This past year—2007—was another solid one for Korea’s economy. Buoyed by continued strong exports and a pickup in domestic demand, real GDP is estimated to have grown by nearly 5 percent in 2007, similar to the previous year, while inflation remained well under control, at about 2.5 percent on average for the year. Prospects for this year are also generally favorable, with growth expected by the IMF to moderate slightly, to about 4.5 percent, in line with slowing global growth and inflation remaining moderate.
It is true, of course, that the current volatility in global financial markets has intensified risks to this outlook. The direct impact on the Korean financial system of the ongoing global turmoil related to the U.S. subprime crisis appears limited. But with a sharp slowdown in the United States and the European Union, Korea’s exports—along with those of the rest of Asia—would surely slow. Higher oil prices also have the potential to slow growth and raise inflation pressures. Nevertheless, Korea seems well positioned to weather any such contingencies.
In the longer run, however, Korea faces a sterner test. In particular, a rapidly aging population will threaten Korea’s growth potential and impose enormous fiscal pressures. These issues are not unique to Korea—other advanced economies are also growing older—but Korea is aging faster than perhaps any other country in history. Without a forceful policy response to this dramatic shift, the Korean labor force will begin to decline within the next decade, while spending onpensions, health care, and long-term care will rise precipitously over the next half century.
The good news is that the full effect of these pressures should not be felt for several decades. There is, then, still time to address these problems. Moreover, Korea’s history of fiscal prudence provides confidence that the necessary steps will be taken. But the window of opportunity is actually much smaller than one might think, and early action will be needed to allow a smooth transition to a significantly older Korea. More concretely, the key will be to use a broad range of policy tools, including pension and health care reform; tax base broadening and improved tax collection; a reallocation of public expenditures; and measures to boost labor force participation rates of, in particular, women and older workers. Perhaps the first step is to move the policy debate forward by raising consciousness of the challenges ahead and laying out policy options.