OECD Economic Outlook, Volume 2019 Issue 1

Korea

Economic growth is projected to slow to around 2½ per cent in 2019-20, reflecting weakness in domestic demand and international trade. Restructuring in the manufacturing sector, notably in some industries facing weak overseas demand, and double-digit increases in the minimum wage are holding back job creation. Fiscal stimulus is projected to support growth, while core inflation will pick up to around 1½ per cent in 2020.

Fiscal stimulus should continue in 2020, accompanied by an easing of monetary policy, as headline inflation is well below the 2% target. Minimum wage increases should be moderated, while focusing more on reforms to boost productivity, particularly in the service sector and in small and medium-sized enterprises. Measures to reduce air pollution are a priority to improve well-being and productivity.

Domestic and overseas demand has slowed

Weaker economic growth is due in part to a decline in fixed investment and weak job creation, reflecting restructuring in manufacturing. In addition, the 29% increase in the minimum wage over 2018‑19 has held back job gains, particularly for low-skilled workers. Employment growth in 2018 dropped to 0.4%, the lowest since 2009. The job market improved in early 2019, but most new jobs in the first quarter were in social services and healthcare. Exports have been declining since late 2018 as global trade and demand from China lost momentum. The downturn in the semiconductor market, which peaked in mid‑2018, also had a negative impact, as Korea accounted for more than 60% of the world memory market in 2018. Headline inflation dropped to 0.5% in early 2019, well below the 2% target, in part due to government measures to reduce prices of healthcare and telecommunications and a temporary tax cut on oil.

Inflation, business and residential investment: Korea

1. Excludes food and energy. The central bank's target is for CPI inflation.

2. Annualised change of three-quarter moving average.

Source: OECD Economic Outlook 105 database.

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Korea: Demand, output and prices

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Expansionary fiscal policy should be accompanied by structural reform

The government responded to weaker growth with fiscal stimulus. Spending is set to increase more than 9% in 2019, focusing on social welfare and job creation, which is to rise by 22%. In addition, the government aims to boost public employment by 0.8 million, a 34% increase, over 2017-22. Nevertheless, the general government fiscal balance is projected to remain in surplus at around ½ per cent of GDP in 2020, while gross government debt stays below 45% of GDP. The 2019 supplementary budget, which includes outlays to address fine dust pollution, will boost the economy.

The Bank of Korea raised its policy interest rate in late 2018, partly due to concerns about high and rising household debt. Household debt rose less than 6% in 2018, the lowest in five years, reflecting the tightening of regulations on mortgage lending, but still outpaced household income.

Korea’s key challenge is to raise labour productivity, which is only about half of that in the top half of OECD countries. Robust labour supply that has offset low productivity is shrinking with the cut in maximum weekly working time from 68 to 52 hours and the decline in the working-age population since 2017. With the fertility rate falling below one in 2018, Korea faces the fastest population ageing in the OECD area. The scope for productivity gains is largest in the service sector, where output per employed person is only about half of that in manufacturing. Priorities are regulatory reform and policies to promote greater dynamism in small and medium‑sized enterprises, which are dominant in services.

Growth of 2½ per cent is projected in 2019-20

Growth will be supported by fiscal easing and a rebound in fixed investment in 2020, leading to GDP growth near Korea’s potential rate. If such an upturn fails to materialise, additional fiscal support will be necessary. Further large minimum wage increases would reduce job gains and the competitiveness of Korean firms if not accompanied by higher productivity. Korea is also exposed to a sharper‑than‑projected slowdown in China, which accounts for a quarter of its exports, and to the US-China trade dispute.