KDI - Korea Development Institute - RESEARCH - Economic Outlook

Summary

KDI Economic Outlook 2025-2nd Half Increasing Overseas Abroad: Macroeconomic Context and Implications

■ As in Japan’s case, the slowdown in productivity growth has been a major driver of declining capital returns in Korea, leading to a shift from domestic to overseas investment.

- Looking ahead, a shrinking working-age population will weaken labor input and domestic capital returns, further accelerating the shift toward overseas investment.

- A productivity slowdown directly reduces GDP and also shrinks the domestic capital stock, amplifying the total impact on GDP to about 1.5 times the direct effect.

- In Japan, where productivity and demographic shifts occurred about twenty years earlier than in Korea, slower productivity growth led to a marked loss of economic dynamism and greater reliance on investment income from abroad.

■ Therefore, restoring growth momentum will require sustained structural reforms that boost productivity.

- If the productivity slowdown persists, adverse effects may broaden, particularly for those who depend heavily on labor income.

- This will require building an environment that enables innovative firms to enter and unproductive firms to exit, alongside a more flexible labor market that supports economy-wide productivity growth.

※ The shift to overseas investment arises from declining domestic productivity and helps offset the resulting loss in national income. It would therefore not be advisable to restrict it by policy.

※ Since the current account surplus is equivalent to net overseas investment, an increase in the surplus should be interpreted with caution.

Summary

KDI Economic Outlook 2025-1st Half Potential Growth Outlook and Policy Implications

■ Demographic changes will continue to depress Korea’s potential growth rate, projected to be near 0% by the 2040s.

- With 2025’s potential growth rate in the upper 1% range, the baseline scenario projects negative growth by the late 2040s, while the pessimistic scenario, with delayed structural reforms, anticipates its onset by the early 2040s.

- Accordingly, policy efforts should prioritize TFP enhancement through structural economic reforms.

- Simultaneously, policies should counter demographic-driven labor force decline by promoting workfamily balance, elderly labor participation, and labor market openness.

■ Slowing growth may push down the neutral real interest rate, increasing the risk of hitting the zero lower bound. This calls for reviewing the monetary policy framework to stabilize inflation expectations.

- If the neutral real interest rate declines alongside low inflation expectations, the nominal interest rate (= real rate + expected inflation rate) may remain subdued, constraining rate cuts. A balanced approach is therefore needed to address both upside and downside inflation risks.

- High interest rates, maintained for financial stability as a newly adopted monetary policy objective, may lead to disinflationary effects. Therefore, monetary policy frameworks should balance financial stability and inflation expectations through careful evaluation.

With slowing potential growth expected to strain government fiscal soundness, caution should be exercised to prevent repeated stimulus measures from creating structural budget deficits.

- A shrinking tax base from slower growth will strain public finances, requiring reforms to fiscal systems designed with the assumptions of high growth and labor participation

- To boost economic dynamism, policy efforts should prioritize correcting market failures and reforming distortionary systems over fiscal spending.

- Misreading potential growth decline for a cyclical downturn and using repeated stimulus measures could undermine fiscal soundness and macroeconomic stability.

Summary

KDI Economic Outlook 2025-1st Half Demographic Drivers of the Propensity to Consume: Effects and Implications

■ Driven by a sharp increase in life expectancy, Korea’s average propensity to consume has declined over the past two decades, serving as a key factor behind the persistent lag in private consumption growth relative to overall economic growth.

- Despite longer life expectancy, the average retirement age from primary lifetime employment has remained largely unchanged, reinforcing precautionary saving that lowers the propensity to consume in anticipation of relatively lower and more uncertain income from secondary employment after retirement.

- The responsiveness to increased life expectancy is greater among older adults with shorter remaining life expectancy, as reflected in a marked decline in their propensity to consume.

■ Looking ahead, however, as the pace of increase in life expectancy moderates and the share of the oldest old (aged 75 and over) rises rapidly, the average propensity to consume is expected to rebound gradually.

- While life expectancy increased by approximately 6.5 years over the past two decades, it is projected to rise by only about 3.5 years over the next two decades, roughly half the previous increase.

- As low fertility persists and the share of older adults continues to rise rapidly, the working-age population is projected to contract, further dampening growth while slowly lifting the propensity to consume.

- Accordingly, the gap between private consumption growth and overall economic growth is expected to narrow gradually over time.

■ Since the two-decade decline in average propensity to consume reflects structural issues in Korea’s labor market, it is important to develop policy responses to address these challenges.

- Structural barriers to older adults' labor market participation should be removed to align retirement timing with rising life expectancy.

· The recent increase in labor market participation among some individuals in their 60s and older suggests the growing intent to remain in the workforce among older adults in response to rising life expectancy.

- To address structural barriers, policy efforts should focus on expanding labor demand for older workers by resolving labor market frictions, including reforming the seniority-based wage structure to bolster job responsibilities and performance-based pay, as well as promoting reemployment after mandatory retirement.

- Effectively leveraging the capabilities of the older workforce could help partially offset the downward pressure on potential growth resulting from low fertility and population aging.

Summary

KDI Economic Outlook 2024-2nd Half Recent Price Fluctuations: Factors and Implications

■ In the process of inflationary pressures arising from non-policy demand factors after COVID-19, model estimates suggest that fiscal policy exerted upward pressure on prices in 202223, while monetary policy has applied downward pressure since 2023.

- Rapid base rate hikes since H2 2022 have contributed to price stabilization, whereas the sustained expansive fiscal stance at a relatively high level continued to exert upward pressure through 2023.

- Although inflation begin to decelerate in 2024, the sustained high interest rate environment continues to exert downward pressure on prices.

■ With moderation in inflation expected to continue, corresponding adjustments to the macroeconomic policy stance would be advisable.

- Since the lagged effect of non-policy demand factors diminishes if no additional shocks occur, the disinflationary trend may persist in the near term.

- Therefore, the intensity of monetary tightening should be carefully calibrated to prevent inflation from remaining below the target for an extended period, and fiscal policy warrants caution considering the already elevated level of government expenditure.

Summary

KDI Economic Outlook 2024-2nd Half Medium- to Long-Term Deceleration in Private Consumption Growth: Factors and Implications

■ Real private consumption growth continues to slow alongside real economic growth. Considering other factors, recent trends suggest that the trend growth rate of real private consumption is currently in the mid-1% range.

- Given the potential growth rate near 2%, the decreased share of nominal private consumption in GDP due to increased government consumption, and the falling relative price of GDP to private consumption, sustaining the growth trend of real private consumption above the mid-1% range appears unlikely.

- Without substantial structural changes, real private consumption growth is expected to continue its downward trend along with falling potential growth.

■ Assessing recent developments from this perspective, private consumption growth appears to be converging toward its mid-to-long-term trajectory, rebounding from 0.9% in Q2 to 1.3% in Q3.

- The estimated private consumption growth rate for 2025 is in the high-1% range, below the actual rates recorded from 2017 to 2019 (2.8%) and recent potential growth (around 2%). However, as this estimate surpasses the projected trend growth, it implies easing in the private consumption slowdown.

· In 2025, potential rate cuts and export improvements may positively impact private consumption.

■ Accordingly, policy efforts should prioritize stimulating private consumption in the mid-to-long term: structural reforms to mitigate the declining potential growth rate, cautious expansion in government consumption, and strengthening export competitiveness to achieve higher value-added output.

- Over the long term, enhancing productivity is essential for bolstering economic dynamism since income constitutes the foundation of private consumption.

· The development and diffusion of production technology through R&D and education should be actively promoted, along with efforts to increase overall economic flexibility to improve resource allocation efficiency.

- Additionally, to prevent government consumption expansion from limiting private consumption capacity, it should be approached with caution, focusing on enhancing expenditure efficiency.

- Moreover, to address the trend of export prices growing more slowly than import prices, it is essential to significantly enhance the capacity for value-added export generation through advanced technological development.

Summary

KDI Economic Outlook 2024-1st Half High Inflation and Consumption Stagnation: Focusing on the Relative Price between Income and Consumption

■ In South Korea, real private consumption appeared lethargic in 2023 due to the stagnation in real purchasing power, driven by a sharp rise in consumer prices (3.4%) and a decline in the real economic growth rate (1.4%).

- In both 2022 and 2023, the growth rate of real purchasing power stagnated due to falling real income relative to consumption. This slump resulted from the sharp rise in international oil prices in 2022 and the marked decline in semiconductor prices in 2023.

- Additionally, the steep upward trend in consumer prices triggered the adoption of a high-interest rate policy, further exacerbating sluggish private consumption (see Current Affairs I).

■ Going forward, the conditions for real private consumption are projected to gradually improve as the real economic growth rate expands and the value of income relative to consumption increases.

- A majority of forecasting agencies project the economic growth rate to rise to the mid-2% range in 2024, bolstered by a rapid increase in exports, higher than the 2023 figure (1.4%).

- Furthermore, in 2024, the capacity to spur private consumption is expected to experience meaningful expansion as real purchasing power substantially improves due to the marked rise in semiconductor prices.

- However, high interest rates, outside the purview of this report, are still expected to act as a delaying factor for the recovery of private consumption.

■ Therefore, it is assessed that the current situation does not require short-term macroeconomic policies to stimulate private consumption.

- Given the high probability of gradual moderation in consumption stagnation propelled by improving real purchasing power, it is not advisable to consider stimulus measures as requiring urgent action. It is also noteworthy that such policies could disrupt the ongoing trend toward inflation stabilization, potentially delaying interest rate cuts.

- In addition, given that the trends of private consumption and income eventually sync up, the policy focus should be structural reforms that improve income-generating capacity by boosting medium- to long-term economic dynamism.

Summary

KDI Economic Outlook 2024-1st Half Weather Condition Changes on Prices: Effects and Implications

■ Weather shocks raise consumer prices in the short term, primarily affecting fresh food prices. However, their impact on core prices appears marginal.

- Among various types of weather shocks, precipitation has a greater impact on prices compared to temperature, especially during summer.

- As global warming increases summer temperatures and intensifies weather volatility both in frequency and severity, such as through heavy rainfall and droughts, short-term price instability, especially for fresh food, may become more prevalent.

■ Despite the initial divergence between consumer and core prices, driven by volatile prices for food (fresh food) and energy, consumer prices tend to revert to core price levels over the medium term.

- This observation suggests that although temporary spikes in fresh food prices can elevate consumer prices in the short term, they have little impact on the underlying price trend.

■ Therefore, it is not advisable for monetary policy to sensitively respond to short-term fluctuations in fresh food prices.

- To reduce the impact of localized weather shocks on consumer prices, it would be prudent to explore structural measures, such as diversifying supply sources by increasing agricultural imports.

- In addition, strengthening climate resilience through measures like crop variety improvement is necessary to prepare for and mitigate the effects of climate change.

Summary

KDI Economic Outlook 2023-2nd Half Impacts of China’s Shrinking Construction Sector and Implications of Its Changing Mid-to-Long-Term Trade Structure

■ The analysis suggests that a decrease in China’s construction sector output significantly impacts Korea’s GDP through reduced exports of intermediate goods to China.

- A 10% decline in China’s construction production is projected to result in a 0.4% reduction in Korea’s GDP.

- Industries closely related to the production and transportation of construction materials, such as chemicals, mining, shipping, and metal and non-metal product manufacturing, are particularly affected by the contraction in China’s construction sector.

■ The international division of labor between Korea and China is eroding in tandem with China’s growing competitiveness in intermediate goods production, indicating heightened competition in overseas markets for intermediate goods.

- The share of Korean exports to China intended for re-export to third countries after processing is shrinking, while exports catering to China’s domestic demand are increasing.

- In Vietnam’s intermediate goods market, where Korean companies are actively expanding as an alternative to the Chinese market, the increasing market share of Chinese products implies a relative decline in Korea’s competitive position.

■ While devising immediate and clear short-term measures to respond to the evolving international division of labor with China may be challenging, it is necessary to consistently pursue risk diversification strategies, such as the expansion of export and investment markets.

- Corporate expansion into rapidly growing emerging markets in Southeast Asia and India, as well as into the Middle East and Eastern Europe, should be actively supported through government networks (e.g., KOTRA).

- Anticipating China’s shift from an investment-led to a consumption-led demand structure as its overinvestment is calibrated, sustained efforts to enter and tap into the Chinese consumer market are also crucial.

■ Concurrently, the drive for economic structural reforms to enhance Korea’s international competitiveness should continue.

- To smoothly navigate internal and external changes, it is imperative to enhance the flexibility of the Korean economy.

· A rigid economy is vulnerable to adverse spillover from shocks, whereas a flexible economy can absorb and adapt to such disruptions.

- Ultimately, the positive outcomes of market diversification hinge on securing corporate competitiveness. Therefore, maintaining ongoing efforts to invigorate economic vitality through structural reforms is necessary, including easing market entry barriers, increasing labor market flexibility, and overhauling the education system.

Summary

KDI Economic Outlook 2023-2nd Half The Rising Labor Participation of Women in Their 30s: Underlying Factors and Implications

■ The upward trend in the labor force participation rate among women in their 30s is closely linked to the declining proportion of women with children within this age bracket.

■ Currently, the reduction in the number of women in their 30s with children is mitigating the slowdown in labor supply. However, over time, it could result in a shrinking working-age population and labor force, exacerbating economic and societal challenges.

- Over the next five years (2024-2028), anticipated demographic changes, including a declining working-age population and aging, are forecasted to reduce the number of employed individuals by 30,000 to 40,000 annually. On the other hand, the rising labor force participation rate among women in their 30s is expected to bolster the employment numbers by approximately 40,000 each year, counteracting the effects of these demographic shifts.

- However, the economic participation of women in their 30s is on the rise coinciding with a deepening trend of low birth rates (the total fertility rate declining to 0.7 in the second quarter of 2023). In the long run, this poses alarming concerns regarding economic slowdown, pension fund stability, and deteriorating fiscal health for the government.

■ To address the observed trends and challenges, sustained policy support for work-family balance is essential to simultaneously boost both the labor force participation and birth rate of women during their childbirth and child-rearing years.

- While there appear to be considerable advancements in conditions that support the economic activities of women with children, child-rearing remains a chief deterrent to women’s workforce participation.

- It is essential to further develop and widely promote measures that support work-family balance, including options for reduced work hours during child-rearing phases and flexible work arrangements, alongside fostering a more universally family-friendly workplace culture.

- In addition, it is vital to strengthen economic self-sufficiency and accelerate the transition to family life for younger adults by enhancing their engagement in economic activities, which requires creating high-quality job opportunities to improve their current employment rates that lag behind those of major economies.

Summary

KDI Economic Outlook 2023-1st Half Semiconductor Market Trends and Macroeconomic Implications

■ Korea's semiconductor exports have been heavily concentrated in the highly volatile memory sector, making the industry more vulnerable to downturns.

- As of 2022, the proportion of the highly volatile memory semiconductor sector within Korea's semiconductor market was more than twice that of the global market. This discrepancy may have contributed to the 9.5%p decline in semiconductor exports during Q1.

- Despite the growing investment in non-memory semiconductors since 2018, Korea's semiconductor industry continues to exhibit a significant reliance on the memory sector, leading to persistently high levels of volatility in semiconductor exports.

■ The trajectory of the semiconductor industry is shrouded in uncertainty, but certain indicators suggest a potential trough might occur between Q2 and Q3.

- The latest replacement cycles of semiconductor-related products, coupled with the trends in production and inventory cycles, hint that the semiconductor industry may be approaching a trough.

- A deceleration in the semiconductor economy is likely to exert a negative impact not only on exports but also on domestic demand via income channels. This slowdown may lead to deteriorating tax revenue conditions in 2023-2024.

- However, given the relatively modest employment multiplier effect of the semiconductor industry, the repercussions on the labor market are expected to be minimal.

■ Elevating the share of the non-memory sector could contribute to reducing economic fluctuations. In addition, concerted efforts are needed to mitigate the spillover effect of intensifying geopolitical risks in recent times.

- Acknowledging the growing macroeconomic significance of the semiconductor industry, the recent diversification towards increasing the investment in the non-memory sector can be viewed positively from a standpoint of economic stability.

- Conversely, the semiconductor industry's high susceptibility to geopolitical risks, particularly in the context of the escalating US-China conflict, underscores the critical need to strengthen industrial, trade, and diplomatic leadership strategies to mitigate uncertainties in associated sectors.

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