This paper newly estimates the potential growth rate of the Korean economy, by comprehensively considering its structural changes and external and domestic conditions, while using improved estimation methods. According to the results of the estimation, the potential growth rate stood at around 5 percent in the early 2000s, but fell to the low- to mid-3 percent range in the 2010s and will likely decline further to 2.8 to 2.9 percent between 2016 and 2020.
This continued decline in the potential growth rate seems to have resulted from the weakening of total factor productivity and a slowdown in capital accumulation. The diminished total factor productivity appears to be related closely to the weakened productivity of the Korean economy, due for example to the insufficient development of service industries and high level of regulations. Sluggish investment resulting from economic maturation and heightened uncertainties seems to have acted as a major factor behind the slowdown in
capital accumulation. Going forward, rapid population aging and a decline in the working-age population will likely increase downward labor-side pressures on the potential growth rate.
In order to expand growth potential in a situation where growth led by inputs such as labor and capital is limited, it is most important to strengthen economic fundamentals through social and economic structural reforms, in addition to implementing macroeconomic policy aiming at ensuring economic momentum. To
this end, efforts need to be maintained to enhance the productivity of the Korean economy, through industrial restructuring, reforms in the labor, goods and services markets, and technological innovation. In addition, comprehensive measures in response to demographic changes such as the low birth rate and population aging need to be developed and implemented more actively from medium- to long-term perspectives, while institutional arrangements should also be developed to ease sectoral imbalances.