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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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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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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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Edited by Dongchul Cho, Takatoshi Ito and Andrew Mason

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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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Mohamed A. Gadhoum and Shamsher Mohamad

Benchmarks serve a critical role financial markets as a point of reference for pricing the riskiness of a financial security, to indicate the relative value or opportunity cost of capital while it also serves as a yardstick for the relative performance of a portfolio. The existence of a transparent, observable, liquid, easy-to-compute and non-manipulative benchmark is vital for efficient financial markets. Islamic finance has yet to develop appropriate benchmarks and currently use LIBOR as the reference benchmark in determining expected rate of return in shariah-compliant securities. This practice has been allowed by scholars as an exception under the law of necessity. Unfortunately, despite being in practice for decades, this exception has become a general rule and the practice is so prevalent that most practitioners in the Islamic finance Industry. The key difficulty lies in obtaining a rate of return in an economy based on profit-and-loss sharing. This chapter discuss in detail the development of a benchmark for shariah-compliant investments taking into consideration the conceptual and practical issues.

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Abbas Mirakhor

Benchmarks serve a critical role in financial markets for pricing the riskiness of a financial security, to indicate the relative value or opportunity cost of capital and to serve as a performance yardstick. The Islamic finance industry globally has yet to develop appropriate benchmarks and currently use LIBOR as the reference benchmark in determining expected rate of return in shariah-compliant securities. This chapter explains the significance and the critical role of LIBOR as a financial benchmark in current conventional banking and financial markets, and discusses the issues arising from the use of LIBOR as a compliant investment. A linkage between the concept of benchmarking and the doctrine of market price in Islam is established and contrasted from the perspective of wealth management in Islam. The risk of using an interest rate-based benchmark by Islamic financial institutions is highlighted and there is an urgent need to create an interest-free benchmark in place of LIBOR is explained.