When South Korea escaped the middle-income trap through several decades of export-driven growth strategies, it was looked upon as a shining example for low-income countries to follow. As a measure of that success, South Korea’s GDP per capita overtook Japan’s in 2018 and is now more than two-thirds that of the US. However, the economy currently faces new challenges, including slowing growth, high levels of debt, weakening productivity and an increasingly elderly population.
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Economic growth in South Korea slowed in the 2010s, after a long period of very strong growth. The annual rate during this period averaged 3.3%. While this was less than half the average pace achieved during the preceding 30 years of high growth, it was still better than countries at similar income levels, such as the UK and Japan. In more recent times growth has been weak post-COVID, as in many other economies. Recently however it has started increasing again.
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The main reason for growth picking up again in 2023 Q3 was an increase in exports. South Korea has had a positive trade balance each month since June 2023, as demand for exports (among others, for the key industries of semiconductors and automobiles) has started increasing after a period of weak global demand and a slow post-COVID recovery in China.
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Further headwinds for the South Korean economy have come from higher inflation and interest rates (thus higher debt-servicing payments), which have weakened private consumption and investment; South Korean household debt levels are among the highest in the world. After rising to its highest level in more than a decade, the policy rate has been 3.5% for the last twelve months to tackle inflation. Inflation has been falling, but it was 3.2% in December 2023 and still above the target of 2%. Although nominal interest rates have increased post-pandemic, the real interest rate is close to zero, and has been low (or negative) for many years. Cheap debt servicing generally means that less-profitable firms are able to survive, which could hamper long-term growth.
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A factor that could hamper future growth levels is South Korea’s high level of debt. South Korea’s credit to the non-financial sector was 273% of GDP in 2023 Q2. Fathom has previously shown that accumulation of non-financial debt beyond 250% of GDP stops being effective and starts to damage growth significantly. Furthermore, productivity growth remains below the pre-GFC level, and there is a large productivity gap between large and small firms.
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Furthermore, South Korea’s demographics are changing towards an increasingly elderly population, which will mean that higher fiscal spending will be required in the future; and this will either have to be financed through even more debt or higher taxes.
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On the positive side, the unemployment rate is at low levels (3.3% in December 2023), and youth unemployment has been falling since its peak of 13.3% in August 2018. However, the unemployment rate started increasing towards the end of 2023, and according to the OECD, is expected to further increase as demand slows.
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Another challenge facing the labour market is the 17.4 percentage point gap between the male and female participation rate, which is significantly higher than the UK (8.3 percentage points) and US (11.3 percentage points). Reducing this gap could decrease gender inequality and help the country to ease expected labour shortages in the years ahead as the population ages. This could be tackled through, for example, greater financial support and/or childcare support for working parents, although these policies, while popular, are often expensive.
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In conclusion, after structural reforms between 1960-1980 gave South Korea impressive growth and led to its high-income status, the country’s economy is now facing multiple headwinds. These include slowing growth and productivity levels, a high level of debt and a growing elderly population. On the plus side, unemployment rates are low, and a pick-up in exports post-COVID has led to an increase in growth. To avoid the risk of challenges hampering growth in the long run, the country can implement structural reforms, such as allowing unproductive firms to fail, increasing labour rights for workers in smaller firms to narrow the productivity gap between large and small enterprises, and implementing the proposed fiscal rule to manage the country’s high levels of debt.
The views expressed in this article are the views of the author, not necessarily those of LSEG.
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