| Date | November 2020 | Marks available | 4 | Reference code | 20N.2.HL.TZ0.1 |
| Level | Higher level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Explain | Question number | 1 | Adapted from | N/A |
Question
South Korea’s current account surplus
- South Korea, Asia’s fourth-largest economy, has experienced a current account surplus since 2012. South Korea’s large working-age population, which tends to save a large portion of its income for retirement, contributes to the surplus. The South Korean government has expressed concerns about the impact of the high savings on domestic demand and the level of imports. However, it has been predicted that as the population ages the surplus will gradually disappear by 2042.
- The South Korean won (South Korea’s currency) recorded the second highest appreciation against the United States dollar (US$) in 2017 among currencies of the G20* nations. The current account surplus, the improved economic conditions and the expectations of an interest rate rise have all helped increase the South Korean won’s value.
- The South Korean won officially operates under a floating exchange rate system, but the central bank would intervene if there were major fluctuations in the market that needed to be managed. The US is monitoring the exchange rate policy of South Korea due to the significant trade imbalance between the two countries. If the US identifies that a major trading partner like South Korea tries to limit an appreciation of its currency, then the US may consider tariffs to reduce the imbalance.
- South Korea’s financial account in the balance of payments recorded a deficit of US$13 billion in 2018, as Koreans have invested extensively in other countries. Furthermore, foreigners have been reluctant to invest in South Korea due to the trade disputes and the potential of a trade war erupting between the US and China. The US and China are South Korea’s largest trading partners, and South Korea, with its export oriented economy (exports amount to 43 % of gross domestic product [GDP]), is sensitive to external demand shocks.
- South Korea’s domestic investment in key areas (such as manufacturing, construction and machinery) fell during 2018, and GDP grew by less than expected. Additionally, private consumption increased only by 0.3 % in 2018, the slowest growth for 4 years. There is also concern about the level of unemployment, especially the high rates of youth unemployment.
- Normally, in a situation of low growth, the central bank would implement expansionary monetary policy. However, the US Federal Reserve (the central bank of the US) and the European central bank are considering monetary tightening. If the South Korean central bank does not raise interest rates in line with the US and the European Union it runs the risk that the South Korean won may depreciate. Therefore, the South Korean government has begun discussions on using fiscal policy to help revive the job market and support domestic demand.
[Source: Adapted from: South Korea Current Account, Trading Economics, https://tradingeconomics.com/south-korea/currentaccount;
and Anon, 2018. S. Korean Won’s Appreciation 2nd Highest in G20 Last Year. KBS World Radio,
http://world.kbs.co.kr/service/news_view.htm?lang=e&Seq_Code=133432.]
* G20 members include: Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Republic of Korea (South Korea), Mexico, Russia, Saudi Arabia, South Africa, Turkey, the United Kingdom, the US and the EU
Define the term interest rate indicated in bold in the text (paragraph [2]).
List two components of the financial account (paragraph [4]).
Using an exchange rate diagram, explain how South Korea’s current account surplus could have “helped increase the South Korean won’s value” (paragraph [2]).
Using an AD/AS diagram, explain how the use of fiscal policy could lower “the high rates of youth unemployment” in South Korea (paragraph [5]).
Using information from the text/data and your knowledge of economics, discuss the possible implications on South Korea’s economy of a current account surplus.
Markscheme
Candidates who incorrectly label diagrams can be awarded a maximum of [3].
For an exchange rate diagram, the vertical axis may be exchange rate, price of Korean won in another currency, another currency/Korean won or other currency per Korean won. The horizontal axis should be quantity, or quantity of Korean won. A title is not necessary.
Candidates who incorrectly label diagrams can be awarded a maximum of [3].
Candidates who do not refer to the impact on youth unemployment in the explanation can be awarded a maximum of [3].
NB Full marks can be awarded if a student correctly applies a fiscal policy tool that has a supply side impact, such as subsidies for apprenticeships or education and training.
For AD/AS, the vertical axis may be “price level” or any similar terms such as “average (general) price level”. For the horizontal axis, “real (national) output/income” or “real GDP”. Any relevant abbreviations are acceptable.
Examiners should be aware that candidates may take a different approach which, if appropriate, should be rewarded.
Do not award beyond Level 2 if the answer does not contain reference to the information provided.
Command term
“Discuss” requires candidates to offer a considered and balanced review that includes a range of arguments, factors or hypotheses. Opinions or conclusions should be presented clearly and supported by appropriate evidence.
Responses may include:
- Definition of current account surplus.
Economic analysis may include:
- AD/AS theory
- exchange rate market
- balance of payments
- economic growth.
To discuss:
- Slowing domestic consumption (paragraph [5], slowest growth in 4 years), impact on AD, economic growth and employment opportunities, making it more difficult for unemployment issues (paragraph [5]).
- Koreans investing overseas rather than domestically (paragraph [4]), but this may lead to inflow in the current account through primary income in the long run.
- Insufficient domestic investment in key areas (paragraph [5]), limiting economic growth.
- Encourages appreciation of the won (paragraph [2]), leading to imports cheaper, leading to lower imported inflation, exports more expensive/less competitive, may impact economic growth – important considering it is not growing as expected (paragraph [5]).
- Appreciation of the won from current account surplus, in theory (paragraph [2]) should be self-correcting, but this does not apply to this case due to large working-age population contributing to the surplus (paragraph [1]).
- Suggests that the current account surplus may have long-term consequences on the economy – until 2042 (paragraph [1]).
- Domestic firms competing from cheaper imports suffer – due to the current account surplus encouraging an appreciation (paragraph [1]).
- Persistent imbalances with trade partners may encourage protectionist measures from trade partners (paragraph [3]). This may lead to problems with exports, growth.
- Current account surplus is influencing decisions made by government regarding policy which may conflict with other macro objectives.
- Contractionary monetary policy (paragraph [6]) to avoid a depreciation will negatively impact on economic growth, but important to avoid issues of a current account surplus.
Any reasonable discussion.
Examiners report
Generally well answered.
Most answers included Foreign Direct Investment or reserve assets. Some students provided unnecessarily long answers.
Students in the main clearly understood the impact of the current account surplus on the value of the won. Those who explained the reasons for the higher demand for the won earned full marks for their explanation. Some lost marks for incorrect labelling such as P or won/US dollar.
In most instances, candidates understood the effect of expansionary fiscal policy on unemployment in general, but a significant minority produced generic answers. Furthermore, they did not explain the effects of expansionary fiscal policy or failed to refer to youth unemployment as required in the question.
Of all the part (d) questions, this was probably the best answered though the quality of analysis and evaluation was limited, resulting in the vast majority of the marks being at levels one and two. One of the main weaknesses was a tendency to focus on the reasons for a current account surplus or government policies to deal with that surplus rather than the implications of the surplus. Also, some students focused too much on the effect of the surplus on exchange rates to the exclusion of other implications.
