Blog Post

Weathering the storm: differences in crisis response in the EU and Korea

There is a striking difference between the ways in which the EU and Korea responded to the crisis. While the initial shock was broadly similar after the collapse of Lehman Brothers in September 2008, Korea has recovered very quickly and output in 2011Q3 exceeded by almost 10 percent the pre-crisis level, but the EU’s output […]

By: Date: January 27, 2012 Topic: Global economy and trade

There is a striking difference between the ways in which the EU and Korea responded to the crisis. While the initial shock was broadly similar after the collapse of Lehman Brothers in September 2008, Korea has recovered very quickly and output in 2011Q3 exceeded by almost 10 percent the pre-crisis level, but the EU’s output has not yet returned to pre-crisis values. What could explain this difference?

Figure 1 shows quarterly developments in GDP and its main components in the EU27 and Korea. There are indeed striking differences. In the EU, the decline in GDP started a few quarters before the collapse of Lehman Brother and the fall accelerated up to 2009Q1, while in Korea there was a sudden drop in a single quarter, in 2008Q4. But the major difference is the aftermath: in Korea growth picked up instantly when global trade started to recover, while the EU recovery was gradual and modest, even if there are differences between EU countries. Certainly Korea, a country that has a lower GDP per capita than the EU27 average, should grow faster because of convergence, but the differences are unlikely to be related to this convergence factor.

Major differences can also be observed in domestic demand developments. The reaction of investors was almost identical up to 2009Q1, but investment fell further in the EU and has hardly recovered, in contrast to Korea where it has recovered quickly. Initially, private consumption fell much more in Korea than in the EU, but while it has also recovered quickly in Korea, it remained sluggish in the EU. Public consumption grew much faster in Korea. The external trade dynamics were not that different, though growth, especially of exports, was much faster in Korea.

One factor that could explain these differences is policy response. Korea has implemented a very significant fiscal stimulus: the fourth largest among G20 countries, well above the stimulus provided by any EU countries. While most EU countries also embarked on fiscal stimulus in the early phase of the crisis, their stimulus packages were much smaller due to much more binding fiscal constraints, which is the consequence of the generally higher debt levels and contingent liabilities. Also, several EU countries had to consolidate later. The Korean case therefore exemplifies the benefits of low public debt and the consequent fiscal space.

The differences in monetary policy response were not significant. Both the European Central Bank and the Bank of Korea lowered interest rates considerably and implemented decisive measures to support the banking sector.  Both central banks cooperated with the Federal Reserve in terms of swap agreements to alleviate the US dollar liquidity problems of their respective financial systems.

However, there was a major difference in the reaction of the exchange rate: the real effective exchange rate of the Korean won depreciated by more than 30 percent and is still about 20 percent below its pre-crisis value. A recent International Monetary Fund research study concluded that without this significant depreciation, the output contraction would have been about five percent greater. In contrast the euro, the currency of 17 EU countries to which three others maintain a fixed exchange rate, after a sharp but short-lived impact, hardly depreciated during 2008-09. There was depreciation in 2010 but to limited extent, only about 10 percent, and, according to measures of the equilibrium exchange rate, the euro continues to be overvalued. This is certainly not helpful for economic recovery. On the other hand, most central European EU countries with floating exchange rates, as well as Sweden and the UK, witnessed a significant deprecation, which may have helped to dampen the impact of the crisis.

A major, and perhaps the most important, reason for the different outcomes in the EU and Korea could be related to the lingering euro crisis, which impacts all EU countries because of their strong trade and financial linkages. The crisis has revealed specific problems related to (a) public finance sustainability and resolution of sovereign debt crises, (b) excessive private sector imbalances and competitiveness problems, and the consequent private sector debt accumulation, (c) the lack of sufficient mechanisms for fostering structural adjustment, (d) the lack of EU-wide mechanisms for supporting economic growth in the most distressed regions, (e) the discrepancy between the high-level banking sector integration and the weaknesses of the EU frameworks for regulation, supervision, and crisis resolution, and (f) more generally the weaknesses in the governance of the euro area, which has led to patchy, inadequate and belated policy responses.

There is a negative feedback loop between the crisis and growth in the EU, and without effective solutions to overturn the crisis, growth is unlikely to resume.

Figure 1: Quarterly GDP and its main components (2008Q3 = 100, constant prices, seasonally adjusted), 2005Q1-2011Q3

Source: Eurostat and OECD.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article
 

Opinion

COP26: why carbon pricing is crucial to China’s climate change pledges

China’s emissions trading scheme is a welcome but to reach its full potential, it needs to cover more of China’s emissions, go beyond the electricity sector and let prices reflect the true cost of carbon.

By: Alicia García-Herrero and Junyu Tan Topic: Global economy and trade, Green economy Date: October 22, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

Will ‘common prosperity’ address China’s inequality?

Why is China reviving this old mantra?

By: The Sound of Economics Topic: Global economy and trade Date: October 13, 2021
Read article More by this author
 

Opinion

European governance

The inconsistency in global strategic relations

All of this talk on strategic retrenchment and autonomy is the language of escalation, not of appeasement and collaboration.

By: Maria Demertzis Topic: European governance, Global economy and trade Date: October 13, 2021
Read article
 

Opinion

Xi’s pledge on financing coal plants overseas misses point

China’s domestic installation of coal-fired power plants continues at great pace.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Global economy and trade, Green economy Date: October 7, 2021
Read article More by this author
 

Blog Post

European governance

Pandemic prevention: avoiding another cycle of ‘panic and neglect’

Agreement is needed at international level on mechanisms to ensure better preparedness for the next pandemic.

By: Anne Bucher Topic: European governance, Global economy and trade Date: October 7, 2021
Read article
 

Opinion

Will China use climate change as a bargaining chip?

Beijing shows signs of changing tactics ahead of the COP26 conference.

By: Alicia García-Herrero and Simone Tagliapietra Topic: Global economy and trade, Green economy Date: October 6, 2021
Read article More on this topic More by this author
 

External Publication

A world recovery fund to overcome developing countries’ post-covid debt woes?

Proposal to set up a World Recovery Fund (WRF), aimed at addressing some of the key problems with the design of the DSSI and more generally the existing international financial architecture for dealing with debt problems in the developing world.

By: Alicia García-Herrero Topic: Global economy and trade Date: October 6, 2021
Read article More on this topic More by this author
 

Opinion

The geopolitical conquest of economics

Although economics and geopolitics have never been completely separate domains, international economic relations were shaped for 70 years by their own rules. But the rise of China and its growing rivalry with the United States have brought this era to an end.

By: Jean Pisani-Ferry Topic: Global economy and trade Date: October 4, 2021
Read article More on this topic More by this author
 

Opinion

What Evergrande signals about China's economic future

Under Xi Jinping's new economic agenda 'common prosperity', China is cracking down on indebted real estate developers like Evergrande.

By: Alicia García-Herrero Topic: Global economy and trade Date: September 30, 2021
Read article More on this topic
 

Blog Post

German elections: seizing the moral and economic opportunity of global health security

The new German government should play its part in global health security and preparedness.

By: Amanda Glassman and Guntram B. Wolff Topic: Global economy and trade Date: September 24, 2021
Read article More on this topic More by this author
 

Opinion

Europe doesn’t need a ‘Mega-Fab’

Europe should defend its existing dominance in equipment manufacturing for semiconductors and invest in chip design instead of luring high-end fabrication to its shores.

By: Niclas Poitiers Topic: Global economy and trade Date: September 22, 2021
Load more posts