The International Monetary Fund (IMF) has warned the Korean economy that it will fall in a low-growth slump for the next five years if it does not take proper steps to reform its structure now.
According to an analysis of the IMF’s recently released annual report on Korea, the country’s gross domestic product (GDP) growth is expected to remain in the low 2% range over the next five years. The projections are 1.4% this year, 2.2% next year, 2.3% in 2025, 2.2% in 2026 and 2027, and 2.1% in 2028.
A potential growth rate refers to the maximum rate of growth that can be achieved without triggering inflation. The IMF report forecasts that Korea’s potential growth rate will hit 2.1% this year, 2.2% next year and 2025, and 2.1% in 2026, 2027 and 2028. Its grim outlook is that Korea’s potential growth rate, which fell to 1.3% in 2020 due to the COVID-19 shock and struggled to rise to 1.9% in 2021, will stagnate at 2.1% or 2.2% going forward, leading to a period of low growth.
The IMF suggested structural reforms as a solution to overcome low growth, especially labor and pension reforms. “Korea’s rapid aging is a risk factor,” the IMF Executive Board said, suggesting that “increasing labor market flexibility and narrowing the gender gap are needed to boost Korea’s productivity.”
On Korea’s pension system, the IMF warned that if the current system is maintained, public sector debt will rise to 200% of GDP in 2075, 50 years from now. The current national pension was projected to post a deficit starting from 2041 and run out of funds in 2055. The civil service pension is already in deficit.
The IMF’s recommendations for pension reform include increasing pension contribution rates, extending the retirement age, lowering the income replacement ratio of pensions, merging the national pension with other pensions, and raising the basic pension benefit level.
The IMF’s prioritization of labor and pension reforms is in line with the fact that the root cause of Korea’s low growth is a declining birthrate and an aging population. Korea’s total fertility rate is one of the lowest in the world (0.78). The poverty rate of the elderly aged 65 and over was the highest (40.4%) among OECD member countries from 2006 to 2020. The labor market is becoming less active due to a declining birth rate, and the fiscal situation is deteriorating due to expanding pension expenditures for the super-aged population, which is depleting financial resources for stimulating the Korean economy.
The Korean government is facing a dilemma between growth and inflation. Growth is important, but the Korean government has no choice but to tackle high inflation ahead of next year’s general election. After consumer price inflation spiked to 6.3% in July last year, the Korean government aimed to stabilize inflation in the first half of this year and then stimulate growth with economic stimulus measures in the second half. This is where the economic outlook comes from.
But as high inflation persisted into the second half of the year, the government was unable to do much in the way of implementing stimulus packages. This is because any stimulus that involves loosening monetary policy or lowering interest rates to pump money into the market is bound to fuel inflation. As a result, the Korean government is stuck in a situation where raising interest rates to control prices slows down growth and trying to stimulate economic growth lets consumer prices rise.
In this situation, the IMF’s proposal for growth through structural reforms has serious implications because it is not accompanied by rising prices. “Growth policies that release liquidity have inflationary pressure but structural reforms do not increase inflationary pressure, so it is possible to raise growth rates through labor and pension reforms and maintain a high interest rate stance to keep inflation under control,” said Sung Tae-yoon, an economics professor at Yonsei University.
Of course, the Korea government knows this well. It is pushing for labor reforms centered on making a change in working hours and pension reforms to ensure sustainability.