🚨 Decline in Korea's Potential Growth Rate: A Warning Sign of Economic Weakness

Today Korean Economic News | 2025.05.13

📌 Korea's Potential Growth Rate Falls Below 2% for First Time…Signal of Economic Weakness

💬 The OECD forecasts Korea's potential growth rate will be 1.98% in 2026. Domestic institutions also predict rates in the 1% range, with declining working-age population due to low birth rates and aging society identified as the main cause. The Korea Development Institute (KDI) warned of possible economic slowdown due to weak domestic demand and worsening external conditions, emphasizing the need for structural reforms to improve total factor productivity.

1️⃣ Easy Understanding

There are growing concerns about the weakening of Korea's basic economic strength. The economic community is on alert as the OECD forecasts that Korea's potential growth rate will fall below 2% for the first time in 2026.

Potential growth rate means the maximum speed at which an economy can grow without causing inflation. Simply put, it's the economy's "basic strength." Korea's potential growth rate, which was in the 7% range in the 1990s, has been continuously declining, and now it's expected to fall below 2%.

The biggest cause of this decline is low birth rates and aging population. Korea is one of the fastest-aging countries in the world, with a rapidly decreasing working-age population (15-64 years). According to Statistics Korea, the working-age population has been decreasing by about 300,000 people each year since 2020, and this rate is expected to accelerate from the 2030s.

Weak domestic demand is also a serious problem. While semiconductor exports have recently shown recovery, domestic consumption and investment still lack vitality. Increased household debt, real estate market depression, and high interest rate burdens are weighing down the domestic economy. In addition, strengthened U.S. protectionism and deepening U.S.-China conflicts are limiting Korea's growth potential.

Economic experts at home and abroad agree that Korea needs to pursue structural reforms to secure new growth engines and improve productivity. They point to the need for expanded investment in advanced technology fields such as AI, robotics, and biotech, along with regulatory reform, increased labor market flexibility, and educational innovation.

The decline in potential growth rate directly affects people's daily lives. When economic growth slows, job creation becomes difficult, income growth is limited, and the government's ability to increase welfare spending may be reduced. Therefore, it's time for the government, businesses, and citizens to recognize the seriousness of this problem and work together to find solutions.

2️⃣ Economic Terms

📕 Potential Growth Rate

Potential growth rate means the maximum economic growth rate that can be achieved without causing inflation.

• It's the growth rate possible when production factors such as labor, capital, and technology are maximally utilized.
• It's an indicator of a nation's basic economic strength and an important standard for establishing economic policies.

📕 Working-Age Population

Working-age population refers to people between 15 and 64 years old who can participate in economic activities.

• It's a key factor determining a country's labor supply.
• Due to low birth rates and aging population, Korea's working-age population began to decrease in 2020.

📕 Total Factor Productivity

Total factor productivity shows how much factors other than labor and capital contribute to economic growth.

• Technological innovation, management efficiency, and institutional improvements affect total factor productivity.
• Improving total factor productivity is essential for long-term economic growth.

📕 Structural Reform

Structural reform means institutional and policy changes to fundamentally improve economic conditions.

• It includes reforms to increase efficiency across the economy, including labor markets, financial systems, public sectors, and business environments.
• Though costs may occur in the short term, it's necessary to secure long-term growth potential.

3️⃣ Principles and Economic Outlook

💡 Causes and Effects of Declining Potential Growth Rate

• Let's analyze the causes and effects of Korea's declining potential growth rate.

  • First, population structure change due to low birth rates and aging is the biggest cause. Korea's total fertility rate is 0.72 as of 2023, the lowest among OECD countries. As a result, the working-age population is rapidly decreasing and is expected to fall by about 40% from 2020 to 2050. The decrease in labor input is a direct factor in the decline of potential growth rate. Also, the increase in elderly population raises the nation's dependency burden and weakens fiscal soundness. In particular, aging can lead to reduced productivity and innovation capacity, having complex effects on potential growth rate.

  • Second, stagnant investment and productivity are problems. Korean companies' facility investments have been stagnant in recent years. Except for some advanced industries like semiconductors and batteries, active investments are not being made, and small and medium-sized enterprises have even more limited investment capacity. Also, the total factor productivity growth rate has dropped significantly from the 3% range in the 1990s to less than 1% recently. This means that productivity improvement through technological innovation and institutional improvement is insufficient. It shows that securing new growth engines in the era of the 4th industrial revolution is being delayed.

  • Third, declining potential growth rate causes various economic and social problems. When economic growth slows, job creation becomes difficult and income growth is limited. In particular, youth unemployment may become more serious. Also, fiscal soundness may worsen due to reduced tax revenue and increased welfare spending. When the national debt ratio rises, the burden on future generations increases and economic stability decreases. In the long term, it could lead to weakened national competitiveness and declining international status, requiring responses across the economy and society.

• The decline in potential growth rate is an important signal showing structural changes in the Korean economy. Since this is a long-term trend rather than a short-term economic fluctuation, fundamental measures are needed to improve population structure and enhance productivity.

💡 Weak Domestic Demand and Consumer Spending Cycle

• Let's look at the causes and effects of the long-term weakness in the domestic economy.

  • First, households' consumption capacity is weakening. With high household debt reaching about 105% of GDP, interest burdens have increased due to high interest rate policies. Falling housing prices have reduced asset effects and weakened consumer sentiment. Also, income growth is limited due to employment instability and lack of quality jobs. Recent price increases have further weakened real purchasing power. Food prices have risen significantly, with the price of a serving of samgyeopsal (pork belly) exceeding 20,000 won, increasing the consumption burden on households.

  • Second, companies' investment enthusiasm is also reduced. Due to increased future uncertainty and weak consumption, companies tend to prefer holding cash rather than investing. Export prospects are also unclear due to the global economic slowdown and strengthened protectionism. Small businesses and self-employed people are experiencing management difficulties due to minimum wage increases, raw material price increases, and rent burdens. Construction investment is also contracting due to the real estate market depression, becoming an obstacle to domestic demand activation.

  • Third, if domestic demand remains weak, the economic virtuous cycle structure may collapse. When consumption decreases, corporate sales decrease, which leads to reduced investment and employment. When employment decreases, household income decreases and consumption is further reduced, creating a vicious cycle. This weak domestic demand risks deepening economic polarization and expanding social inequality. Also, when the domestic economy is weak, it becomes more vulnerable to external shocks, reducing the stability of the entire economy.

• To stimulate domestic demand, various policy efforts are needed, including increasing household income, promoting corporate investment, and improving consumer sentiment. It's important to approach with a medium to long-term perspective to strengthen economic fundamentals along with short-term economic stimulus measures.

💡 Strategies to Secure Growth Potential

• Let's explore strategies and policy directions to enhance Korea's growth potential.

  • First, digital transformation and technological innovation for productivity improvement are essential. It's important to upgrade the industrial structure by actively utilizing digital technologies such as AI, robotics, and big data. The government is investing in data infrastructure, 5G networks, and AI ecosystems through the 'Digital New Deal', but more bold support is needed. In particular, helping small businesses and traditional industries with digital transformation and expanding regulatory sandboxes to promote new industry growth are necessary. Digital financial innovations, like the recent discussion on Security Token Offering (STO) legislation, are also important tasks to increase economic efficiency.

  • Second, investment in human capital and labor market reform are needed. In response to workforce reduction due to low birth rates and aging, it's necessary to increase the utilization of women, elderly, and foreign workers, and improve productivity through education and training. Building a lifelong learning system and developing talent that meets industry demands are important. Also, efforts are needed to resolve the dual structure of the labor market and reduce discrimination between employment types. Improving working environments for work-family balance and expanding job opportunities for young people are also urgent tasks.

  • Third, structural reforms and discovering new growth engines are important. Regulatory reforms to lower entry barriers and promote competition are needed to increase economic dynamism. It's also important to enhance the health of the industrial ecosystem through win-win cooperation between large and small companies. Strategic investments and support for new growth industries such as carbon neutrality, green energy, biohealth, and aerospace should be expanded. Trade strategies to raise the status of Korean companies and secure new market opportunities in the process of global value chain reorganization are also important.

• A productivity-led growth strategy is essential for the Korean economy to avoid falling into a low-growth trap. It's necessary to pursue balanced growth of domestic demand and exports by increasing total factor productivity through technological innovation, human capital investment, and regulatory reform.

4️⃣ In Conclusion

The forecast that Korea's potential growth rate will fall below 2% for the first time is a warning sign that economic strength is weakening. It's the result of a combination of factors: decreasing working-age population due to low birth rates and aging, stagnant investment and productivity, and weak domestic market.

The decline in potential growth rate is not just a change in statistical figures but an important issue directly linked to people's quality of life. When economic growth slows, job creation and income growth are limited, and fiscal soundness worsens, making welfare expansion difficult. It may also lead to social problems such as generational conflict and deepening polarization.

However, this challenging situation is also an opportunity to fundamentally improve the quality of the Korean economy. New growth engines can be secured through various strategies such as productivity improvement through digital transformation and technological innovation, human capital investment and labor market reform, deregulation, and new industry development.

In particular, advanced technologies and new financial services such as AI, biotech, green energy, and security tokens (STO) can bring vitality to the Korean economy. Efforts to increase household income and improve consumer sentiment to stimulate domestic demand should also be carried out in parallel.

Ultimately, overcoming the crisis of declining potential growth rate requires awareness change and cooperation from government, businesses, and citizens. We should focus on strengthening economic fundamentals and building social safety nets from a long-term perspective rather than short-term results. It's time to gather national capabilities so that the Korean economy can re-enter a sustainable growth path without falling into a low-growth trap.