Korea’s strong recovery from the 2008 global recession has been driven by buoyant export growth, due to the won’s depreciation and demand from China, and an effective policy response. The fiscal stimulus was the largest in the OECD area, while monetary policy and measures to support financial institutions helped to prevent a liquidity crunch. Output is projected to grow 5¾ per cent in 2010 and 4¾ per cent in 2011, as a double-digit increase in exports leads to stronger domestic demand growth. With the recovery on track, government spending is being reduced in 2010, which is necessary if Korea is to achieve its medium-term target of cutting the fiscal deficit to close to zero by 2013 and keeping gross government debt below 40% of GDP. Meanwhile, the policy interest rate has remained at a record low of 2% for more than a year. Given the strength of the expansion, it is important to begin normalising interest rates to ensure that inflation remains within the central bank’s 2% to 4% medium-term target.

Korea has achieved one of the fastest recoveries in the OECD area from the global recession. Korea’s trade-dependent economy had initially been hard hit by severe global financial distress in late 2008, leading to exceptionally sharp declines in exports and output. The recession was accompanied by financial turbulence that widened risk premia and tightened bank lending attitudes. Large capital outflows pushed down equity prices but the resulting depreciation of the won – by 25% in effective terms during the six months from August 2008 – combined with strong demand from China laid the foundation for an export-led recovery. Indeed, Korea became the ninth-largest exporter in the world in 2009, from 12th in 2008, and its current account surplus rose to 5% of GDP. Korea’s strong recovery, together with its chairmanship of the G20 in 2010, have significantly raised its profile in the global economy.

Korea has achieved one of the strongest recoveries among OECD countries from the 2008 global recession, led by its robust export performance and the largest fiscal stimulus among member countries. The expansion is projected to continue through 2011 as the positive impact from external demand spreads further to the domestic economy. Sustaining high growth over the medium term requires narrowing the large labour productivity gap with more advanced OECD economies through reforms, particularly in services, where productivity is low. The priority is to strengthen competition by eliminating domestic entry barriers, accelerating regulatory reform, upgrading competition policy and reducing barriers to trade and inflows of foreign direct investment. Such measures should be accompanied by reforms to reduce labour market dualism, which has negative consequences for growth and equity. In addition, it is important to increase labour force participation, notably among women and older persons, not least to mitigate the impact of population ageing.

Korea’s strong recovery from the global financial crisis stems in part from an effective macroeconomic policy response. The prompt withdrawal of fiscal stimulus in 2010 will help meet the medium-term fiscal plan for reducing budget deficits. Given the increase in government spending in the past, making the targets in the plan more binding is important to help achieve the fiscal target. In addition, the broadening of tax bases would be beneficial in this regard. While such policies would help limit government debt, it is also necessary to contain the rapidly rising debt of public corporations, in part by further progress in the 2008 privatisation programme. Monetary stimulus has also supported the recovery. Given the expected strength of output growth in 2010, it is important that the Bank of Korea not fall behind the curve in withdrawing monetary stimulus. Korea should continue its flexible exchange rate policy.

The intensification of the global financial crisis in late 2008 led to large capital outflows from Korea and turmoil in its capital markets. However, the prompt response by the government and the central bank stabilised Korea’s financial sector in early 2009 and recovery followed relatively quickly. In contrast to 1997, financial institutions have overcome the crisis without significant damage. Increased assistance for small and medium-sized enterprises has played a large role in overcoming the crisis, but should be scaled back to avoid supporting non-viable firms and to expand banks’ capacity for risk appraisal, leading to a more marketoriented financial system. As a small open economy, Korea also needs to reduce its vulnerability to sudden capital outflows. In addition, it is important to use prudential regulations effectively to limit the risk of mortgage lending, upgrade the corporate governance of financial institutions and develop securitisation by ensuring transparency.

Korea’s health-care system has contributed to the marked improvement in health conditions, while limiting spending to one of the lowest levels in the OECD through high patient co-payments and limited coverage of public health insurance. However, spending is now increasing at the fastest rate in the OECD. With continued upward pressure, not least from rapid population ageing, it is essential to boost efficiency by reforming the payment system, reducing drug expenditures, shifting long-term care out of hospitals, promoting healthy ageing and introducing gatekeepers. As the heavy reliance on social insurance payments for health will be an increasing drag on employment as the population ages, it is necessary to raise the share of tax-based financing in conjunction with effective measures to keep spending in check. Measures to ensure adequate access for low-income households are a priority given the high out-of-pocket payments. Quality should be improved by enhancing transparency, promoting restructuring in the hospital sector and expanding the number of doctors.

Korea’s greenhouse gas emissions almost doubled between 1990 and 2005, the highest growth rate in the OECD area. Korea recently set a target of reducing emissions by 30% by 2020 relative to a “business as usual” baseline, implying a 4% cut from the 2005 level. Achieving this objective in a cost-effective manner requires moving from a strategy based on voluntary commitments by firms to market-based instruments. The priority is to establish a comprehensive cap-and-trade scheme, supplemented, if necessary, by carbon taxes in areas not covered by trading. Achieving a significant cut in emissions requires a shift from energy-intensive industries to low-carbon ones. Korea is strongly committed to promoting green growth through its Five-Year Plan, which envisages spending 2% of GDP per year through 2013. One challenge is to ensure that these expenditures are efficiently targeted so as to develop green technologies, while avoiding the risks inherent in industrial policy.