As a result of low birth rates and an aging population, projections from a national research institute indicate that South Korea's potential growth rate will remain in the 0% range during the 2040s. There are also observations that during the latter half of the 2040s, when the decrease in labor input worsens, the potential growth rate could enter a phase of negative growth.
The suggestion is to focus on improving total factor productivity through economic restructuring and to refrain from excessive fiscal input to offset the deceleration in growth caused by the decline in potential growth rates.
◇ “The era of negative potential growth rates will arrive in the 2040s”
The Korea Development Institute (KDI) stated in a policy analysis report titled 'Outlook for potential growth rates and policy implications' published on the 8th. The potential growth rate refers to the medium to long-term growth trend that excludes cyclical factors in the economy. The potential growth rate is typically estimated by setting a production function composed of production factors (labor and capital) and total factor productivity.
The KDI Economic Outlook Office analyzed South Korea's potential growth rate in three scenarios—pessimistic, neutral, and optimistic—based on 'total factor productivity.' The analysis results indicate that in the neutral scenario, South Korea's potential growth rate will continue to decline, reflecting around 0% in the 2040s. This year's potential growth rate is estimated to be in the late 1% range, and it is expected to drop to the low 1% range by 2030.
The biggest factor impacting the future decline in potential growth rates was demographic changes. According to the future population projections from the Statistics Korea, the working-age population is expected to continuously decline after peaking in 2019. The proportion of the working-age population, which maintained in the low 70% range, is projected to fall below 70% this year and drop to 51.9% by 2050. This means that by 2050, the working-age population in South Korea will remain at half the total population.
KDI noted, "As the working-age population rapidly decreases, the contribution of labor input to potential growth rates will turn negative around 2030," adding, "As the decline in labor input worsens, negative growth in potential growth rates is expected in the latter half of the 2040s."
With a sharp decline in the working-age population expected, the remaining variable is total factor productivity. In the optimistic scenario, where economic restructuring is successfully implemented, it is projected that the point of negative growth will not occur in the 2040s and growth can continue into the 2050s. However, in the pessimistic scenario where economic restructuring is delayed, the point of negative growth is brought forward to the early 2040s.
The per capita GDP growth rate is also expected to decline due to the rapid increase in the elderly population ratio, projected to drop until the mid-2040s. Considering prices and exchange rates at the 2024 level, per capita GDP in 2050 is expected to be $53,000 in the optimistic scenario, $48,000 in the neutral scenario, and $44,000 in the pessimistic scenario.
◇ “Improving productivity through economic restructuring… Be cautious of excessive fiscal spending”
In light of the expectation that the potential growth rate will continue to decline, KDI emphasized the need to concentrate efforts on improving total factor productivity through economic restructuring.
Deputy Minister Jeong Gyeol said, "If we can create conditions that allow new innovative corporations to enter the market by easing entry barriers and reforming regulations that restrict competition, it would help improve productivity," and added, "If there is a system in place where individual economic entities are rewarded for their performance, each can develop and showcase their capabilities."
Deputy Minister Jeong noted, "Measures against labor force decline are also necessary. In South Korea, women’s participation in economic activities tends to decrease during the childbearing and childcare years in their 30s," indicating that "it is difficult to balance work and family. Improvements in this area would promote women's economic participation and help enhance birth rates."
He also emphasized the need to respond to the low price situation caused by growth rate slowdown. Deputy Minister Jeong stated, "When the growth rate slows, the neutral real interest rate tends to decline," and added, "Monetary policy will lower nominal interest rates to respond to downside risks in the economy, but it is difficult to lower the nominal interest rate below 0%. The lower the trend of nominal interest rates goes, the less room there will be for monetary policy."
He continued, "It is necessary to stabilize expected inflation so that it does not decrease," and said, "While it is important to address risks of high inflation, responding to low inflation risks is equally important."
Regarding fiscal policy, he recommended refraining from excessive fiscal input for short-term economic stimulus. Deputy Minister Jeong said, "A decline in the growth rate means that the tax base is weakening, which will significantly burden finances in the future," adding, "The systems we designed in the past when the working-age population ratio was high and the growth rate was high may no longer be effective or sustainable."
He added, "If we misjudge the slowdown in growth rate due to the decline in potential growth rate as a short-term economic downturn and repeatedly stimulate the economy, fiscal soundness will be compromised and the economy will become more unstable," and emphasized the need for caution when implementing policies that increase fiscal deficits.