Homework 25 marker

To increase South Korea’s trade surplus the country needs to be exporting more. One way of doing this is through monetary policy creating greater incentives for domestic businesses to invest. However, further cuts in interest rates could cause slowdowns in the economy through increased incentives to save reducing consumer spending. Another way of increasing exports is through supply side policies - supporting the creation new businesses aiming to reduce South Korea’s dependence on computer chips exportation.

By decreasing interest rates borrowing becomes cheaper. This increases incentives for businesses to invest as they can take out loans with cheaper repayments. These investments can be spent on new machinery, greater wages, more employees which can boost productivity and reduce cost of production per item produced. By reducing production costs and productive efficiency the business may be able to produce more goods for exportation increasing the trade surplus in South Korea. The bank of Korea had already cut interest rates in 2019 (from 1.75% to 1.5%) due to falling exports. Continuing with monetary policy could further support growth of exportation. Furthermore, decreasing the interest rate would lead to a depreciation in the Korean won leading to further increases in exportation as Korean goods would become cheaper. This is because lowering interest rates reduces return on investment for investments held in that currency. This leads to investors taking their capital out of the Korean won depreciating the currency.

Lowering interest rates which shift aggregate demand from AD1 to AD2. This shift represents higher demand for South Korean goods, both domestically and internationally. The rise in real GDP from Y1 to Y2 reflects the increased production towards exportation. The higher demand means increased pressure on firms which could lead to them increasing their prices represented by the price increase (Demand pull inflation) from p1 to p2.

However, while lowering interest rates may boost the economy in terms of exportation it may lead to slowdowns in the economy as a whole. This is because decreasing interest rates further from its already reduced point could further increase incentives for domestic consumers to save leading to less consumers spending. This lower spending reduces aggregate demand as AD = C+I+G+(X-M) where C = consumer spending. So, while reducing interest rates can make Korean goods cheaper and increase exportation investment its it risks being pointless due to a fall in economic growth from incentives to save. So, the effectiveness depends on the knock on effects on consumption.

A second way of increasing exports is through supply side policies aiming to diversify the Korean export economy and create new export industries. This can be done through research and development grants and also subsidisation. Government funding on research and development innovations could lead to new flourishing industries within Korea such as biotechnology or AI. This would reduce Korea’s dependence on computer chip exports, as mentioned in Extract F, which suffered from the fall in chip prices. Furthermore, by diversifying the Korean export economy Korea would protect itself from future economic shocks as they would have other industries to fall back on if their primary industry becomes less profitable. Subsidisation could also be used to increase exportation. Subsidising major Korean export businesses would allow them to lower their costs increasing profit despite the reductions in computer chip prices.

Research and development increases supply of new goods from new industries. Subsidisation allows current domestic businesses to increase their supply as the cost of production is cheaper. This is seen by the shift in LRAS from LRAS1 - LRAS2. The increase in supply leads to an increase in AD as more domestic and international consumers buy these goods. This leads to economic growth increasing closer to the previous average rate of 7.3% (real GDP increasing from y1 to y2). Increased supply allows for greater exportation increasing the trade surplus.

However, the problem with research and development grants is they have a big time lag. It can take years of expensive investment to see improvements in exports and new industries emerge. This is because research takes time, and businesses take time to get off the ground. Also, It is difficult to implement subsidization and research grants as these policies require increased government spending which would require increases in tax for funding which may be unpopular domestically. This unpopularity could cause further economic problems as reduced disposable income leads to reduced consumer spending reducing business revenue reducing business output reducing Korea’s output as a whole.

In conclusion, both monetary and supply side policies can be used to increase the trade surplus in Korea. Monetary policy aims to increase business investment leading to increased capacity and thus greater exportation of goods. Whereas, supply side policies aim to increase incentives/ diversify the Korean economy preventing future shocks and increasing exportation domestically. However, they both have downsides. Monetary policy could lead to reduced growth and supply side policies can take a long time to take effect and require funding via taxation which also causes issues. So, while these are two ways of increasing the trade surplus in theory with ceteris paribus, in the real world they could cause issues.