South Korea's potential growth rate is projected to fall into the 1.5% range next year, declining to the mid-1% level just two years after dropping below 2% for the first time last year. While the semiconductor super-cycle drove a surprise expansion in the first quarter of this year and fueled optimism about the annual growth rate, analysts say structural limits remain firmly in place. Koo Yun-cheol, Deputy Prime Minister and Minister of Economy and Finance, said the potential growth rate "is not fixed" and pledged to create a turning point through an artificial intelligence (AI) transformation and other initiatives.
According to the latest data from the Organization for Economic Cooperation and Development (OECD) released Wednesday, Korea's potential growth rate is estimated to drop 0.21 percentage point from 1.92% last year to 1.71% this year. Next year's rate is projected to fall a further 0.14 percentage point to 1.57%, a record low.
The potential growth rate refers to the growth rate of potential gross domestic product (GDP). Potential GDP represents the maximum output a country can achieve by mobilizing all production factors, including labor, capital and resources, without triggering inflation, and serves as an indicator of a nation's growth potential. The rate tends to decline in advanced economies that have already reached high income levels.
The concern is that Korea shows no signs of a rebound. According to OECD estimates, Korea's annual potential growth rate climbed 0.01 percentage point from 3.74% in 2010 to 3.75% in 2011, but has been declining for more than a decade since 2012, when it stood at 3.63%. It fell below 2% starting last year.
Particularly painful is the fact that Korea's potential growth rate lags that of the United States, the world's largest economy with a GDP more than 10 times that of Korea. The U.S. surpassed Korea's potential growth rate for the first time in 2023 and is projected to outpace Korea for five consecutive years. The gap is expected to widen from 0.03 percentage point in 2023 to 0.28 percentage point in 2025, 0.32 percentage point this year, and 0.38 percentage point next year.
Domestic institutions also forecast that a rebound will be difficult. The Bank of Korea (BOK) projected that Korea's potential growth rate, which stood at around 2.1% between 2021 and 2023, will gradually decline to 1.8% from 2025 to 2029 and 1.3% from 2030 to 2034. Although Korea's economy grew 1.7% in the first quarter of this year from the previous quarter, raising hopes of achieving annual growth in the 2% range, short-term surprise gains alone cannot reverse structural weakness in growth potential, analysts said.
There are also concerns that Korea's real GDP will continue to fall short of its potential GDP. According to the latest International Monetary Fund (IMF) data, Korea's GDP gap, defined as the difference between real GDP and potential GDP, is estimated at -0.9% this year and -0.63% next year. This means actual output will remain below the level achievable with full utilization of production factors, indicating a prolonged period of economic underperformance.
Experts cite declining labor supply from an aging population, deteriorating profitability in manufacturing sectors outside of semiconductors, and regulatory environments that lag those of advanced economies as factors behind the falling potential growth rate. They argue that Korea must urgently identify next-generation flagship industries and pursue structural reforms.
"At the current potential growth rate, if war continues and semiconductor exports take a hit, growth will not even reach 1%," said Yang Joon-suk, an economics professor at Catholic University of Korea. "Korea must attract capital by nurturing other flagship industries and strengthen competitiveness through bold structural reforms in education, services and finance."
The government also plans to accelerate efforts to improve the economic structure. Koo said on his X (formerly Twitter) account Wednesday that "the potential growth rate can change significantly depending on shifts in the economic structure and policy responses." He added, "We will further accelerate the implementation of a hyper-innovation economy through the AI transformation and the Green Transformation (K-GX), and will particularly nurture hyper-innovation industries such as defense, bio and K-culture as second and third semiconductors." He continued, "We will prepare the second-half economic growth strategy containing a specific blueprint and action plan in June," emphasizing that he intends to make this year the starting point for a rebound in the potential growth rate.
