Conference Papers
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August 2004, The 2004 KDI-KAEA Conference
Current Economic Issues of Korea-
Chapter 1-1An Analysis on the Recent Fertility Drop in Korea
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Chapter 1-2Population Aging and its Effect on the Inequality: An Extended Empirical Study of the Kuznets’ Inverted U-hypothesis
To investigate the relationship between population aging and inequality, we used three test methodologies such as panel data analysis, inverse logistic function estimation, and nonparametric kernel estimation. We compute the Gini index using the Luxembourg Income Study (LIS). Old age dependency ratio and other variables came from the World Development Indicator 2003 (WDI2003). The estimation result by using the panel data analysis, inverse logistic function estimation, and nonparametric kernel estimation shows that Kuznets’ hypothesis does not hold in our sample and degree of inequality increase at increasing rate as old age dependency ratio goes up. And we also find the policy implication that fiscal policy may weaken the effect of the population aging on inequality.
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Chapter 2-1Performance of Korean Banks and Implications for Regulatory Reform
Two competing hypotheses have been proposed in regard to the relationship between structure and performance in the banking sector. The market structure hypothesis postulates that banks in a concentrated market can charge higher loan rates and pay lower deposit rates through their market power as well as lowering collusion costs, thus generating more profits. On the other hand, the efficient structure hypothesis states that efficient banks can obtain higher profitability as well as greater market share because of their efficiency, which will lead to a more concentrated market. Numerous studies have tested these two competing hypotheses for U.S. banks and European banks. The purpose of this paper is to identify the major determinants of profitability in the Korean banking sector for the period of 1992-2002 by testing the two competing hypotheses in an integrated model which incorporates the variables representing both hypotheses. The results obtained for the panel data, including both nationwide and regional banks, indicate that market concentration and market share are insignificant variables in explaining bank performance in Korea while the measures of efficiency affect bank profitability significantly. The unique feature of this paper is the estimation of allocative inefficiency by the directional technology distance function and the use of this estimate in explaining bank performance. Another contribution of this paper is a finding that the major determinants of bank profitability in Korea have changed between pre- and postcrisis periods. Before the currency crisis, all three variables – market concentration, market share and efficiency - were significant explanatory variables. However, after the crisis, the measures of efficiency stand out as the most significant variable, and the importance of equity ratio was also noted. This paper also provides several policy implications for bank regulatory reform.
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Chapter 2-2Risks and Supervisory Challenges of Financial Conglomerates in Korea
Recent research indicates that one cannot ascertain a clear-cut relationship between financial consolidation and financial stability. Financial consolidation may not always create market power and desired diversification effect for large financial institutions, and various features of conglomeration may actually increase the scope for instability, in particular when they lead to a small number of large conglomerates, which are too big to fail, to discipline, and to liquidate. This paper examines recent developments in financial consolidation and conglomeration in post-crisis Korea. With a review of the progress in financial restructuring, we study implications of the consolidation and conglomeration for both financial risks of individual conglomerates and systemic risk potential. We provide diagnostic analyses on various channels through which financial consolidation and conglomeration can impact financial stability. While it is premature to conclude, our analyses suggest that both geographic and cross-industry diversifications in Korea may have a limited scope in reducing financial risks for individual conglomerates. It also turns out that consolidation has increased systemic risk potential as both direct and indirect interdependencies among large banking institutions have substantially increased in the post-crisis period. Furthermore, financial conglomerates have become more vulnerable to contagion risks from non-bank and non-financial sectors as they expand their involvement in high risk activities that are closely tied to non-bank financial firms and capital markets In the face of the shifting risk structure, financial supervisory and regulatory systems must be upgraded toward a more risk-based, consolidated supervision. Currently in Korea, only a rudimentary form of consolidated supervision is applied to financial holding companies, and no consolidated supervision has been introduced for other types of financial conglomerates. For instance, prompt corrective action provision for financial conglomerates must be based upon fully consolidated group capital adequacy, and effective supervisory devices need to be introduced to avoid inadvertent extension of public safety net to cross-sectoral activities of financial conglomerates. At the same time, it is also critical to strengthen internal control and risk management capacities at financial conglomerates, and to establish strong market discipline by improving information transparency and monitoring incentives in the financial market. For early detection and better management of potential systemic risk events, it is also necessary to establish an effective institutional mechanism for communication, cooperation, and check and balance among related regulatory authorities.
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Chapter 2-3Risk and Capital Regulations on Financial Institutions in Korea: With a special reference to measuring credit risk of SME loans
This paper examines current issues regarding capital regulation in Korean banking industry, focusing on the capital requirement framework for SME exposures. By constructing a multi-factor risk model using large samples of Korean SMEs, the results of the empirical analysis show that that the correlation of SME exposures decreases as the asset size of the obligor firm increases. This indicates that the positive relationship between the obligor’s size and credit correlations assumed using the risk-weight formula proposed by the Basel Committee cannot be supported in Korea, and financial regulators should be careful when treating small business exposures as retail exposures. Our results also suggest that financial supervisors need to deeply consider the industrial composition of SME exposures, when adopting the New Accord and proposed special treatment of SME exposures using the risk-weight formula. In particular, regulators may require banks to have a higher level of capital for SME portfolios which are concentrated with firms from the construction or service industry.
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Chapter 2-4Financial Supervisory Service, “Does Bank Structure Matter?”
This paper addresses the question of whether a mega-bank or monopoly banking system can lead to a higher steady state level of capital stock. There is substantial evidence of a positive relationship between financial market development and long-term output growth. Little is known, however, about the role played by the market structure of the banking sector on growth. In addition, little work, if any, has attempted to analyze how the degree of information externality affects the relative performance of a monopoly bank and competitive banks. This paper shows that the optimal bank structure is dependent upon the degree of information externality, associated with financial market development and the stage of economic development. In addition, this paper shows that the monopoly banking system obtains higher steady state level of capital as information externality increases. This result suggests that not only developing countries but also industrial countries may benefit from a concentrated banking system. Hence, this provides an alternative explanation of the recent deregulation and resulting trends in mergers and acquisitions.
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Chapter 2-5Identification and Management of Systemic Risks : Macro and Micro Evidence in Korea
This study attempts to empirically identify the external shocks causing a systemic crisis and their propagation mechanisms over financial system in Korea. The measured macro aggregate shock series are found to have played a crucial role in explaining systemic crises in the past. It is also found that macro aggregate disturbances, instead of idiosyncratic factors, could affect the behaviors of individual economic agents like firms and financial institutions in a great deal. From the corporate data analysis, the credit channel effect in the course of shock amplification and propagation seems rather weak in Korea. The comovement of asset portfolios and loan loss provisions across financial institutions together with their weak correlation of individual banks’ portfolios over time implies the importance of paying attention to macro risk factors in managing systemic risks.
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Chapter 3-1On the Insider Trades of SK Chaebol
This paper concerns the insider trades between affiliates of the SK group. Before the IMF crisis, this group was one of the top five Chaebols, which was in relatively sound financial statements and kept less diversified business structure. Moreover SK group has rapidly grown under the Kim Dai-Jung administration, and has since a far-reaching influences upon the Korean economy. But, after the exposure of the 2002 windowdressings made by the SK Global Co., many economists and financial analysts debate again over the merits and demerits of the Chaebols. Obviously, the insider trades between group affiliates are one of the key points concerning the Chaebol problems. It has an effect on the structures of business systems like the Chaebol and it also indicates the outcomes of business restructuring. Insider trades are classified as trades of goods and services; trades of capitals such as investment into the stocks of other affiliates, debt guarantees; and dispatching manpower to other affiliates. The main focus of this paper is on the topics related to the insider trades of goods and services. Those insider trades of goods and services will be specified in detail by subcategories such as 1) insider sales (gains), 2) insider purchases (expenses), 3) insider account receivables, and 4) insider trade account payables. In section Ⅱ, we briefly reviews the historical growth paths of the SK Chaebol, by looking at total assets, capital stocks, debts and sales. In Section Ⅲ, we demonstrate the resources, scales and rates of the insider trades of the SK group in general by including their individual affiliates. Based on these findings, some hypothetical analyses are suggested, for example, a comparative analysis on the results of before and after the IMF crisis, and on the rates of insider trades between listed and unlisted companies. Also we focus on the insider trades between Information & Telecommunications (IT) companies and non-IT companies. The supporting effects of insider trades on the IT companies, especially incorporated after the financial crisis (1997), will be discussed in this section. And lastly but not least, we investigate the relationships of the insider trades with stock shareholdings. In section Ⅳ we conclude by presenting some hypothetical suggestions on the transformation of business structures and the evolution of the Chaebol organization.
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Chapter 3-2The Grand Unified Theory of the Firm and Corporate Strategy Measures to Build Corporate Competitiveness
A good understanding of the nature of the firm is essential in developing corporate strategies, building corporate competitiveness, and establishing sound economic policy. Several theories have emerged on the nature of the firm: the neoclassical theory of the firm, the principal agency theory, the transaction cost theory, the property rights theory, the resource-based theory and the evolutionary theory. Each of these theories identify some elements that describe the nature of the firm, but no single theory is comprehensive enough to include all elements of the nature of the firm. Economists began to seek a theory capable of describing the nature of the firm within a single, all-encompassing coherent framework. We propose a unified theory of the firm, which encompasses all elements of the firm. We then evaluate performances of Korean firms from the unified theory of the firm perspective. Empirical evidences are promising in support of the unified theory of the firm.
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Chapter 3-3The Market for Liars: Reputation and Auditor Honesty
In the model there are two types of financial auditors with identical technology, one of which is endowed with a prior reputation for honesty. We characterize conditions under which there exists a “two-tier equilibrium” in which “reputable” auditors refuse bribes offered by clients for fear of losing reputation, while “disreputable” auditors accept bribes because even persistent refusal does not create a good reputation. The main findings are: (a) honest auditors charge higher fees, and have economic profits accruing to reputation; (b) as the fraction of auditors who are honest increases, the premium charged by reputable auditors eventually decreases, which diminishes the incentive to refuse bribes; (c) if the fraction of honest auditors exceeds an upper bound, there does not exist a two-tier equilibrium; (d) thus the reputation mechanism may be undermined by entry into the honest segment of the industry, if it is possible; (e) increasing auditor independence increases the upper bound.
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Chapter 4-1Enhancing Productivity through Innovation: Korea’s Response to Competitiveness Challenges
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Chapter 4-2Productivity and Patterns of Trade - The Experience of Korea in the 1990s
This paper analyzes the industrial growth of Korea in the 1990s and its relationship with the nation’s export performance. The paper showed that total factor productivity(TFP) played a significant role in the growth of some industries, where in particular a sharp increase in TFP was observed in the electrics and electronics industry and the automobile industry in the late 1990s. While CEPII RCA indexes for the Korean industries such as IT industry and automobile industry significantly increased since 1998, only limited evidence was found that TFP or TFI influenced RCA. Investigating Korea’s export performance in the Northeast Asian context, this paper shows that, in the 1990s, the growth of Korea’s exports to Japan was led by industries that recorded relatively fast growth in total factor input (TFI). In contrast, that to China was almost equally contributed by industries that experienced relatively fast growth in TFP or TFI. This paper also investigates competition between Korea and China, and Korea and Japan in the world market. The competition between Korea and China was relatively stronger for the Korean industries to whose growth TFI made a more significant contribution. While no decisive evidence is found for the relationship between TFP growth in Korean industries and their competition against Japan in the world market, it is revealed that the competition between Korea and Japan became less intense for the Korean industries to whose growth TFI made a stronger contribution.
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Chapter 5-1How the Exchange Rate Regime Has Been Switched in Korea : A Public Choice Inquiry
Public choice submits that legal changes can be endogenous in such a way that they are manipulated by bureaucrats who want to maximize rents from transactions with various interest groups. This paper takes the change in Korean exchange rate regimes to empirically examine the premise. It offers a two-stage method, in which we first show that the exchange rate is influenced by interest group pressures, and subsequently that the 1990 market average regime (MAR), as a phase-in policy in Korea, was introduced at least partly to serve bureaucratic incentives. This method is expected to be useful to various studies attempting in many countries to test a possible existence of bureaucratic or other hidden motivations behind any \"isolated\" event of policy change.
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Chapter 5-2The Term Structure of Interest Rates as Target of Monetary Policy
Our paper explores a transmission mechanism of monetary policy through bond market. Based on the assumption of delayed repsonses of economic agents to monetary shocks, we derive a system of equations relating the term structure of interest rates with the past history of money growth rates and test the equations with the US data. Our results confirm that monetary policy targeting a certain shape of the term structure of interest rates could be implemented with certain time lags due to path-dependency of interest rates.
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Chapter 5-3Enhancing Efficiency of Government Budget and Fiscal Policy
When one thinks of efficiency in connection with government budget and fiscal policy, the first thought is usually how to find ways to make the budget and fiscal process work more efficiently. How can the funds needed to pay for government be collected and disbursed with minimum cost? A corollary to this mindset is that taxpayers are entitled to have their public servants spend their tax dollars, yen, won or euros wisely and efficiently. There is some validity to this viewpoint, since it seems irrational to advocate less efficiency rather than more. However, there are two sides to this coin. Those who think efficiency should be the goal are thinking like a businessman. Businesses should be run efficiently and so should governments, according to this mindset. But there are other ways to view this issue. It should be kept in mind that government has no resources of its own. Whatever resources it has, it must first take from someone. That being the case, is it really a good idea to try to find ways to make it easier for government to take assets from private individuals and businesses? This article explores this question from both perspectives. It begins by looking at the methods that have been found over the years to make the budget and fiscal process work more efficiently. It then looks at the other side of the issue and discusses instances when less efficiency might be better.
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Chapter 6-1The Dynamics of Korean Stock Market in Response to Fiscal and Monetary Shocks Around Foreign Currency Crisis
This paper investigated the efficiency of the Korean capital market with respect to fiscal and monetary policies before and after a crisis has occurred. For this purpose, the paper applied FIML technique to a set of monthly data over the period 1982.01 to 2000.12. The model was particularly designed to take into the problems of generated regressors and simultaneous equation bias in the test of market efficiency. The overall results indicate that the Korean stock market is efficient with respect to monetary policy. However, the result with fiscal policy is inconclusive. The study also found that market participants reacted to the macro-economic shocks more sensitively after the recent foreign currency crisis in Korea. However, there is no concrete evidence that the stock market opening contributed to the market efficiency.
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Chapter 6-2Dynamics of Business Cycles in Korea: The Role of External Shocks
Using a multi-sector dynamic stochastic general equilibrium model, we investigate the dynamic effects of a variety of shocks to a small open economy. In particular, we calibrate the model to match the main characteristics of business cycles in Korea and analyze the effects of external shocks: the terms of trade and world real interest rate shocks. The simulation results suggest that an improvement in the terms of trade has positive impact on investment, output and consumption, while a decrease in the world interest rate has a significant and positive effect on investment. This paper concludes that external shocks significantly influence business cycle fluctuations in Korea.
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Chapter 7-1New Look at Development Economics through Korea’s Experience - The Paradox of Economic Development -
Why have economists given up their search to discover the “secrets” of economic development? Is economic development too complex that there are really no discernable truths that might be useful when thinking about the subject? Through the reflection of economic life and the experiences of Korea’s modernization, we take on the challenge to discover the principles of development economics. Specifically, “discrimination”, we find, is the key to economic development, which we discuss thoroughly to build a discrimination-verticalism framework. On the other hand, we contrast this with its antithesis, the egalitarian-horizontalism world, which can be seen as the theory of economic digression. The development paradigm presented in this paper is applied more concretely not only to help us understand better Korea’s development experience of the past 40 years, but also to clear some perennial issues in development economics: namely, 1) the meaning of markets, 2) the roles of government and markets in economic development, 3) the dilemmas presented by democracy and positive economics, 4) the questions of income distribution, and 5) the controversies of conglomeration in economics and development. The discussions here are far-reaching, not only in the scope of socioeconomic issues it attempts to address, but also in its highly philosophical attitude, which questions the very foundations of human existence and beliefs and, above all, the possibilities of economic progress.
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Chapter 7-2Short-run versus Long-run Income Inequality
Using panel data sets, this paper examines income inequality in Korea during 1988-1997. It shows that income inequality arises from persistent factors such as unmeasured individual characteristics rather than transitory components. In addition, the sources of income variations have systematic patterns among educational groups. When income inequality is compared between 1988-92 and 1993-97, various indices indicate that income inequality has reduced. However little improvement was made in terms of persistency of income inequality. This result may suggest that the attainment of low inequality during the period is not as desirable as it appears once long-run income inequality is taken into account.
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