Korea's potential economic growth rate on rapid decline

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Labor flexibility, deregulation needed for innovation

By Lee Kyung-min

Korea's potential economic growth rate is on a steeper-than-feared decline, impacted heavily by a reduction, or outright loss, of employment as well as an overall drop in labor productivity in the services industries due to the COVID-19 pandemic.

The fast-aging population has long been a protracted cause for the loss of vitality in the country's labor market, and this is increasing concerns that the public health crisis-driven decrease in both labor input and corporate investment will significantly undermine growth prospects for the economy.

Potential economic growth, or potential GDP, is an estimate of the output that would have been produced by the economy with labor and capital at their maximum sustainable rates, without triggering inflation. Factors that determine the year-on-year figure include labor force participation, capital stock and total factor productivity (TFP). Growth in TFP is used to explain output not contributed by labor and capital.

Experts say capital and labor input have neared their limits, a reason why the TFP should be bolstered via technological innovations anchored by predictability and consistency in government policy assistance and tax incentives to foster long-term corporate research, development and investment.

Equally to be pursued are the prompt removal of regulatory hurdles and the establishment of social capital including compliance protocols and business confidence, an environment crucial to sustaining corporate activities that almost always remain as the sole driver underpinning the long-term growth of a country.

Bank of Korea Governor Lee Ju-yeol. Korea Times file

Bank of Korea Governor Lee Ju-yeol said at a press briefing, Aug. 26, that Korea's average potential growth between this year and the next is likely to dip to 2 percent, mostly due to pandemic-induced global value chain disruptions, a weakened labor market and productivity decline.

The governor added that the figure for between 2019 and 2020 had dropped to 2.2 percent, down from a range of between 2.5 and 2.6 percent forecast in August 2019.

The central bank said Korea's downward revision for the potential growth figure is moderate, since eight countries including Japan, Canada and Germany revised their figures by as much as as 3.6 percentage points.

But the argument is weakened by an Organization for Economic Development (OECD) assessment that said Korea was among the top of its member countries whose potential output fell at the fastest pace.

According to the OECD, Korea's figure was lowered to 2.5 percent last year, down 0.2 percentage points from its previous estimate. Despite the pandemic factor, the figure is not likely to improve this year or the next, unless the country's birthrate sees a meaningful uptick or corporate investment leads to ground-breaking innovation.

The International Monetary Fund said in its March report that the expected downward pressure on Korea for potential growth "highlights the urgency of structural reforms that can provide some compensating upward momentum."

An illustrative scenario shows sizable possible gains from structural reforms that would be "sufficient to raise medium-term potential growth by about half a percent per year," it said.

But the much-needed increase in the potential output figure will not materialize, unless the country's unions agree to substantially reduce their bargaining power and perks in a country where businesses are left with little choice but to kowtow to the demands of workers, according to Korea Economic Research Institute economist Choo Kwang-ho.

Union members led by hardliners are interested almost always in ways to protect their vested interests, and not how to bolster production capacity or making investments, according to Choo.

"The firm making more money means nothing if they do not see an increase in their wages. Firms not being able to dismiss employees for poor performance is another endemic problem unlikely to be resolved not anytime soon, not ever," Choo said.

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