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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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An Institutional Critique

Frank H. Stephen

Chapter 1 sets the scene for the book. It discusses the reasons for the interest in the relationship between the law and economic development beginning with an outline of theories of development. The theory of development currently favoured by multilateral development agencies such as the World Bank is one of market-led development which emphasizes the role of the financial sector. Drawing on an analysis of the reasons why the Law and Development Movement of the 1960s and 1970s failed, criteria by which theories of law and the legal system’s role in development should be evaluated are identified. It is argued that a theory based on New Institutional Economics can satisfy these criteria.

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Dongchul Cho, Takatoshi Ito and Andrew Mason

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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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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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Law and Development

An Institutional Critique

Frank H. Stephen

This book draws on the analytical framework of New Institutional Economics (NIE) to critically examine the role which law and the legal system play in economic development. Analytical concepts from NIE are used to assess policies which have been supported by multilateral development organisations including securing private property rights, reform of the legal system and financial development. The importance of culture in shaping the legal environment, which in turn influences financial sector development, is also assessed using Oliver Williamson’s ‘levels of social analysis’ framework.
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Frank H. Stephen

Chapter 3 considers legal reform in developing countries through an examination of Legal Origin Theory which argues that economies based on the Common Law have higher growth levels than those based on Civil Law. This theory is outlined and evaluated. A powerful critique of Legal Origin Theory (as a foundation of policy) is provided by the transplant effect. This considers the factors which influence the effectiveness of transplanting laws or parts of legal systems from one jurisdiction to another. Whether a transplant is successful or not is related to the motives behind the transplant. Is the recipient jurisdiction receptive to the transplant? Is there a demand for the transplant? When neither of these is the case, transplants will increase transaction costs and lower legal effectiveness. This chapter examines the evidence to support this approach and discusses its implications for legal reform as a route to development.

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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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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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New Institutional Economics

An Institutional Critique

Frank H. Stephen

In Chapter 2 the main concepts and ideas of New Institutional Economics are introduced. These are used with some additional adaptations in Chapter 4 to develop a theory of the role of the law and legal institutions in the process of development. According to a study by Ménard and Shirley in 2014, transaction costs is one of three core concepts in the development of NIE. The others are property rights and contracts. These three have played a crucial role in understanding the role of institutions in society and feature prominently throughout this book.