Expansionary fiscal policy

Korea must avoid populist policies for fiscal prudence

The nation's proposed 2026 budget, totaling 728 trillion won ($523 billion), reflects a sharp pivot toward an expansionary fiscal policy. Representing an 8.1 percent increase over the previous year, it is the steepest rise in four years and the first full budget under the Lee Jae Myung administration. The plan highlights significant investment in future-oriented sectors, with artificial intelligence (AI) funding nearly tripling to 10.1 trillion won and R&D spending rising 19.3 percent to 35.3 trillion won.

The commitment to innovation is laudable. As global economies race to harness AI, Korea's substantial investment may provide much-needed momentum to transition from a manufacturing-heavy, export-reliant model to a knowledge-based, innovation-driven economy. Lee has framed this strategy as "borrowing seeds to sow for the future," emphasizing the need for forward-looking investments even in tight fiscal times.

However, this ambition must be tempered by fiscal realism. The budget's aggressive expansion comes amid deteriorating public finances. Government revenue is projected to grow just 3.5 percent, lagging significantly behind expenditures. The national debt is set to rise to 1,415 trillion won, pushing the debt-to-GDP ratio to 51.6 percent, the highest in the nation's history. The managed fiscal deficit is expected to widen to 4.2 percent of GDP, well above the government's own threshold of 3 percent.

This trajectory raises serious questions about long-term fiscal sustainability. Bloomberg Intelligence projects Korea's debt ratio could reach 70 percent by 2030 and 100 percent by 2045, driven by demographic decline and rising welfare obligations. In April, Fitch Ratings warned that Korea's public finances were "no longer a credit strength," and that continued expansion without corresponding revenue reforms could weigh on its sovereign credit rating.

Experts have also raised concerns about potential inflationary pressure. While inflation is currently subdued, excessive public spending in a supply-constrained environment could accelerate price increases and undermine monetary stability. If the government pursues fiscal expansion without tight coordination with its monetary policy, we could see inflationary spillovers that hurt low-income households the most.

Another risk is the "crowding out" of private investment. Government-led investments, especially in strategic industries, can be catalytic, but they must be carefully designed to complement, not displace, private sector initiatives. Overreliance on public funds may discourage corporate R&D or distort capital allocation.

Moreover, the quality of spending matters as much as the quantity. Past AI investments illustrate the risks of poorly managed projects. A recent audit revealed that 122 out of 360 AI datasets, built with 702 billion won in public funds, were left unused, wasting 115 billion won in taxpayer money. Successive governments have promoted new industries, but vague plans have often led to inefficiency.

There is also the risk of populist spending creeping into the budget under the guise of stimulus. Mandatory expenditures such as welfare, pensions and employment benefits already account for more than half the national budget. Meanwhile, tax expenditures (revenue forgone via deductions and exemptions) will exceed 80 trillion won for the first time. The education subsidy system continues to operate under outdated formulas, even as the school-age population shrinks.

To avoid long-term damage, the government must couple its investment agenda with comprehensive tax reform, tighter fiscal oversight and outcome-based budgeting. Policymakers should conduct rigorous cost-benefit analyses, implement sunset clauses for ineffective programs and enhance transparency in spending. Expanding the tax base fairly, particularly by addressing under-taxed sectors, will be crucial to maintaining fiscal health without stifling growth.

Lee's metaphor is compelling, but for borrowed seeds to grow, they must be planted in well-managed, fertile fiscal soil. Korea's economic future depends not just on how much the government spends, but on how wisely, transparently and sustainably it does so.

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