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Keiko Ito and YoungGak Kim

Ito and Kim use a large-scale dataset to examine differences in allocative efficiency between Japanese and Korean firms from 1995 to 2008. They measure the firm-level distortions in terms of total factor productivity, output and capital, employing the Hsieh and Klenow approach. They find that distortion measures are more dispersed in Korea than in Japan. As a result, neither economy has improved allocative efficiency, which is lower for Korea than for Japan. Low productivity firms in both economies tend to overproduce, suggesting that resources are not moved from low productivity firms to high productivity firms. Improvement in resource allocation is an urgent policy issue for both countries in order to realize the efficient level of output, given that both countries are highly likely to face serious labor shortages in the near future due to population decline and aging.

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Preface

Exploring the Causes and Remedies of Japanization

Edited by Dongchul Cho, Takatoshi Ito and Andrew Mason

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Misallocation in the manufacturing sector of Korea: a micro data analysis

Exploring the Causes and Remedies of Japanization

Jiyoon Oh

This study evaluates the allocative efficiency in the Korean manufacturing sector following the methodology of Hsieh and Klenow. Overall allocative efficiency has declined from 1990 to 2012. The potential loss from worsening misallocation is estimated at 0.6 percentage point each year, which is considerable in terms of overall total factor productivity. In terms of firm size distribution, large establishments are more likely to expand initially, if distortions are removed in most countries. One notable feature in Korea is that this pattern is pronounced.

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Lessons for Korea from Japan’s fiscal policy

Exploring the Causes and Remedies of Japanization

SeongTae Kim

SeongTae Kim investigates Japan’s experiences since the 1990s to find lessons for Korea’s future fiscal policy. Japan’s deteriorating fiscal soundness is attributed to the decline in revenue (from tax cuts, recession and deflation) and increases in expenditure (largely for social welfare, local tax grants and public works, exacerbated by weakness in the legislative-executive checks-and-balances system). By contrast, Korea in the 2010s is in better fiscal shape than Japan was in the early 1990s, with a much lower debt-to-GDP ratio, structural balances still positive, a slower growth-rate decline, more stability in its tax-burden ratios and a better checks-and-balances system, although the share of non-age-related central government expenditure is still far larger in Korea than the OECD average. To ensure longer-term fiscal soundness and not repeat Japan’s experiences, comprehensive reform of fiscal policy is inevitable, with special attention to the tax base and social welfare expenditure in an aging society.

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Japanization: is it spreading to the rest of the world?

Exploring the Causes and Remedies of Japanization

Takatoshi Ito

Japanization is defined as a combination of (1) a lower actual than potential growth rate for an extended period; (2) a natural real interest rate below zero; (3) a nominal (policy) interest rate at zero; and (4) deflation (a negative inflation rate). A proposed Japanization index measures these conditions. Japan entered this state through (1) its 1990s overkill of the bubble; (2) a nonperforming loans problem resulting in a major banking crisis; (3) failure in engineering a soft landing of the banking crisis; (4) failure to adopt quantitative easing early and decisively to get out of deflation; (5) failure to adopt an inflation targeting regime; and (6) failure to adopt a large fiscal stimulus. Ongoing success of Abenomics in lifting the economy out of deflation shows it is possible to prevent or cure Japanization.

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Is Korea’s monetary policy following in the footsteps of Japan?

Exploring the Causes and Remedies of Japanization

Dongchul Cho

Dongchul Cho examines Korea’s recent monetary policy in comparison with Japan’s experiences in the 1990s. As in Japan, the Bank of Korea’s forecasts were excessively optimistic during the 2012 to 2015 period, resulting in conservative monetary policy, while Korea differs from Japan in having a milder pace of disinflation and a low likelihood of a real estate bubble-bust. Nonetheless, conservative policy based on past experiences could become risky in a rapidly changing environment, particularly with Korea’s rapid aging and declining potential growth. The answer to the question, whether Korea with a lag of two decades will follow Japan into deflation, lies in future monetary policy.

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Introduction and overview

Exploring the Causes and Remedies of Japanization

Dongchul Cho, Takatoshi Ito and Andrew Mason

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How to deal with the rise of zombie firms in Korea

Exploring the Causes and Remedies of Japanization

Daehee Jeong

Daehee Jeong examines the increase in Korea’s zombie firms, in the context of Japan’s experience of negative effects on employment, investment, productivity and overall dynamics of the economy. Korea’s delay in corporate-sector restructuring led to an increase in zombie firms, making zombie lending to distressed firms more severe in Korea than in most developed countries. The increase is attributed largely to maturity extensions by banks, rather than to interest exemption by general creditors. Korea’s zombie lending is driven not by insolvent commercial banks but by public banks. One remedy is thus to address their politically directed lending, which has increased exposure to large firms, and instead to restore their role in supporting sectors where the financial market fails, such as small and medium-size enterprises and newly established firms. In addition, the Financial Supervisory Service should ensure that standards for classifying bad loans are consistent across commercial and public banks.

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Kyooho Kwon

Kyooho Kwon examines how Korea’s demographic structure resembles Japan’s, with a 20-year lag, and how productivity growth and solving structural problems are key to maintaining dynamism in the Korean economy. Japan’s “lost decades” and lethargy in Korea’s economy lead some Korean economists to worry that Korea may follow in the footsteps of Japan, with its declining growth rate. Japan’s stagnant total factor productivity growth depressed the demand for labor and capital; and the slower growth rate of the working-age population imposed a constraint on labor supply. These factors together caused the marginal product of capital to fall, dampening the demand for additional capital stock and impeding GDP growth potential. Korea’s demographic structure is evolving in a pattern similar to demographic change and unprecedented aging in Japan and is already playing a role in economic slowdown.

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Financial market efficiency: a comparative perspective

Exploring the Causes and Remedies of Japanization

Mitsuhiro Fukao

Mitsuhiro Fukao examines Japan’s zombie banks since the early 1990s. The causality of these severely undercapitalized banks runs as follows: increasing loan losses from bankrupting borrowers weaken banks’ capital base; undercapitalized banks start to hide losses and provide evergreening loans to loss-making firms; and undercapitalized banks as well as firms continue to operate with deposit taking by zombie banks under forbearance of regulators. The most important factor during Japan’s worst financial crisis (1997–2003) was the loss of confidence in the accounting and auditing system. Unreliable financial statements resulted in a vicious cycle of credit contraction and impeded the functioning of the market economy. Close relationships among bankers, regulators and accountants impeded quick resolution by allowing nonviable banks to hide loan losses. Complex debtor-creditor relationships among related companies make it difficult to ascertain the scale of the bad-loan problem. The most adverse effect is the increased risk of financial crisis.