South Korea’s Next S-Curve: A New Economic Growth Model for 2040

Despite achieving remarkable success in rapid economic growth in recent decades, South Korea now sits with historic low economic growth rates of under 2%. Taking immediate action with a new growth model could help the country rise again to become a powerhouse of productivity and value and become a top 7 economy.

South Korea is at a crossroads. Once a country that propelled itself from poverty into a successful economy with an astounding annual growth rate of around 6 to 9% through the 1980-2010 period, its growth rate has now plateaued at 1 to 2%.

The situation could be very different. McKinsey’s analysis indicates South Korea has the potential to reach $70,000 GDP per capita by 2040 and become one of the top seven economies in the world. To attain this, however, South Korea’s GDP growth will need to double from today’s numbers to 4%. This is no small undertaking, and the fact is that its current growth model, focused on heavy manufacturing industries, will face continued declines in growth without a fundamental change.

With a new growth strategy, South Korea once again could unleash significant economic growth. The country has various hurdles to conquer, however. External factors, such as trade tensions between China and the United States and the conflict in Ukraine present challenges that are affecting countries worldwide. Internally, South Korea need to address, among other factors, its decreasing population, slow-to-develop capital markets, and weakening core industries.

South Korea’s population is steadily declining, despite government efforts to boost population growth. In fact, South Korea currently has the lowest birth rate in the world with around 0.7 births per woman. The software, biopharmaceutical, and semiconductor industries are lacking essential skills – industries that are vital to economic growth.

South Korea’s capital markets are underdeveloped relative to its economy. For example, with $18 billion, it ranks 23rd in foreign direct investment, behind Indonesia and Chile, despite being a top 13 economy in 2022. The level of financial depth (measured by the value of private and public equity vs. its GDP) is less than 10%, behind China and Malaysia. This is mainly caused by investors undervaluing South Korean company stock, low venture capital funds, and unpredictable start-up funding rounds.

South Korea’s previously high economic growth was pushed by a growth model that focused on heavy and chemical industries. They now account for about 38% of the country’s manufacturing industry and play an important role in exports. However, these industries are currently threatened by increasing competition and lower global demand, and are no longer fit to boost the economy. For example, the petrochemical industry, which was the #2 export sector in 2022, faces an almost 20% oversupply in China, which is South Korea’s main export destination.

South Korea needs to change its growth model to avoid economic decline. McKinsey has identified eight actions along three strategic imperatives: restructure, shift, and cultivate. With the adoption of these initiatives, South Korea’s economy could be characterized by various growth-boosting features by 2040. Examples of these actions include:

Restructure: The first is restructuring industries facing disruptions – including core areas such as automotive, petrochemicals, and shipbuilding. For example, more than 60% of South Korean automotive component companies are unprepared for the shift to EVs. They will need to radically shift their portfolio with the decline of internal combustion engines. In shipbuilding, the number of employed workers declined by more than 50% from 2014 to 2022, from 204,000 to 92,000. Shipbuilders will need to find new higher sources of value add, such as autonomously driven ships.

Shift: South Korean companies need to shift to higher value-added, next-generation technologies across its core industries. For example, in semiconductors, areas such as neuromorphic and quantum computing are expected to be over $1 trillion industries by 2035. In the energy industry, there is a major shift to renewable and sustainable growth, with carbon capture, SMRs (Small Modular Reactors for nuclear), and offshore wind expected to be major growth drivers.

Cultivate: One of the key opportunities will be cultivating talent in high-growth areas. For example, in artificial intelligence alone, South Korea needs to aim for 50,000 additional skilled workers. Given slowing birth rates, attracting foreign talent will be critical. South Korea's overseas inflow rate for people with higher education was 2.8%, ranking 33rd out of 37 OECD countries. Only Turkey, Chile, Colombia, and Mexico had lower rates. While the number of foreign professionals quadrupled in Japan from 2012 to 2022, this stayed flat in South Korea. South Korea will have to take an active approach to attracting global talent.

It's now time for South Korea to emerge from economic stagnation. Failing to act could lead to the economy falling to lower levels. There are signs of potential growth: digital innovation, start-ups, the emergence of high-growth industries, and opportunities for cooperation with other countries. By implementing a new growth model and boosting productivity, South Korea could kickstart its next S-curve to become a global economic leader by 2040.

Richard Lee is a senior partner in McKinsey’s Seoul office.