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[2019-8] Estimation of Korea’s Potential Output Growth

Group : Macro Economy
Research Department (02-759-4150) 2019.10.24 1320

This paper re-estimates Korea’s potential output growth in consideration of the trend of slowdown in the growth rate as well as demographic and labor market changes. This paper departs from previous literature in the following two respects: First, the measure of labor input is changed from the number of persons employed to quality-adjusted working hours. Second, a new model (multivariate filtering model) is added to the existing three estimation models (production function model, semi-structural model and HP filtering model), in order to enhance the robustness of the estimation of the potential output growth and make up for the shortcomings of the production function model.

 

The re-estimation of Korea’s potential output growth using modified and supplemented methodologies shows that it is declining faster than previously forecast. The potential output growth for the 2016-2020 period is estimated at a range of 2.7-2.8%, 0.1%p lower than the original forecast of 2.8-2.9%, and the rate for the 2019-2020 period is estimated at a range of 2.5-2.6%.

 

Looking at the contributions of individual factors to the potential output growth, the decline in the potential output growth since 2010 is accounted for by the slowdown in the growth of production inputs such as labor and capital amid stagnant total factor productivity growth. More specifically, the decrease in the contribution of labor input is mainly due to the slowdown in the growth rate of population aged 15 or higher. The contribution of capital inputs has declined because investment growth has fundamentally slowed with the maturing of the Korean economy and heightened uncertainties at home and abroad.

 

Korea’s potential output growth is expected to fall further in the long term, as the productive population declines in line with population aging and the low fertility rate. In this regard, in order to expand the growth potential, it is important to enhance productivity through structural reform across the economy. Deregulating excessive regulations, lowering barriers to entry and reducing labor market inefficiency will be imperative to encourage technological innovation and improve the efficiency of resource allocation. In addition, it is necessary to slow down the decline in labor supply resulting from population aging and the low birth rate, through policy efforts including encouraging women and young people to participate in economic activities and coping actively with the low birth rate.

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