Changes in the Global Income Elasticity of South Korean Exports, with Implications for Policy

Over the last two decades, South Korean automotive and semiconductor exports have grown dramatically, while exports of other products have either stagnated or declined. In this report, we seek to explain these phenomena using income elasticity. The global income elasticity of Korean exports (the percentage change in Korean exports in response to a percentage change in the world income) is influenced by structural factors, such as the competitiveness of and preference for Korean-made products, and which cannot be explained by cyclical factors such as demand and exchange rates. An overall decline in the income elasticity of Korean industries (and particularly the materials industry) appears to stem from the fragmentation of the global economy, offshoring by manufacturers, and China’s growing ability to produce intermediate materials domestically. Growing demand for eco-friendly vehicles (electric, hybrid, etc.) and the rising popularity of Korean culture and brands (Hallyu) may have helped the income elasticity of the Korean automotive industry turn positive in 2022. In comparison, the income elasticity of the Korean semiconductor industry has been soaring since 2015, thanks to years of aggressive investment, innovations fueling demand growth, and the United States’ institution of sanctions against China. In the coming years, the income elasticity of Korean industries is likely to drop further due to four main factors: 1) slower trade due to escalating tensions between the United States and China and the continued fragmentation of the global economy, (2) increasingly restrictive net-zero regulations that disproportionally affect emissions-heavy industries, (3) more offshoring, (4) continuous Chinese investment in cutting-edge industries. Korea needs to attract investment by fostering an RE100-friendly business environment, (2) establish a comprehensive plan for maintaining its technological superiority in cutting-edge industries, and reconfigure global supply chains to ensure the continued stability of its production network.