Intranational Consumption Risk Sharing in South Korea: 2000–2016

• Author: Joongsan Ko
• Published date: 01 March 2020
• DOI: http://doi.org/10.1111/asej.12195
• Date: 01 March 2020

Intranational Consumption Risk Sharing in

South Korea: 2000–2016

Joongsan Ko*

Received 20 November 2018; Accepted 18 January 2020

This paper examines consumption risk sharing among 16 regions in South Korea

over the 2000–2016 period. The empirical results show that 91.8 percent of

shocks to gross regional domestic product are smoothed in South Korea. Capital

markets, the tax-transfer system and credit markets absorb 29.9, 28.9 and 33.0

percent of shocks to gross regional domestic product, respectively. Most notably,

South Korea relies more on credit markets for risk sharing than capital markets,

an opposite pattern to advanced countries like the USA, Canada and Australia.

Furthermore, the patterns of consumption risk sharing are different before and

after the 2007–2008 global financial crisis, and differences in regional industrial

structure and local development can influence these patterns. This paper attempts

to infer the connection between these findings and both the rapid economic

growth of South Korea and the Asian and global financial crises.

Keywords: consumption risk sharing, risk-sharing channel, South Korea.

doi: 10.1111/asej.12195

I. Introduction

Households in a nation earn income through production and then consume in

proportion to income. Thus, if idiosyncratic shocks cause a decrease in produc-

tion, the households take it for granted that their income and consumption con-

sequently decrease too. However, the degrees of decline in income and

consumption depend on how consumption risk sharing works. Theoretically, if

financial markets are complete or institutions exist that implement the optimal

allocation in a nation, regional consumption will no longer depend on regional

output but will mutually covary, and, hence, covary with aggregate consumption

(Asdrubali and Kim, 2011). Specifically, output shocks can be shared within a

nation through capital markets, the tax-transfer system and credit markets, which

is known as ‘consumption risk sharing’.

1

*Dr. Ko (corresponding author): Doctoral Candidate, Department of Economics, Seoul National

University, 1 Gwanak-ro,Gwanak-gu, Seoul 08826, South Korea. Email: joongsan@snu.ac.kr.

1 Capital markets share risks through cross-ownership of productive assets, while credit markets

share them through lending and borrowing. The tax-transfer system serves as a medium for further

consumption risk sharing. (See Section II for more details.)

© 2020 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2020, Vol.34 No. 1, 29–49 29

The earliest studies that related to the above tested the null hypothesis of full

consumption risk sharing at various aggregation levels, such as individuals in

villages (Townsend, 1994), households (Altug and Miller, 1990; Cochrane,

1991; Mace, 1991) and countries (Canova and Ravn, 1996; Lewis, 1996; Kim

et al., 2004). The null was rejected indicating consumption risk sharing is

incomplete. To understand the cause of this incomplete risk sharing, Asdrubali

et al. (1996) developed the cross-sectional variance decomposition method and

identified risk-sharing channels in the USA from 1963 to 1990. They showed

that capital markets, credit markets and the federal government absorb

39, 23 and 13 percent of shocks to gross state product, respectively, while the

remaining 25 percent of shocks are not smoothed. In addition, based on the

results, capital markets are the major channel for risk sharing in the USA.

The method introduced by Asdrubali et al. (1996) has been used frequently

for measuring the degree and identifying the channels of consumption risk shar-

ing among regions and countries, and the results are easily comparable with

those presented in other studies. Based on the scope of analysis, subsequent

studies are categorized into two groups distinguished at the international and

intranational levels.

The first group focuses on international consumption risk sharing to analyze

the risk-sharing effect of economic and monetary unions. The OECD and the

European Community, East Asia, and ASEAN absorbed approximately 40, 20,

and 24 percent of shocks to GDP, respectively (Sørensen and Yosha, 1998; Kim

et al., 2006; Ko, 2020). The CFA franc zone consists of two monetary unions in

Africa: the Central African Economic and Monetary Community (CEMAC) and

the West African Economic and Monetary Union (WAEMU).

2

Yehoue (2011)

also showed that for the CEMAC and WAEMU, approximately 24 and 22 per-

cent of shocks to GDP are shared, respectively. The common finding of these

studies is that capital markets play a minimal role in the smoothing process.

Moreover, several studies have analyzed the impact on international consump-

tion risk sharing of: (i) financial globalization (Kose et al., 2009); (ii) social and

political integration (Balli et al., 2018);

3

and (iii) the quality of institutions

(Balli and Pierucci, 2020). They show that these factors are significantly interre-

lated with risk sharing among advanced countries (or high-income countries)

but not in emerging countries (or low and middle-income coun tries).

In contrast, the second group focuses on intranational consumption risk shar-

ing and shows that consumption risk sharing at the intranational level is far

greater than that at the international level. For example, in Norway, Australia

2 CEMAC consists of six countries: Cameroon, Central African Republic, Chad, the Republic of

the Congo, Equatorial Guinea and Gabon. Its currency is the Central African CFA franc. WAEMU

consists of eight countries: Benin, Burkina Faso, Guinea-Bissau, Ivory Coast, Mali, Niger, Senegal

and Togo. Its currency is the West African CFA franc.

3 Balli et al. (2018) offer well-organized information about several studies that have opposite

views on the relation of risk sharing and globalization.

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