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December 2007, The 2007 KDI-KAEA Conference
Enhancing Productivity and Sustaining Growth-
Chapter 1-1Current Issues of Productivity Growth in Korea: A Survey
This paper is to review overall productivity of the Korean economic sectors and manufacturing industries to take a lesson from the past growth experience. The paper surveys the effect of the Korean government industrial policy that intended to promote the heavy and chemical manufacturing sectors during the 1970s. Also, the paper investigates the impact of information technology that has led the economy after active investments by the government and large firms in 1990s. Finally, the paper reviews the productivities of undeveloped services and agricultural sectors that have long been left behind without government promotion. The paper also suggests research ideas and topics that may bring in valuable policy implications.
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Chapter 1-2Optimal R&D Intensity: Welfare Analysis
Not only has spending on research in Korea been growing in real terms, but its relative importance compared to other economic activities has been steadily increasing as well in Korea. In this paper, we introduce the socially optimal share of R&D in the economic growth model. We consider both laissez-faire(market equilibrium) steady-state growth rate and the social optimum. Because individuals and individual firms do not internalize the effect of individual knowledge accumulation when optimizing on consumption and capital accumulation, the equilibrium growth rate may be less than the socially optimal rate of growth. We develop the model(Jones and Williams, 2000) that find the decentralized economy typically underinvests in R&D relative to what is socially optimum. We also examine how far deviates the steady-state growth rate from social optimum in Korean economy. We focus here on the positive external effects of R&D. According to ordinary LS analysis, the estimate of λ(the elasticity of knowledge production to R&D personnel) is 0.1559. So, we can see the optimal R&D share in Korea is 3.32%. This implies that the ratio of optimal share to market share of R&D in Korea is 1.8. According to Johansen(1991)’s cointegration analysis, the estimate of λ ranges from 0.294 to 0.365. So, we can see that the lower bound for the optimal share of R&D in Korea, is 3.74%. In brief, from all cases of the form for the knowledge production function, we could decide that both the intertemporal-spillover and appropriability effects in Korean economy tendto make the average growth rate less than optimal. Because the business-stealing effect that tends to make it greater than optimal conflicts and is dominated by the former two effects, the laissez-faire average growth rate in Korea may be less than optimal.
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Chapter 2-1Integration and Growth in East Asia
This paper empirically analyzes the experience of East Asia’s economic growth with data both at aggregate-economy and micro-firm levels, focusing on the role of international integration through trade and direct investment. The analysis within a framework of cross-country panel regression shows that trade openness and foreign direct investment (FDI) inflows have a positive effect on gross domestic product (GDP) growth—particularly in the 1970 and 1980s—while FDI outflows appear to have a negative effect on GDP growth. Micro-level evidence based on manufacturing data in the Republic of Korea (Korea) confirms the positive effect of trade and investment integration on plant-level productivity growth. It also suggests the relationship between FDI outflows and productivity growth depends on the characteristics of a recipient economy. We find that FDI to the People’s Republic of China tends to reduce productivity growth of firms in Korea while FDI to the United States or Japan works in favor of productivity growth.
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Chapter 2-2Vertical Intra-Industry Trade (VIIT) and Foreign Direct Investment(FDI): In Case of Automobile Component Industry of China, Japan and South Korea
Reduced service-link costs and easiness for arms-length transactions have urged “Fragmentation” in production process. It means products are finished throughout numerous processes, and companies may not stick to produce or purchase only domestic ones in manufacturing industry. In particular, it happens frequently in case of components-oriented industry such as automobile industry. This thesis aims to analyze Vertical Intra-Industry Trade-trade (VIIT) occurring in East Asia and its relationships with Foreign Direct Investment (FDI). This study focuses on Intra-Industry Trade in automobile component industry among China, Japan and South Korea. Especially, it pays attention to the roles of medium-sized country in Intra-Industry Trade such as South Korea deadlocked between labor-abundant country such as China and capital-abundant country such as Japan. For it, Grubel-Lloyd Index (G-L index) was used to calculate degrees of Intra-Industry Trade among three countries. In addition, statistics of export and import in components according to HS Code classification (10 digits for South Korea and 9 digits for Japan) were used to analyze comparative advantage and national competitiveness. Lastly, based on the Production Life Cycle theory, trends of trade patterns in components between Asian countries (in case of steering wheels and car stereo) were analyzed. There are 5 findings as follows; first, Japan still maintains comparative advantage in technology-intensive components such as piston (engine) and brake-related components. In fact, Japan could have sustained its national competitiveness in most of automobile components till the early 1990s, compared with South Korea and China. However, Japan’s national competitiveness in case of sound arrester and suspension shock absorber was transferred from Japan to South Korea since the 1990s. This kind of transfer also happens between South Korea and China. For example, in case of relatively labor-intensive automobile components, China’s export ratios for Japan have been increased. In contrast, South Korea became to lose its competitiveness what it had had before since China’s rise in these sectors. Second, FDI seems to function to influence Production Life Cycle and national competitiveness. In other words, comparative advantage can be influenced not only by one’s own technology development (inward), but also by FDI of foreign companies (outward). For example, airbag case shows how FDI can affect trade patterns between two countries. However, regarding qualitative aspects of technology transfer, we should be considerate to estimate China’s production abilities in terms of components. That is, FDI urges quantitative growth and reduction of import from abroad, but it is not clear that how fast and to which extent FDI can spur technology transfer considering rates of localization rate related with vital components in China. Third, South Korea whose factor endowment is neither labor-abundant as China nor capital-abundant as Japan plays a major role in the Vertical Specialization. For instance, in case of safety belt, gearbox and steering wheels, South Korea seems to function as broker who imports from Japan with huge scale, but also export unilaterally to China at the same time. In other words, medium-sized country seems to fill out technology gap between China and Japan (layers of technology). Fourth, however, medium-sized country’s role cannot be continued in the long-term because VIIT may be the Heckscher-Ohlin (H-O) theory’s another aspect due to fragmented production process. Therefore, it is necessary to adopt FDI actively in vital components to extend comparative advantage from labor-intensive to capital-intensive components. Fifth, compared with shoes industry, VIIT in automobile components industry shows possibility of “Agglomeration.” It is because of characteristics of “various factor intensities of automobile components” from labor-intensive to capital or technology-intensive ones. Thus, this kind of “Common Interest in Industrial Clusters” should be prior to other controversial issues in Free Trade Agreement negotiations in East Asia.
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Chapter 2-3A Political-Economy of the Free Trade Agreement : Temporal and Distributional Effect
We examine what determines the successful conclusion and the distributive implications of Free Trade Agreements (FTAs). Theoretically, we specify a political economy model of bargaining while facing an exogenous deadline that details the conditions under which domestic constraints matter for distribution and delay. We show that, as the Schelling conjecture implies, a nation facing greater constraints receives more rewards. However, we also demonstrate that the more each country is constrained, the less efficient the resulting process is due to delay. Empirical analysis of FTAs is consistent with our model and its corresponding comparative statics. Our model offers into the role that domestic constraints play in international negotiation and has important policy implications for when, and with whom, leaders should negotiate.
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Chapter 3-1Foreign Ownership and Corporate Performance
Despite the political sensitivity of foreign capital, existing work on the effect of foreign ownership at the firm level is slim. This paper examines the effect of foreign equity ownership on firm performance using a panel of Korean firms for the period of 1993-2002 when foreign capital inflows increased dramatically. Empirical results show that foreign equity ownership positively affects firm performance due to monitoring and shareholder activism, complementing domestic institutional investors and countering indigenous factors such as family and business group. In addition to shareholder activism, board participation by foreign investors also has a significant positive effect. There is also monotonically a positive relationship between the degree of foreign control and firm performance. Sub-period estimation shows that the effects of market liberalization were more gradual than abrupt even though the holding limit on foreign equity ownership was lifted only after the Asian financial crisis.
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Chapter 3-2Boundary and Efficiency of Internal Capital Markets and Organizational Structure in Spin-offs: Control vs. Focus
This paper examines how the boundary and efficiency of internal capital markets (i.e., firm size) is affected by corporate spin-offs. A spin-off is classified by its organizational structure: whether or not spun-off firms are operationally controlled by parent firms after a spin-off. Surprisingly, in about 58% of the 102 spin-off transactions we studied, parent firms retain “control” of spun-off firms through overlapping management. Our result implies that these two types of parent firms are systematically different in their management of the internal capital market. That is, we find that corporate spin-offs themselves do not change investment sensitivity in parent firms after spin-offs. However, investment activities have already been sensitive to the change in Tobin’s Q around the spin-off events for the parent firms that do not control (i.e., focused). In contrast, the controlling parent firms turn out thave maintained inefficient capital markets around spin-offs. We find that most of the focused parent firms in our spin-off sample are much larger than the controlling parent firms prior to spin-offs. Furthermore, for the controlling (focused) parents, the investment sensitivity increases (decreases) as firm size increases. These results are consistent with our argument that a spin-off appears to be a means to maintain an optimal firm size as suggested in Aron (1988), Gertner, Scharfstein, and Stein (1994) and Stein (1997). We show that the pre- and post spin-off market-adjusted performances are also consistent with the efficiency of the internal capital markets under these two types of parents. Given the debates on the optimal firm size of leading Korean firms, our findings suggest importand implications on the industrial policies of Korea.
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Chapter 4-1Effects of Sectoral Shifts on Average Duration Unemployment
The source of the upward trend in the unemployment duration relative to the unemployment rate and the cause of the changes in their historical relation since 1990s have been investigated in many recent studies. This paper investigates the effect of sectoral shifts of labor demand across industries on the average duration of unemployment. Sectoral shifts of labor demand imply intersectoral moves for workers who lost their jobs and micro data analysis in the literature shows a longer duration of unemployment for the intersectoral movers. This implies that workers who are adversely affected by sectoral shifts of labor demand will experience a longer duration of unemployment compared to those who are affected by temporal aggregate shocks. Consequently, sectoral shifts of labor demand will increase the proportion of unemployed workers with a longer duration of unemployment and the average duration of unemployment. This hypothesis is tested by using the natural rate of unemployment as the measure of sectoral shifts.
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Chapter 4-2Dynamics of Inflation Rate: Comparison of New Keynesian Models via Simulated Density
We set up a variant of New Keynesian models for the dynamics of inflation, and discuss the relative importance of the expected inflation rate and past inflation rate. Many papers have studied the price decision rules in monopolistically competitive product markets. This paper employs a Calvo-type (1983) staggered price setting that has become a standard way to introduce nominal rigidities in the quantitative general equilibrium model. Firms that cannot optimize their prices set their prices with indexation to the past inflation rate. The “Canonical” and “Hybrid” New Keynesian models are without and with this indexation to the past inflation rate, respectively. Different degree of indexation is also considered for the Hybrid models. Rather than merely evaluating each of the alternative New Keynesian models, we compare different New Keynesian models (Canonical and Hybrid models) by constructing the test statistics between the distribution or density of empirical data and those of the simulated data from each theory model. Model parameters are calibrated and thereality check of White (2000) is applied to compare the models. The dynamics in inflation rate are compared for models with different degree of indexation. By comparing the simulated density or distribution to that of the empirical data, Hybrid New Keynesian models have better loss values, but the Canonical New Keynesian model can not be rejected with various degree of nominal rigidities. Moreover, we find that with a high degree of nominal rigidities, most firms follow the optimal pricing rule and indexing to past prices is suboptimal.
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Chapter 4-3ECM Threshold Co-integration Tests and Nonlinear Monetary Policy in Korea
The goal of this paper is to examine the validity of nonlinear Taylor rules in Korea. To perform our tests, we utilize new IV ECM threshold cointegration tests that are invariant to nuisance parameters. The new tests have a standard chi-square distribution and the same critical values can be used throughout. This is in contrast to OLS ECM threshold cointegration tests, which depend on nuisance parameters and have nonstandard distributions. After finding significant support for nonlinear cointegration, we find that the Bank of Korea raises the call rate of interest only when inflation is above a threshold rate. We additionally find that the Bank of Korea increases the call rate of interest to possibly counter domestic currency deprecation only when the rate of currency deprecation exceeds a threshold.
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Chapter 5-1Public Finance, Ethics and Tax Evasion: A Comparative Study of China, Japan and Korea
The ethics of tax evasion has been discussed sporadically in the theological and philosophical literature for at least 500 years. Martin Crowe wrote a doctoral thesis that reviewed much of that literature in 1944. The debate revolved around about 15 issues. Over the centuries, three main views evolved on the topic. But the public finance literature has paid scant attention to this issue, perhaps because of the belief that tax evasion is always unethical. This paper examines the tax evasion ethics data for Korea, Japan and China that was gathered as part of a much larger study on human beliefs and values. Country comparisons were made as well as comparisons based on gender, age, education, religion and marital status to determine whether views on tax evasion differ based on those demographics. Some conclusions that can be drawn from the present study are: ● All groups were strongly opposed to tax evasion. This finding conflicts with other studies on the ethics of tax evasion. ● The sample population from Japan tended to be more strongly opposed to tax evasion than were the sample populations from the other two countries. Japanese women were significantly more opposed to tax evasion than were Japanese men. That could not be said of the samples from China and Korea. ● People tend to become more opposed to tax evasion as they get older. This could be because older people have more respect for government and the rule of law than do younger people. ● People also tend to be less opposed to tax evasion as their level of education increases. This could be because the more educated people are, the less they feel that they have an absolute obligation to pay the state whatever it demands in taxes. ● Buddhists and atheists/agnostics tend to be more opposed to tax evasion than do Christians. ● As to the reason for the strong opposition to tax evasion, the duty to God rationale is perhaps the weakest rationale, since a significant portion of the sample did not espouse any religious conviction. The duty to the state rationale is likely a more powerful influence, since the populations of these Asian countries are generally perceived to give a great deal of deference to the state. The duty to fellow citizens probably also accounts for a portion of the strong opposition to tax evasion, especially in the case of Japan.
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Chapter 5-2Welfare Effects of Tax Reform: Case of Korea
This paper analyzes welfare effects of revenue neutral tax reform using a small open economy dynamic general equilibrium model. We apply this model to the Korean data and examine welfare effects of various tax reforms; removal of capital income tax and/or labor income tax financed by consumption tax. We investigate both long run equilibrium and transitional dynamics. The results suggest that there are sizable welfare gains (1-3% of lifetime consumption) when factor income taxes are replaced by consumption tax. Overall gains are generated by long run gains despite short run welfare losses. However, there is welfare loss when capital income tax is replaced by labor income tax.
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Chapter 6-1Uncovered Interest Parity Puzzle: Cross-sectional and Time-series Analysis
This paper proposes a new explanation for the UIP puzzle by analyzing a large number of cross-country bilateral exchange rates in two dimensions, cross-sectional and time-series. The exchange rates analyzed here include a broad spectrum of developed and developing countries. Based on the empirical evidence, there does not appear to be a well-publicized UIP puzzle for cross-sectional UIP, and the slope estimates remain largely between zero and one throughout the sample periods, with a few exceptions. As interest rate maturity becomes longer, UIP relationship becomes stronger. For time-series UIP, short-term (one month) UIP holds well and UIP puzzle is largely confined to the key currencies. We introduce the key currency bias to explain the empirical failure of UIP in these cases. The key currency concept is a similar to the home bias for portfolio holdings. UIP seems to fail more often when a key currency is involved in the bilateral exchange rate relationship than when only non-key currencies are involved, especially when the key currency offers higher return on capital. This paper presents an empirical evidence for a state-dependent asymmetric response in exchange rate changes depending on the direction of the forward premium.
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Chapter 6-2Tick Size, Market Structure and Trading Costs
Large tick sizes imposed on high-price stocks on the Korea Stock Exchange (KSE) are significant binding constraints on bid-ask spreads. Nearly 60% of quoted spreads are equal to the tick size for stocks with the largest tick size. The average spread of KSE stocks is smaller than that of the matched sample of New York Stock Exchange (NYSE) stocks, although the average spread of KSE stocks that belong to larger tick size groups is greater than that of matched NYSE stocks. These results suggest that the KSE’s electronic limit order market provides cheaper executions than the NYSE’s specialist system for our matched sample of stocks, and the KSE could further reduce trading costs if the large tick sizes imposed on highprice stocks are replaced with smaller ones.
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Chapter 6-3External Finance and Productivity Growth in Korea: Firm Level Evidence Before and After the Financial Crisis
This paper empirically investigates the finance-growth linkage in Korea by utilizing firm-level data of manufacturing industries before and after the 1997 financial crisis. We find that, first, an increase in external finance is associated with a faster subsequent capital accumulation of firms. However, this capital accumulation channel became relatively attenuated after the crisis. Second, the total factor productivity growth effect of external finance has been considerably weak both before and after the crisis. Third, the information production and industry restructuring effects of external finance have also remained weak despite the gradual improvement after the crisis. While the limited role of finance in post-crisis Korea partially reflects sluggish corporate investment and weakening dependence of good credit firms on external finance, in order to effectively sustain economic growth, further reform efforts are required to upgrade resource allocation and governance roles of financial markets and institutions.
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