South Korea’s Neo-Mercantilist Growth Engine Has Stalled

Capital accumulation and productivity growth are the outcome of free market investment and not of government spending. This is well known to Austrian school economists. Rothbard1 argued that only the free market can ensure an efficient allocation of factors of production whereas government sponsored investment is “either malinvestment or not investment at all, but simply waste assets.” Mises2 explained how restricting market competition shifts production to places with less favorable conditions, resulting in lower labor productivity and standards of living. Nevertheless, this point still needs to be understood by countries such as South Korea, whose growth model driven by state-led and export-oriented industrialization appears to have reached its limits.

Remarkable Success Story of Growth at First Sight

Korea grew from one of the poorest economies in the 1960s into an advanced economy while avoiding the middle-income trap. Its GDP per capita in PPP (purchasing power parity) almost reached the OECD (Organisation for Economic Co-operation and Development) average in 2018 after having been less than one-sixth in 1970 (Graph 1). Rapid growth rates of between 7 and 10 percent for several decades until the mid-1990s were propelled by very high investment which peaked at 40 percent of GDP in 1990 and has averaged around 32 percent of GDP since then (Graph 2).


Rapid industrialization and deep integration in the global value chains helped Korea become the world’s fifth-largest exporter of manufactured goods in 2017. It is most striking that behind this seeming outstanding success lies an active industrial policy. Government support for large business groups, known as chaebols, via subsidies and trade and investment barriers turned the likes of Samsung, Hyundai, LG, Kia, and Daewoo (now defunct) into global champions. But as Ryan McMaken points out, there are a lot of “unseen” missed economic opportunities behind Korea’s government-corporate “cooperation,” which means that centralized decision-making and government favoritism to big businesses obviously come at a price.

Growth Slumping While Productivity and Consumption Lag Behind

Growth typically decelerates when countries grow richer. Yet Korea’s decline in real GDP growth has been very abrupt—from about 7–8 percent in the 1980s and 1990s to below 3 percent currently. Its potential output has also slumped, driven by slowing capital accumulation and total factor productivity despite the very high investment rates. Most importantly, labor productivity has lagged significantly behind the rapid GDP growth. In 2018 Korea’s real GDP per capita was one-third lower than that of the top half of OECD countries, while labor productivity was 46 percent below that of the same sample (Graph 3). The difference is compensated by longer working hours—Koreans work 15 percent more than the OECD average and 30 percent more than the EU average.

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