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An Analysis of Demand Structure and Policy Effects in the Korean Automobile Industry

Author Park Sang-soo, Kim Kyung-you, Yoon Ja-young Date 2017.12.20 Page

The automotive industry is crucial to the Korean economy. According to the 2015 Mining and Manufacturing Survey, the sector has 4,660 companies and 348,000 employees, accounting for 6.7 percent of all manufacturing companies in the country and 11.8 percent of the manufacturing labor force. Cars also account for 13.5 percent of combined production value and 12 percent of added value in manufacturing. The industry is also tops in the sector in exports (13.3 percent). With immense influence over upstream and downstream industries, this core sector greatly affects a range of other industries. 


Due to its far-reaching impact, government policy toward the industry has sought to stimulate the sluggish domestic economy as a whole. A flexible rate program has been used for the individual consumption tax imposed on passenger cars, a key durable good, thereby allowing the tax to be set at a lower rate for a given period. Most recently, this tax was lowered in 2015 as a preemptive response to a feared decline in automotive exports and production and a slowdown in consumption due to the 2014 sinking of the Sewol ferry and the 2015 outbreak of Middle East respiratory syndrome (MERS). Because the tax cut has expired, it is necessary to study whether the policy was an appropriate tool for its intended goal, and if its effects met expectations in terms of direction and scale. Based on the results, guidelines should be proposed to justify similar policy proposals, predict the scale of their effects, and formulate policy actions that meet their goals. 


Recognizing these issues, this study analyzed the effects of a lower rate of the individual consumption tax on passenger cars in 2015 through a counterfactual experiment and devised policy implications for consideration. First, a model was designed to estimate the function of supply and demand in the Korean automotive industry, and more specifically the passenger car market, as an analysis tool for the experiement. This model was used to predict the reactions of passenger car consumers and manufacturers to lower prices enabled by the tax cut and changes to sales volume. Using this model, economic players that are direct stakeholders in the policy change were categorized as consumers, producers, and the government, and the net welfare of society was calculated and evaluated comprehensively considering the benefits to consumers and producers and changes to the government’s tax revenue. 


Finally, this study explored how the tax cut-induced stimulation effect for the domestic car market influenced other industries directly and indirectly associated with the automotive sector. The counterfactual model designed by this study will likely serve as basic data not only for analysis of the government policy’s effect but for many other studies, including one that estimates how benefits for economic players change along with shifts in the market structure and the environment, such as corporate mergers and new product launches.