South Korea’s labour productivity increase during 1960-2023 was one of the fastest among G20 countries, although its level still lags the OECD average. Its rapid economic transformation, particularly during its high growth era (1962-96), has been studied as a model for developing countries, although there are diverse opinions on whether Korea’s success was government -driven or market-led. Productivity and output growth remained consistently robust during this period, while policies shifted abruptly from general export promotion to the Heavy and Chemical Industry drive and to market reforms. This suggests that rapid growth was primarily due to getting the fundamentals right: i) a high level of investment in education; ii) outward-oriented policies; iii) maintaining macroeconomic stability; iv) encouraging business investment; and v) developing rural areas.
However, extensive government promotion of specific industries during the 1970s resulted in a period of “inefficient growth” with declines in total factor productivity (TFP). Moreover, Korea failed to develop sufficiently the rules for a market economy, leaving it vulnerable to the 1997 Asian Financial Crisis. Despite many reforms since then, Korea’s potential growth rate has slowed to 2%, limiting the scope for further convergence to the highest -income countries. Growth is limited by the legacy of Korea’s development strategy, which left it with a polarised economy; large productivity gaps between the manufacturing and service sectors and between large firms and SMEs, as well as labour market dualism. Moreover, with the world’s lowest fertility rate, Korea faces heavy demographic headwinds, as well as diminishing returns from its large investment in factor accumulation, making TFP the key to sustaining growth. This requires increasing openness by further reducing barriers to trade, FDI and foreign workers, improving the innovation system, reforming education, improving SME policy, strengthening competition policy and enhancing labour market flexibility.
Author Randall S. Jones