginal rate of substitution augmented by a markup. - Calibration and simulation findings: - Elasticity of substitution parameter (ߣ) typically in the 7 to 9 range in related studies, implying a wage markup of around 15 percent. - Reducing labor market rigidity (increasing ߣ and thereby reducing markups) yields efficiency gains, higher labor supply (notably female participation), and higher potential output. - Example simulation: decreasing wage markups from 25 percent to 2 percent could increase potential output by 10.7 percent in the long run (row [B]), which could imply about a 1.1 percent per year increase over a decade if realized over that period (row [F], η=1). *Source: _wp12250 - 2. Social Spending Gap (IMF PDF).* ### References ### References ### Cited works - Alesina, A. and D. Rodrik, 1994, “Distributive Politics and Economic Growth,” The Quarterly Journal of Economics, Vol. 109. - Alp, Harun, Selim Elekdag, and Subir Lall, 2011, “Did Korean Monetary Policy Help Soften the Impact of the Global Financial Crisis of 2008–09?” IMF Working Paper, 12/5 (Washington: International Monetary Fund). - Bae, J. ,2011, “Korean National Pensions: Facts and Functions in 2009,” in Economic Crisis and Social Integration, Vol. 1. - Balakrishnan, R., C. Steinberg, and M. Syed, 2011, “Asia’s Quest for Inclusive Growth,” Asia and Pacific Regional Economic Outlook, October, (Washington: International Monetary Fund. - Chami, Saade, Selim Elekdag, and Ivan Tchakarov, 2004, “What are the Potential Economic Benefits of Enlarging the Gulf Cooperation Council?” IMF Working Paper, 04/152 (Washington: International Monetary Fund). - Elekdag, Selim, Alejandro Justiniano, and Ivan Tchakarov, 2006, “An Estimated Small Open Economy Model of the Financial Accelerator,” IMF Staff Papers, International Monetary Fund, Vol. 53, pp. 219–41. - Feyzioglu, T., M. Skaarup, and M. Syed, 2008, “Addressing Korea’s Long-Term Fiscal Challenges,” IMF Working Paper 08/27 (Washington: International Monetary Fund). - Koh, Y., (2011), “Social Safety Net in Korea: From Welfare to Workfare,” Korea Development Institute, mimeo. - Koske, I. J. Fournier, and I. Wanner (2011), “Less Income Inequality and More Growth–Are They Compatible?: Part 2, The Distribution of Labour Incomes,” The Organisation for Economic Co-operation and Development (OECD), Economics Department Working Papers, No. 925, OECD, Paris. - McKinsey & Company (2010), “South Korea: Finding Its Place on the World Stage,” McKinsey Quarterly, April. - The Organisation for Economic Co-operation and Development (OECD), 2012, OECD Economic Survey of Korea, OECD, Paris. - Sakong, Il (1993), Korea in the World Economy, Institute for International Economics, Washington, DC. *Source: _wp12250 - References* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2012/_wp12250.pdf_