The global recession will slow the recovery. While domestic-oriented activity will normalise gradually, the global recession will hold back exports and investment, even assuming no resurgence of the pandemic (single-hit scenario). A second global wave of infections (double-hit scenario) would delay the recovery in consumption and exports, further depress investment and push up unemployment (Table 1).

A permanent slump in world trade is a downside risk. As an export-oriented economy, Korea is vulnerable to further weakness in foreign demand and to lasting disruptions in global value chains.

Fiscal policy is very expansionary. The government is appropriately using the fiscal space offered by strong public finances, with general government gross debt at around 40% of GDP, to damp the impact of the crisis. The budget balance is projected to move from a surplus in 2019 to a deficit of more than 3% of GDP in 2020 in the double-hit scenario and 2.8% of GDP in the single-hit scenario. Fiscal policy needs to continue supporting the economy. Additional stimulus through growth-enhancing investments could strengthen the recovery.

Monetary policy is accommodative. The Bank of Korea cut its policy rate by 50 basis points in March 2020 and by another 25 basis points in May, to 0.50%, and implemented a range of measures to increase liquidity in response to the crisis. With inflation projected to remain very low (Figure 2), monetary policy should remain accommodative. As there is limited room left for significant policy rate cuts, the Bank of Korea should be prepared to consider unconventional monetary policy measures, going beyond liquidity support.

The crisis raises financial vulnerability. The magnitude of the COVID-19 crisis creates risks for financial stability, especially corporate debt, as some businesses, notably SMEs, are heavily indebted. Some households will also struggle to repay their debt. Nevertheless, Korea’s financial system is protected by a number of buffers. The financial authorities have taken determined action to address financial risks and now appear to have stabilised financial markets.

Korea scores poorly in some well-being dimensions. The country’s outstanding income growth over the past decades has yet to fully translate into high well-being, notably in terms of perceived health, environmental quality and work-life balance.

Income inequality is relatively high, due to wage dispersion and limited redistribution (Figure 3). A dual labour market and partly related large differences in productivity between large firms and SMEs, and between industry and services, generate strong wage inequality. Redistribution through taxes and benefits is weaker than in most other OECD countries. Female employment is relatively low and the gender wage gap is the highest in the OECD. Inequalities are exacerbated by the COVID-19 crisis, which affects disproportionately those with the weakest labour market positions.

Old-age poverty is still high. More than 40% of people aged 65 or over live in relative poverty, the highest rate in the OECD, albeit on a declining trend. Old-age poverty is driven by limited pension income, partly due to the immature pension system, and low earnings for many of those still working, despite often long working hours.

Air pollution is a major issue. Most of the population is exposed to high levels of small particle air pollution, with detrimental impacts on health and well-being. Although the government has taken significant steps to curb air pollution, more is needed.

Renewable energy investments will help green the recovery. Energy generation is still overwhelmingly reliant on fossil fuels, and low oil prices risk delaying the transition to cleaner energy sources. The government has set ambitious targets for the share of renewables in electricity generation, which should rise from about 8.3% in 2018 to 20% by 2030 and 30-35% by 2040. Boosting investment in renewable energy and clean technologies would help achieve a sustainable recovery.

Korea’s population is ageing rapidly, but digitalisation could raise productivity. The old-age dependency ratio will be the highest in the OECD by 2060 (Figure 4). Korea has potential to build on its advanced IT technology to foster innovation and raise productivity. The recently announced Korean New Deal, which will boost digital, green and skills investments, has the potential to support a green and inclusive recovery.

The shrinking labour supply tends to lower the economy’s growth potential. According to the OECD long-term model, Korea’s annual GDP per capita growth was set to slow to a pace similar to that of other OECD countries. The COVID-19 crisis is likely to pull down Korean and global growth further. However, there is scope for raising employment rates and productivity to lift GDP per capita growth by one to almost two percentage points.

The new OECD Jobs Strategy suggests ways to boost employment and foster inclusive growth. Raising the employment rate and quality of jobs of Korean women, who are on average highly skilled, should be a priority. Moreover, there is a need to enhance the quality of jobs for older workers, who tend to retire late but often end their working lives in low-quality jobs, and to facilitate youth’s access to employment, especially through enhanced vocational training and career guidance.

Social protection should be strengthened. The COVID-19 crisis illustrates the vulnerability of non-regular workers to economic shocks, despite emergency measures to support households and businesses. Along with stronger social protection, easing labour market regulations once the COVID-19 crisis is overcome would promote the reallocation of workers towards their most productive use and reduce labour market duality. While social protection schemes have been gradually extended, compliance remains a challenge.

Shifting the focus of active labour market policy from direct job creation, which accounted for about half of spending before the crisis, to training and job counselling, along with enhanced adult education, would enhance job quality. The crisis-time public job creations need to be complemented by further investments in human capital.

Productivity varies widely across economic sectors. Productivity is outstanding in IT manufacturing and strong in other manufacturing, but lagging in services, including IT services (Figure 5). The gap is also wide between big firms and SMEs. Narrowing those gaps is key to raising aggregate productivity.

Technology diffusion is uneven. Use of advanced IT technologies like cloud computing and big data is lagging in SMEs, which face difficulties in recruiting skilled workers and managers and training their workforce. Scale-up success is limited, despite extensive government R&D support.

Product market regulations remain stringent, holding back competition and productivity growth. The government has introduced a programme to shift the burden of proof from the regulated to the regulator and regulatory sandboxes to allow firms in new technologies and new industries to test their products and business models without being subject to all existing legal requirements.