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[2015-12] Estimation of the Korean Economy`s Growth Potential

Group :
Research Department 2016.01.31 4207

  Although a long time has passed since the global financial crisis, economic growth in major countries has failed to reach pre-crisis levels. Accordingly, international organizations and domestic economic policymakers are showing great concern over whether the potential growth trend has changed. In the case of the Korean economy, in particular, real economic growth has recorded an annual average of a mere 3.0% since 2011, raising worries that Korea's growth potential has become much lower than the previously estimated mid- to upper-3% level. Since potential GDP and the indicators derived from it, such as potential growth and the output gap, are benchmarks for assessing the national economy and its growth potential, properly estimating and assessing these indicators are essential in the effective establishment and implementation of macroeconomic policy.


  There are several ways to estimate potential GDP, including the production function approach, which identifies potential GDP by combining productivity and the potential input of production factors such as labor and capital, the HP filtering method, which separates GDP into cyclical and trend GDP and uses the latter as the estimate of potential GDP, and the semi-structural model, which comprehensively models the behavior of GDP, inflation, and other major economic variables to estimate potential GDP. This paper uses these various models to estimates changes in the growth potential of the Korean economy after 2000.


  The results of the estimation show that the potential growth of the Korean economy, at around 5% in the early 2000s, showed a continuing downward trend, and has declined even further since the financial crisis to recently stand at the lower-3% level. When potential growth is broken down into its contributing factors, the contribution of total factor productivity has declined the sharpest, followed by that of capital investment. The contribution of labor input is estimated to have risen slightly in the 2010s, driven by seniors' increased economic participation and a rise in employment in the service sector, such as in health and social welfare services. However, after 2017, when the working-age population will decrease, the contribution of labor input is likely to gradually decline.


  The downward trend of the potential growth since 2000 can be attributed to a combination of changes in the social structure, such as population aging, and problems in the economic structure, such as stagnant productivity in the service sector and sluggish investment. Therefore, to prevent the prolongation of low growth and to boost growth potential, countercyclical policies to ensure economic momentum, along with improvements in the social and economic structure to strengthen economic fundamentals and boost the effectiveness and productivity of all sectors, are more urgent than ever.