Economic growth and interfactor / interfuel substitution in Korea

Contents

1  Introduction  3

2  The model  8

2.1  The static model  8

2.2  The dynamic model  10

3  Estimation  12

3.1  Data description and estimation procedure  12

3.2  Interfactor model  12

3.3  Interfuel substitution  15

4  Sub-period analysis  18

5  Conclusion  21

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List of Figures

1 Gross Domestic Product . . . . . . . . . . . . . . . . . . . . . . 4 2 World Energy Consumption . . . . . . . . . . . . . . . . . . . . 5 3 Energy Supply and Demand . . . . . . . . . . . . . . . . . . . . 6 4 Primary Energy Consumption . . . . . . . . . . . . . . . . . . . 7 5 Plot of the own-price elasticities of factor demand . . . . . . . . 19 6 Plot of the own-price elasticities of fuel demand . . . . . . . . . 19

List of Tables

1 Implied elasticity of substitution (σ ij ) and price elasticity (η ij ) for the interfactor substitution . . . . . . . . . . . . . . . . . . . 14 2 Implied elasticity of substitution (σ ij ) and price elasticity (η ij ) for the interfuel substitution . . . . . . . . . . . . . . . . . . . . 16 Total implied fuel-price elasticity (η ^∗ 3 ij ) for the interfuel substitution 18

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1 Introduction

South Korea, the Asian peninsula of Manchuria separating the Yellow Sea and the Sea of Japan, once known to be one of the world’s poorest agrarian societies, has undertaken economic development since 1962 what has become known as the “economic miracle on the Hangang River”. Nevertheless, Korea’s remarkable economic achievements were threatened by the Asian crisis beginning in late 1997 when the Asian tiger nations suffered from overvalued currencies and a lack of regulation in the financial system led to business incest, inflated asset values, high foreign debt and many other problems. But thanks to successful foreign debt restructuring with creditor banks, the nation is currently on track to resume economic growth. “Korea’s macroeconomic performance since the crisis has been impressive, with strong real growth, low inflation, and rapidly growing official foreign reserves.” ¹ Furthermore, since the onset of the crisis, Korea has been rapidly integrating itself into the world economy. To visualize this performance Figure 1 ² shows the impressive economic development of Korea since 1980 and displays the differences in growth to Taiwan and Austria. With this history as one of the fastest growing economies in the world, Korea is working to become the focal point of a powerful Asian economic bloc. As a result of this overwhelming development within the last two decades, the Korean economy, as well as many other representative developing countries, has experienced both a dramatic increase in oil consumption and an upward shift in wage rates. From a general scientific point of view the relationship between energy consumption and economic growth has been the subject of intense research over the past three decades. However, the empirical evidence is ambiguous. Although numerous studies including all different parts of the world into their analysis have investigated the causal relationship between economic development and energy consumption, it is still hard to say that find-

¹ TheWorld Bank Group: Financial Sector Assessment Korea; June 2003, p. 2.

² data: Energy Information Administration, International Energy Annual 2002.

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ings from these studies have reached an overall consensus. However, following a recent study from Wankeun Oh from the Department of Economics at the Hankuk University of Foreign Studies in Seoul, “the empirical results for the case of Korea suggest the existence of a long run bidirectional causal relationship between energy and GDP” ³ . Besides, forecasts of the Energy Information Administration (EIA), shown in Figure 2 ⁴ , predict that energy requirements of developing countries will further increase and will reach the demand level of the so-called industrialized world by 2025.

However, since Korea experienced dramatic shifts in its energy usage by substituting oil for coal and because of no domestic oil reserves, the tiger nation is forced to import all of its crude oil, which makes up the largest share

³ Oh, Wankeun and Lee, Kihoon: Causal relationship between energy consumption and GDP revisited: the case of Korea 1970-1999 ; Energy Economics, Vol. 26, 2004, p. 59.

⁴ data: Energy Information Administration, International Energy Annual 2002.

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in the country’s energy consumption. Korea presently is the seventh largest oil consumer and the fifth largest oil importer in the world. The fraction of imports and exports in comparison to Korea’s energy production is visualized in Figure 3 ⁵ .

Another important resource for the country is coal, which, due to indigenous resources of low-quality anthracite has to be imported since it supplies about 21 % of Korea’s total energy requirements. The fraction of consumption of the individual energy sources is displayed in Figure 4 ⁶ showing the primary energy consumption.

To handle dramatic increases in energy consumption, Korea and many other energy importing countries often aim at stabilizing dramatic shifts in en-

⁵ data:Minstry of Commerce, Industry and Energy: Statistical Handbook of Korea 2002 ; Seoul, 2002.

⁶ data: Korea Energy Economics Institute, 2003.

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