Published on 5 October 2005
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The OECD assessment and recommendations on the main economic challenges faced by Korea are available by clicking on each chapter heading below. Chapter 1 identifies the challenges for which the subsequent chapters provide in-depth analysis and policy recommendations.
Chapter 1: Key challenges facing Korea
Rapid economic growth has boosted per capita income in Korea to two-thirds of the OECD average. Continuing the convergence to high-income countries requires addressing a number of structural weaknesses. This chapter looks at five key challenges: i) maintaining macroeconomic stability and a sound government financial position in the context of strong spending pressures due in part to population ageing; ii) improving the fiscal federalism framework to increase efficiency and provide greater autonomy to local governments; iii) upgrading the innovation framework by improving the R&D system, strengthening product market competition, particularly in the service sector, and restructuring the education system, especially at the tertiary level; iv) improving the functioning of the labour market, in part to reverse the trend toward dualism, and encouraging greater labour force participation, particularly among women; and v) restructuring the SME sector and further upgrading corporate governance practices, while addressing the weaknesses in the capital market.
Chapter 2: Economic prospects and macroeconomic policies
This chapter considers what macroeconomic policies are appropriate for Korea in light of the economic outlook and spending pressures over the medium term. The Bank of Korea should keep interest rates at low levels until domestic demand gains momentum, and avoid using monetary policy as a tool to stabilise real estate prices in some areas of the country. A policy of exchange rate flexibility and limited intervention in foreign exchange markets should be continued. As for fiscal policy, the focus should be on controlling expenditure, given rising spending pressures due to population ageing and the potential cost of economic integration with North Korea. There is an urgent need for reform of the National Pension Scheme, which is not sustainable. The use of public-private partnerships to promote private investment in infrastructure should be implemented cautiously so as to ensure efficiency gains and limit the budgetary costs and contingent liabilities of the government.
Chapter 3: Getting the most out of public-sector decentralisation
This chapter discusses policies to improve fiscal relations between levels of government to better meet the needs of citizens, an objective of the government’s “Roadmap for Decentralisation”. Although local government accounts for around half of total government spending, they have little autonomy and fiscal resources vary sharply between regions. The priority should be to enhance the independence of local authorities by establishing a clear division of responsibilities and transferring additional assignments to the local level. The general local governments should also have more influnence on education, while providing more support, through stronger linkages with the local education authorities, with a final aim of merger. The allocation of intergovernmental grants should be more transparent and the regulations attached to them should be relaxed to expand flexibility, while increasing reliance on block grants. Improving the fiscal federalism framework also requires more revenue raising power for local governments while simplifying the structure of local taxes. Greater accountability and rules are needed to ensure sound fiscal management by local governments.
Read also ECO Working Paper 468 Getting the most out of public-sector decentralisation in Korea
Chapter 4: Sustaining high growth through innovation: reforming the R&D and education systems
With inputs of labour and capital slowing, sustaining high growth rates in Korea will increasingly depend on total factor productivity gains, which are in turn driven to a large extent by innovation. While a number of Korean firms are at the world technology frontier in areas such as ICT, the diffusion of technology to lagging sectors is a priority to sustain growth. This chapter recommends policies to improve the science and technology system by upgrading the R&D framework, in part through closer linkages between firms, universities and the government, and enhanced intellectual property right protection. Strengthened competition, particularly in the service sector, is needed to promote the diffusion of new technologies. Innovation also requires policies to ensure the supply of high-quality human capital through reforms of tertiary education. This requires a restructuring of the university system through increased competition and deregulation, as well as additional financial resources to improve quality.
Read also ECO Working Paper 470 Sustaining high growth through innovation: reforming the R&D and education systems in Korea
Chapter 5: The labour market: enhancing flexibility and raising participation
This chapter analyses the increasing dualism in the Korean labour market and the need to encourage greater labour force participation. Although the rising proportion of non-regular workers lowers labour costs and increases employment flexibility, it has a negative impact on both equity and efficiency over the long term. Relaxing employment protection for regular workers and increasing the coverage of the social safety net for non-regular workers would help limit the extent of dualism. Population ageing is projected to be exceptionally rapid in Korea, leading to a significant decline in the workforce by mid-century. Steps to boost the participation of women through family-friendly policies are a priority. It is also important to encourage employees to stay at firms beyond the age of 50. Making the wage system more dependent on productivity and less on seniority and implementing a company pension system in place of the retirement allowance would help maintain the employment of older persons.
Read also ECO Working Paper 469 The labour market in Korea: enhancing flexibility and raising participation
Chapter 6: Reform of the corporate and financial sectors
This chapter analyses challenges in the corporate and financial sectors. The key priority is to restructure small and medium-sized enterprises (SMEs) to reverse the secular deterioration in their performance. This requires scaling back government assistance, including credit guarantees for lending to SMEs. It is also essential to maintain an open environment for foreign investors and to improve corporate governance further. In the financial sector, the privatisation of government-owned banks should continue, while encouraging banks to upgrade their credit analysis skills. The weak situation of some non-bank financial institutions requires prompt corrective action by financial supervisors. A major priority in this area is to develop the capital market, in part by strengthening credit rating agencies. In addition, there is a need for more long-term financial instruments in the context of population ageing. Finally, it is necessary to resolve the household delinquency problem through increasing reliance on court-based procedures.
A printer-friendly Policy Brief (pdf format) can also be downloaded. It contains the OECD assessment and recommendations, but not all of the charts included on the above pages.
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For further information please contact the Korea Desk at the OECD Economics Department at firstname.lastname@example.org. The OECD Secretariat's report was prepared by Randall Jones, Yokoyama Tadashi and Yongchun Baek under the supervision of Wilhelm Leibfritz.