Korea Faces Fear of Potential Growth Rate Falling to the 1% Range

Simultaneous Decline in Labor and Capital Accumulation... Sharp Population Aging Poses Downward Pressure
"Need to Change Traditional Industrial Methods and Ease Regulations"

[Image source=Yonhap News]

[Asia Economy Reporter Jang Sehee] Concerns are emerging that South Korea's potential growth rate could fall to the 1% range in the future, given the limited growth driven by input factors such as labor and capital. In particular, downward pressure on the potential growth rate from labor factors, including labor market changes caused by COVID-19 and population aging, is expected to increase. Accordingly, experts unanimously agree that concrete measures must be prepared to raise the potential growth rate.

IMF "Potential Growth Rate Expected to Fall to 1.7% Between 2041 and 2050"

According to the International Monetary Fund (IMF) on the 21st, South Korea's potential growth rate is expected to decline to 2.5% during 2021-2030, further drop to 2.0% during 2031-2041, and fall to 1.7% between 2041 and 2050. The potential growth rate refers to the maximum growth rate an economy can achieve without overheating or slowing down, given economic conditions. Rapid low birthrate and aging population, as well as the economic recession caused by COVID-19, were identified as factors hindering future economic growth.

The decline in South Korea's potential growth rate is attributed to a decrease in total factor productivity and a slowdown in capital accumulation. According to the '2020 Labor Productivity Trends' published by the Korea Productivity Center, the labor input across all industries declined annually by 1.2% in 2018, 0.9% in 2019, and -3.2% in 2020. This was due to reductions in working hours and the number of workers. The productivity decline caused by reduced labor input acts as a factor pulling down the potential growth rate. Professor Kim Sangbong of Hansung University’s Department of Economics predicted, "Although the current potential growth rate is around 2%, it could fall to the 1% range over the next decade due to the decrease in the labor population."

Capital accumulation has also sharply declined. According to the Bank of Korea, the contribution of capital income to the potential growth rate factors dropped from 2.2% in the early 2000s to 1.4% recently. As the traditional industrial structure continues and reforms across the industrial structure are delayed, the growth contribution of capital input is not significant. Professor Kim Soyoung of Seoul National University’s Department of Economics pointed out, "In the 1960s, there were no factories, so just building factories had a large production effect. However, since factories are now saturated, even if new facilities are built, the additional production capacity compared to the past is inevitably lower." She added, "Technological innovation, such as introducing information and communication technology (IT) into the production process, is necessary." This aligns with the 'law of diminishing marginal returns,' which states that continuously increasing labor on a fixed amount of land initially improves productivity as expected, but beyond a certain point, the rate of increase slows down.

Excessive market regulation is also cited as a problem. According to the Product Market Regulation (PMR) index released by the Organisation for Economic Co-operation and Development (OECD) in February, South Korea recorded 1.71, higher than the OECD average of 1.41. Compared to other countries such as Germany (1.08) and Japan (1.44), this is a high level. Excessive regulation hinders technological innovation, making productivity growth difficult. Attention is also drawn to the fact that even if productivity increases, the pace may be slow.

Bank of Korea and Ministry of Economy and Finance Say Claims of 1% Potential Growth Rate Are Excessive... Planning 'Mid- to Long-Term Measures' in Economic Policy Direction

In this regard, the Bank of Korea and the Ministry of Economy and Finance assessed that claims of a 1% potential growth rate are excessive. Bank of Korea Governor Lee Ju-yeol and Deputy Prime Minister and Minister of Economy and Finance Hong Nam-ki stated that although there has been some damage due to the COVID-19 crisis, claiming the potential growth rate is in the 1% range is an excessive assertion.

Meanwhile, the government plans to include mid- to long-term measures to raise the potential growth rate in the economic policy direction to be announced at the end of this month. This is because even if exports rebound after COVID-19, if domestic demand does not continue, the actual potential growth rate could decline. A government official said, "There is a consensus that we need to move in the direction of increasing productivity in relation to the continuous decline in the potential growth rate," adding, "Follow-up policies related to the Korean New Deal, carbon neutrality, and semiconductor strategy will be introduced."