Korea 2024 OECD Outlook: Growth, Climate

GDP growth in Korea has recovered, supported by strong exports. Employment remains stable at a high level, while unemployment is low. Interest rates have likely peaked and housing prices have stabilised, all of which should support consumption going forward. Household debt remains high, and construction-related project finance has become a financial stability concern. Reforms to ensure fair competition in the domestic market would increase productivity in the SME sector. Reducing greenhouse gas emissions in line with the 2030 target requires tightening the emissions trading scheme and reforming energy markets to incentivise clean electricity supply and energy savings. The Korean fertility rate has fallen to the lowest in the world, which will put labour supply and public finances under pressure. A large career cost for women who become mothers holds back female employment and fertility, and underpins the widest gender pay gap in the OECD. Improving the work-life balance for both genders, closing remaining gaps in family policies, addressing high housing and education costs, and tackling labour market dualism are key to reverse the trend. Such reforms, combined with increasing the legal retirement age, reducing the high significance of seniority in determining wages, and a more welcoming regime for work immigration, would also boost labour supply and tax revenue.SPECIAL FEATURES: PRODUCTIVITY, CLIMATE POLICY, BOOSTING FERTILITY AND RESPONDING TO AGEINGGrowth has strengthened after a soft patch, largely reflecting the fortunes of semiconductor exports. Monetary policy loosening is on the horizon, while fiscal restraint is needed to prepare for ageing.Trade is a key driver of growth but creates dependencies. Exports, of semiconductors in particular, have accounted for much of the cyclical ups and downs since the exit from the COVID-19 crisis, with GDP growth projected to recover to 2.6% in 2024 and 2.2% in 2025. Trade tensions between Korea’s main trading partners, the United States and China, are felt but with limited economic fallout so far. High supply chain dependencies on individual countries for some critical inputs are key risks to hedge.Private consumption has been weak, pulled down by high interest rates and weak real wage growth but shored up by strong employment and pandemic-era excess savings. With disinflation, interest rates having peaked and housing prices stabilising, consumption is expected to gradually pick up going forward.Annual growth rates, %, unless specified2022202320242025Gross domestic product (GDP)2.71.42.62.2Private consumption4.21.81.42.4Gross fixed capital formation-0.21.41.02.1Exports3.93.66.92.4Imports4.23.51.22.4Unemployment rate (%)2.92.72.93.0Headline CPI inflation5.13.62.52.0Current account balance (% of GDP)1.31.94.54.7General government fiscal balance (% of GDP)-1.7-0.8-0.9-0.3Source: OECD Economic Outlook 115, updated with recent data releases.The government has started to consolidate public finances, after fiscal policy supported demand and reduced poverty during the pandemic. A proposed fiscal rule can help meet spending pressures from rapid ageing, while a tax revenue shortfall in 2023 points to room for improving fiscal and debt management frameworks.Inflation expectations have remained well anchored. The policy rate has been kept at 3.5% since early 2023 after a cumulative tightening of 3 percentage points. Inflation has trended down since July 2022, and is in the process of reverting to target (Figure1 ).A weak property market caused financial turbulence. Housing prices fell around 9% in nominal terms during the year to June 2023, after which they stabilised. Macroprudential easing and policy lending contributed to nominal stabilisation, and macroprudential regulations have limited the risk of widespread defaults on household debt. The combination of tight financial conditions and a weak property market has uncovered vulnerabilities in non-bank financial institutions, centred on construction project finance, but systemic risk remains low.Source: OECD, Economic Outlook (database); Bank of Korea.Productivity growth has declined in Korea, reflecting the global trend and less scope for catch-up growth as Korea has reached the OECD average per capita GDP. Past GDP growth resulted largely from increasing employment and heavily investing in capital and education. Going forward, considerable scope remains to raise SME productivity towards that of large companies by means of pro-competition reforms levelling the playing field in the domestic market.A “red light” reform to consolidate state support could help break a vicious cycle. Central government spending on SME subsidies is high and increasing. A total of 1646 programmes were in place in 2023 to support SMEs, 530 run by 18 ministries and central government agencies and 1116 by the 17 regions (Figure2 ). SMEs also enjoy special treatment in public procurement, lower taxes, size thresholds in regulations and other benefits. Consolidation of support and protection in various forms could reduce the risk that these policies lock resources in low-productive uses and thereby hold back overall productivity.A “green light” reform removing regulatory hurdles could foster private enterprise. Korea has streamlined regulations over time, and overall product market regulations are around the OECD average. Greater foreign competition could be particularly beneficial in domestic markets requiring scale to compete, such as those dominated by the large Korean conglomerates and network sectors. Competition reforms in sectors with heavy state involvement would help provide services more cost-effectively and correct relative price distortions, notably for electricity and rail. Korea has a well-developed system of regulatory sandboxes and “Regulation free zones” which allow trialling new technologies and business models. Many projects are coming to the end of their sandbox period which makes it a priority to speed up the related regulatory overhaul.Korea has pledged to reduce greenhouse gas emissions by 40% in 2030 and become carbon neutral in 2050 (Figure3 ). Proper calibration of allocations to Korea’s emissions trading scheme can ensure that the targets are reached.Emissions peaked in 2018 and the policy framework is moving forward. Approximately three quarters of Korea’s greenhouse gas emissions are capped by the emissions trading scheme. Setting its 2026-30 emissions limit in line with the 2030 target is necessary to inspire confidence in Korea’s overall target achievement.Korea’s economy is very energy intensive. Decarbonising sectors such as petrochemicals, iron and steel will require additional clean electricity and energy savings. In the current system, the carbon price from the emissions trading scheme is not fully reflected in electricity generation. The government has raised electricity prices considerably to better reflect the true cost of energy, but they remain regulated and vary across categories of end users.Koreans support action on climate, but concrete policy instruments are unpopular. Support for necessary but unpopular policies could be built by means of dialogue, place-based measures and by bundling climate policy with policies supporting structural change, reducing inequalities and boosting incomes.Source: OECD, Air and climate (database).The Korean fertility rate has fallen to the lowest in the world (Figure4 ). As a result, the population is set to halve over the next six decades and the old-age dependency ratio is projected to surge rapidly, putting considerable strain on labour supply and public finances. Supporting people to have the number of children they desire would dampen the projected population decline, while lengthening working lives and welcoming more foreign workers would counteract the adverse effects of ageing.Figure4.Korea’s fertility rate is at a record-lowImproving the work-life balance could help reverse the decline in the fertility rate while boosting female employment. Spending on childcare has significantly increased, but the current childcare system does not fully meet the needs of working parents, partly reflecting scarcity of quality childcare and short opening hours. Despite improvements, Korean parents underutilise paid parental leave due to stringent eligibility criteria, low benefits, and a fear of adverse career consequences reflecting the cost on employers.The weak financial position of youth holds back family formation. Addressing labour market dualism by a combination of streamlining employment protection and strengthening social insurance would help. Alleviating the burden of high housing cost and reducing the need to pay for expensive private tutoring would also strengthen the economic position of parents.Korea must prepare for and adapt to the inevitable challenges of ageing. The old-age dependency ratio will surge even more than elsewhere (Figure5 ). Combined reforms to increase immigration, employment and fertility can dampen a dramatic increase in the number of elderly to be supported by each person employed.Figure5.The old-age dependency ratio will be the highest in the OECDRatio of individuals aged 65 and over to those aged 20 to 64Source: OECD (2023), Pensions at a Glance.Careers are shortened by the seniority-based wage system which renders older workers less appealing to firms when the wage rises above productivity. Company-specific mandatory retirement ages below the legal pension age and the practice to encourage older employees to voluntarily leave even before reaching this mandatory retirement age also contribute to premature retirements from their main job.The potential to increase immigration and make better use of foreign labour is considerable. Current low-skill work immigration policies allow low-productivity firms to overly rely on migrant workers on temporary work visas and making these workers dependent on their employers. Meanwhile, high-skill immigration is held back by various visa hurdles. Foreign students find it difficult to stay after graduation and start-up visa issuance remains low, despite growing interest.Responding to inflation and fiscal challengesThe government has proposed a numerical fiscal rule, which is pending parliamentary approval. This rule is meant to complement the current fiscal framework’s long-term projections and spending reviews.Adopt the proposed fiscal rule and continue to carry out regular spending reviews to ensure long-term fiscal sustainability.The budget is projected to remain in deficit in 2024 and 2025.Restrain spending in 2024 and 2025 in line with current plans.Inflation is trending down towards target, despite inflationary pressures related to food and energy in early 2024.Condition monetary policy easing towards late 2024 on inflation approaching the target.Levelling the playing field to boost SME productivityA large share of SMEs receive subsidies, while their productivity gap to large companies remains well above the OECD average.Limit the scope for broadly defined public support to companies to a list of permitted causes linked to market imperfections, regardless of company size.A fragmented and poorly coordinated system of 1646 SME subsidy programmes run by 35 public entities differentiates support by company size.Consolidate public support to companies into a small number of programmes operated by a dedicated public entity at an arms-length distance from politics.Overall product market regulation stringency is around the OECD average, with ample room to reduce barriers to trade and state involvement in business operations in services and network sectors.Shift to a comprehensive negative-list regulatory system.Achieving climate targetsAllocations for the fourth trading period (2026 to 2030) of Korea’s emissions trading scheme will cap three quarters of Korea’s emissions.Allocate a total number of allowances to the emissions trading scheme fully proportional to the 2030 target.Korea’s emissions trading scheme has experienced low liquidity in the past.Auction a considerable share of allowances in regular auctions.In the current system, the carbon price from the emissions trading scheme is not fully reflected in electricity generation. The government has raised electricity prices to better reflect the true cost of energy, but they remain regulated and vary across categories of end users.Build on planned electricity market reforms to move towards a market-based system where the true cost of energy and emissions is fully reflected in electricity supply and use.80% of Koreans support carbon pricing if revenues are used to support low-carbon technologies and environmental infrastructure. Necessary actions to reduce greenhouse gas emissions can have negative distributional consequences.Link revenue from carbon pricing politically to green expenditure, and link reforms to correct energy prices to labour market reform and a strengthening of the social safety net.Responding to population declineWorkplace childcare and public childcare are preferred but in short supply, while there is excess supply of low-quality private childcare, and formal childcare hours do not align with full-time workweeks.Tighten and enforce quality criteria for private childcare, improve the accessibility of public childcare, encourage workplace childcare, and extend formal childcare hours to accommodate working parents’ needs.A considerable share of the workforce is not eligible for paid parental leave due to strict eligibility criteria.Expand parental leave coverage to the entire workforce.The government recently raised the parental leave benefit ceiling in cases when both parents take the leave, while lengthening the maximum duration of the leave.Increase the parental leave ceiling for all leave takers, while introducing the option to take shorter leave at a higher replacement rate, bridging potential funding gaps.Employers carry a considerable share of parental leave costs and co-workers often end up working extra when leave is taken, leading relatively few parents to use their paid parental leave rights compared to other OECD countries.Finance maternity, paternity and parental leave benefits and associated charges with public resources, eliminating the direct costs to employers.Sanctions for workplace discrimination are weak and legal enforcement is patchy.Strengthen sanctions for workplace discrimination and the capacity of the labour inspectorate to follow up.Many young people either postpone their careers to land high-quality jobs in large firms, or start at smaller companies with non-regular contracts.Break down labour market dualism by relaxing employment protection for regular workers, while expanding social insurance enrolment.The housing supply shortage, particularly in Seoul, drives escalating prices, partly hindered by stringent regulations limiting private sector involvement.Consider further relaxing regulations on reconstruction and presale price caps, as they undermine the profitability of private housing projects, thereby restricting housing supply.Many workers are forced to retire early, mainly due to the practice of honorary retirements, company-specific mandatory retirement ages, and the seniority wage system.Introduce a flexible wage system tying wages to job characteristics and performance, irrespective of age, and restrict honorary retirement. In this context, consider phasing out company-specific mandatory retirement ages.The pensionable age is currently 63, one of the lowest in the OECD, and set to increase more slowly than in other OECD countries.Raise the pension eligibility age further than currently legislated by 2035 and link it to life expectancy thereafter.The inflow of skilled migrant workers significantly lags behind other OECD destinations, partly reflecting stringent visa regulations.Relax strict visa eligibility requirements for skilled migrants.Many migrant workers with a visa for low-skilled time-limited work already possess the education sought by employers for higher-skilled jobs.Streamline the transition from temporary low-skilled status to skilled trade worker status. #J-18808-Ljbffr