Korea's Potential Growth Rate Falls to 1.4% Range—No Longer Tolerable

A grave warning has emerged that Korea's potential growth rate will fall to the 1.4 percent range in the fourth quarter of next year. In recently released data, the Organization for Economic Cooperation and Development (OECD) forecast that Korea's potential growth rate would decline from 1.85 percent last year to 1.66 percent this year and 1.52 percent next year, and predicted it would drop to 1.46 percent in the fourth quarter of next year. This marks a step backward from the December projection. At that time, the OECD forecast Korea's potential growth rate at 1.71 percent this year and 1.57 percent next year, with 1.52 percent expected for the fourth quarter of next year.

The potential growth rate refers to the maximum growth rate achievable without triggering inflation when all production factors—labor, capital and technology—are mobilized. The sharp decline in Korea's potential growth rate is an unfavorable sign that the economy's fundamental strength is rapidly deteriorating. Korea's potential growth rate averaged 5.03 percent from 1997 to 2007, but fell to 3.41 percent in 2013 and dropped into the 1 percent range for the first time last year. Moreover, Korea's potential growth rate ranking, which stood among the top performers at seventh place out of 47 major OECD countries (1997–2007), is projected to plummet to 32nd next year.

The plunge in the potential growth rate is highly concerning, sharply diverging from the rosy economic growth forecasts now pouring out. According to the Korea Center for International Finance, the average economic growth forecast for Korea this year presented by eight global investment banks (IBs) reaches 2.8 percent. The OECD also recently raised its growth forecast for Korea from 1.7 percent to 2.6 percent. However, this is merely the effect of strong exports riding on the semiconductor super-cycle, far removed from the fundamental strength of the economy. Behind the growth that depends on the single wing of semiconductors lies the painful reality of a labor supply cliff caused by low birth rates and aging, along with the structural slump in non-semiconductor industries.

The government must not become complacent in the favorable semiconductor winds and overlook the warning signals of the falling potential growth rate. Now that the June 3 local elections have concluded, President Lee Jae-myung must begin the structural reforms in the six core areas he has proclaimed—regulation, finance, public sector, pensions, education and labor—to open a new path for growth. Labor reform, which injects flexibility into the rigid labor market, is particularly important. Pension reform to enhance the sustainability of pensions and public reform to promote efficiency in the public sector must also be accelerated. Without bone-cutting structural reform, a rebound in the potential growth rate cannot be expected.