This study aims to empirically assess Korea’s economic growth since the late 1990s after the 1997 foreign exchange crisis and to draw policy implications.
A proximate determinants study based on growth accounting models found that the slowdown of capital accumulation was the main reason behind the economic slump that Korea suffered after the foreign exchange crisis. This “slower capital accumulation” hypothesis, however, does not successfully explain the mechanisms through which the crisis hampered capital accumulation in Korea, and why several East Asian countries including Korea jointly experienced slower investment growth.
A model analysis found that the changes in the economic growth rate since the 1990s derived mainly from productivity shocks, and that this pattern has grown stronger since the 2000s, which suggests that the lower average growth rate after the crisis represents a lowered potential growth rate. The findings also imply that the lower growth rate is of a permanent nature, and that raising the average growth rate requires policies addressing the supply side of the national economy rather than demand stimulating measures.
It is difficult to argue whether or not China’s explosive growth has been one of the major reasons behind Korea’s slower growth. Although the negative impacts of heightened competition coming from China were mainly concentrated in pre-crisis period, it is hard to deny that China’s aggressive competition negatively influenced Korea’s manufacturing investments. On the other hand, China’s recent economic growth provided Korean firms with many opportunities such as expanded exports of capital goods or machinery parts. China’s future growth volatility or stagnation can threaten Korea’s economic prospects.
From a macro-economic perspective, Korea’s total factor productivity did not worsen after the crisis and even improved a bit. The uncertainty stems from its small magnitude and the presence of many counter-arguments. An international comparison of growth accounting by sectors shows that the service industry has enjoyed relatively slower productivity gains than the manufacturing industry since the 1990s, which means the service sector has an important role to play in raising the overall productivity of the Korean economy in the future. This study empirically shows that the quality of the labor force in Korea is generally on the decline. The diminishing quality of Korea’s highly educated workforce, in particular, is one of the main factors slowing productivity growth in the service sector.
Whereas Korea’s economy has undoubtedly slowed since the crisis, the slowdown need not be viewed too pessimistically when taking into consideration the international standard. Also, Korea can ensure that China’s ongoing strong growth does not threaten its economy by, foremost, differentiating itself from China in technology and human resources management. It is also necessary for Korea to set up a strong institutional infrastructure to maintain stable trade relations with China.