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Causes of the Decline in Korea’s Long-term Growth Trend: Expenditures

Causes of the Decline in Korea’s Long-term Growth Trend: Expenditures

SHIN Changmock

Apr. 24, 2012

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The Korean economy, which had recovered rapidly from the global financial crisis, began to lose recovery momentum from late 2011. Growth decelerated more than expected in the fourth quarter, raising concerns about the economy's prospects this year. Korea's slowing growth however, is not a recent phenomenon, as its long-term growth trend has been falling since the late 1990s. Understanding the causes of Korea's declining growth trend, and finding ways to restore growth is thus as critical to Korea's economy as the provision of short-term stimulus.

Analysis of the nation's expenditures indicates that the cause of Korea's falling long-term growth trend lies in its weak domestic demand. From 1970 to 1990 domestic consumption contributed an annual average of 5 percentage points to Korea's long-term trend growth, functioning as a bulwark of the economy during its high growth period. After the foreign exchange crisis of 1997 however, domestic consumption declined greatly, adding only 1.5 percentage points to long-term trend growth from 2008 to 2011. Facilities and construction investment have likewise weakened. Before the foreign exchange crisis, facilities and construction investment played a major role in promoting growth, contributing an average of one and two percentage points respectively. After the foreign exchange crisis, however, facilities investment contributed only 0.4 percentage points, while construction investment ceased functioning as a growth driver altogether due to a prolonged recession in the construction market.

Korea thus needs to restore the contribution of domestic demand to economic growth if it is to restore its long-term growth trend. In the short-term, it will need to revitalize private consumption by tackling inflation and growing household debt. In the long term, Korea needs to reduce households' uncertainty about their income by expanding employment opportunities.

Second Korea needs to revive facilities investment. To this end, it must strengthen its competitiveness in the parts and materials industry and increase the domestic content of exports. Korea also needs to build a more favorable environment for investment by modernizing its system of labor/management relations and relaxing regulations, while using tax benefits and other policies to draw more foreign companies to invest. On the labor side, Korea needs to make more effort to nurture a core workforce that can provide qualitative improvements in its facilities investment.

Finally, Korea needs to maintain and further develop its already strong export competitiveness. Pioneering new emerging markets and establishing FTAs can help secure stable markets for Korea's exports, while discovering new growth engine industries and bolstering global competitiveness can ensure that exports continue to grow.

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