[Insight & Opinion] Solutions for Escaping the Low-Growth Trap

Recently, the Bank of Korea significantly lowered its growth forecast for South Korea this year from the previous 1.5% to 0.8%. In addition, the potential growth rate of 1.8% is now expected to decline more rapidly than previously anticipated. In the short term, the reasons for South Korea's economy falling into this low-growth trap are the prolonged high interest rates leading to a slump in domestic demand and a decrease in exports due to U.S. tariff policies. However, more fundamental causes lie in the weakening of industrial competitiveness and delays in institutional reforms.

South Korea's economy has been able to grow so far thanks to government industrial policies that strengthened the competitiveness of key sectors such as automobiles, shipbuilding, and semiconductors. However, as China has caught up, competitiveness in industries other than semiconductors has weakened, resulting in job losses and a lower growth rate. To secure new growth engines, South Korea must enhance its competitiveness in emerging industries such as drones, artificial intelligence (AI), batteries, and electric vehicles. However, policy authorities have neglected industrial policy, preventing the South Korean economy from escaping the low-growth trap.

Another reason is the lack of progress in various institutional reforms, including labor, taxation, education, and pensions. Factors that determine economic growth, such as technological advancement, productivity, and birth rates, are all closely related to these institutions. If the wrong institutions are chosen, the economy cannot grow. Recently, as digitalization has advanced, the industrial structure has been changing rapidly. In addition, the population structure is undergoing significant changes due to low birth rates and aging. As the economic environment changes, institutions must also adapt to these new conditions. However, the lack of institutional reform has led to a declining growth rate.

The solution to escaping the low-growth trap must first be found in new industrial policy. In the 1980s, South Korea grew by strengthening the competitiveness of industries such as automobiles and shipbuilding through heavy and chemical industry promotion policies. In the 2000s, the country transformed into an IT powerhouse by fostering the IT industry, boosting growth through semiconductor exports. While government support is unnecessary once an industry has matured, industrial policy that enhances competitiveness through government support is crucial during the development stage. Recently, not only policy authorities in advanced countries such as the United States and Japan, but also the Chinese government, are fully committed to fostering new industries by attracting specialized talent and providing fiscal and tax support. Policy authorities and the National Assembly must create a concrete roadmap for fostering new industries and increase government support. If South Korea secures competitiveness in new industries, as it did with semiconductors, the economy can boost its growth rate and create jobs over the next 20 years.

It is also important to reform institutions to meet global standards. In an economy with open capital markets, institutions that do not conform to global standards are a major cause of low growth. This is because, as is currently the case, the trend of divesting from South Korea in stocks and corporate investment encourages overseas investment, leading to hollowing out domestically. The government and the National Assembly, which determine laws and institutions, must be careful not to allow institutions to be shaped by specific ideologies or political factors. They must also overcome resistance from interest groups that have benefited under existing institutions. Every administration has attempted institutional reforms in areas such as labor and pensions, but failed due to resistance from these interest groups. The National Assembly and the government must reform institutions in line with global standards to encourage corporate investment and raise the growth rate.

If South Korea fails to reform its institutions and does not secure competitiveness in new industries, there is a high possibility that the country will follow Japan's path of prolonged stagnation and low growth. Due to South Korea's high dependence on exports, the pain of low growth could be even more severe than Japan's. Rising youth unemployment and declining retirement income for the elderly could ultimately lead to a sharp increase in household and government debt, repeatedly exposing the country to risks of financial and currency crises. As such, it is more important than ever for the new government economic team, which will soon be inaugurated, to make the right policy choices so that the South Korean economy can escape the low-growth trap.

Kim Jeongsik, Professor Emeritus, Department of Economics, Yonsei University