Two years have passed since the Korean government agreed on the structural adjustment program with the IMF on December 3, 1997. As a sequel to 'Adjstment Reforms in Korea since the Financial Crisis: Volume I,' this volume analyzes the road which the Korean economy has followed, during the past two years, on the basis of the IMF Letters of Intent, from the second half of 1998 to the end of 1999. However, our efforts are not merely record keeping. We explore the future policy direction in which the Korean economy should move forward by thoroughly evaluating the policy measures actually employed under the IMF program.

The policy consultations with the international financial institutions such as the IMF and the World Bank, were extremely valuable to the containment of the crisis and to the improvement of economic fundamentals. However, it should not be overlooked that the Korean government sustained its ownership of the program since the 6th letter of intent in May, 1998. The Korean government clearly recognized the currency crisis stemmed, in large part, from the structural problems, whether government-induced or not, which were not on par with market disciplines. In this regard, the Korean government made serious efforts to revamp the Korean economy and to recover the soundness of the economic fundamentals.

In the new millennium, we should not allow the recurrence of economic crisis. We have already paid too high a cost in lessons learned from the crisis. However, we still have many grave challenges to cope with. While Korea's sovereign credit rating has been upgraded beyond the investment grade, private commercial banks still remain below that level. The potentially damaging assets of the investment and trust companies were not sufficiently cleaned up. In conclusion, Koreans should not give in to any sense of euphoria or self-complacency, again, the reforms are not yet complete. Rather, they should look into ways through which the economic participants - consumers, producers, businesses, labor, and the government - can come together to create the very foundation of a more dynamic and competitive economic system. Thus far, the Korean people and the government have demonstrated that they are serious about economic reform. Koreans should take this one step further and find ways to advance to the level of an advanced economy.

A New Strategy for Northeast Asian Economic Cooperation

This study proposes the formation of the Northeast Asian Economic Cooperation Council to discuss comprehensive economic cooperation and major economic issues between Korea, Japan and China.

In order to meet the challenge of rising regionalism, it is imperative that the central governments of the region involve themselves more actively in Northeast Asian Economic Cooperation. Given the diversity of Northeast Asian countries, it seems to be more realistic to begin with the central governments of the three major countries in terms of economic size.
However, even among these three countries, the prospects for reaching a regional trade agreement such as the North American Free Trade Agreement (NAFTA), let alone a more advanced economic integration type like the EU, are quite dim in the foreseeable future. Thus, Korea, Japan and China must try to gain as many benefits of economic integration as possible through the formation of a regional economic cooperation body.

Some people might argue the usefulness of the Council, because basically it does not go beyond APEC where all three countries are already members. Indeed, this Council would not produce any legally binding decisions. Rather, it would be a loose economic cooperation entity like APEC, or even a more informal forum than APEC. However, unlike APEC, which has 21 members and covers diverse geographic areas, it can function more effectively concentrating on the regional issues that all three countries are interested in. In this sense, the Council will play a supplementary role to APEC.
It seems to be appropriate that the Korean government propose the formation of the Council. Among the three countries, Korea is positioned in the intermediate position both in terms of geography and economic development. Moreover, unlike Japan and China, nobody would suspect that Korea might seek hegemony in the region.

Prior to the launching of the Council, it is necessary to develop an awareness of the need for, as well as a consensus with regard to the establishment of, the Council. In order to attain these goals, a joint study conducted by the research institutes of the three countries, on Northeast Asian Economic Cooperation, seems to be in order.

The type of exchange rate regime in emerging economies has been at the center of economic debate since the Asian crisis. The choice of exchange rate regime has been regarded as critical for emerging economies to achieve sustainable economic growth, and also has important implications for the world economy. In principle, the most appropriate regime for any given economy may differ, depending on the particular economic circumstances, such as the degree of integration into the world economy. Since economic circumstances vary over time, the most appropriate regime for any given country may also change over time.

This paper examines a measure of productivity, the total factor productivity (TFP) growth rate, for both major Korean industries and disaggregated manufacturing sectors. Initially, focus is placed on attaining credible estimates of the productivity measure by using consistent data. Next, interpretation of the estimates are given in an attempt to find a relationship between TFP growth rate and other factors related to production function and industrial structure change. It is followed by an analysis to verify if any differences in TFP growth rate exist among various manufacturing sub-sectors as well as among major industries. Subsequently, this paper attempts to explain why such differences in TFP growth rate, if any, arise. Finally, the relationship between TFP growth rate and export growth rate is examined.

The annual average rates of change in the TFP were calculated as having been relatively high in industries such as (4) Electricity, gas and water (4.89%); (2) Mining and quarrying (3.10%); and (7) Transportation, storage and communication (0.70%). These three sectors have shown relatively rapid increases in investment. In contrast, TFP growth rates were calculated as having negative values in (1) Agriculture, forestry and fishing (-6.62%); (5) Construction (-6.17%); (8) Finance, insurance, real estate and business services (-3.31%); (6) Wholesale and retail trade, restaurants and hotels (-1.86%); and others. Among disaggregated manufacturing sectors, TFP growth rates were calculated as having been relatively high in (h) Electric and electronic products (7.24%); (g) Metal products and machines (5.18%); and (i) Transportation equipment (5.02%). The common characteristics of these sectors were that they were capital and/or knowledge intensive sectors. On the contrary, TFP growth rates were calculated as having low and even negative numbers in labor-intensive traditional manufacturing sectors with low value added. In sum, the high growth rates of TFP in most of the manufacturing sectors were attributed to the fast increase in investment.

TFP growth rates and structural changes seem to have been closely inter-related. Resources, the factors of production, had moved from the primary sectors to the manufacturing sectors of traditional labor-intensive industrial goods and then to the manufacturing sectors of chemical & heavy industrial goods.

The correlation coefficient between the TFP growth rates and the adjusted export growth rates was calculated as being 0.93, which suggests that the two variables were highly correlated. With that result, we might conclude that TFP growth rates had a close relationship not only with technological factors, as denoted in the production function, but also with market demand conditions, especially for exports, for East Asian emerging economies with relatively restricted domestic market demand. Therefore, in order to formulate more complete industrial policies, not only technological characteristics but also market demand conditions should be fully considered.

The type of exchange rate regime in emerging economies has been at the center of economic debate since the Asian crisis. The choice of exchange rate regime has been regarded as critical for emerging economies to achieve sustainable economic growth, and also has important implications for the world economy. In principle, the most appropriate regime for any given economy may differ, depending on the particular economic circumstances, such as the degree of integration into the world economy. Since economic circumstances vary over time, the most appropriate regime for any given country may also change over time.

The Korean government responded to the currency crisis by adopting a free floating exchange rate regime and by more actively pursuing capital account liberalization. As a natural consequence, we may expect that the foreign exchange market is more likely to be linked to other financial markets, such as stock and bond markets. The empirical methodology to uncover inter-relationships among three variables is Granger causality tests and variance decomposition. Empirical results are, however, different from our conjecture: any statistically significant empirical relations are not found among three variables after the crisis. The foreign exchange market has been relatively stable during the post-crisis period, while the stock market has been quite volatile. Since the bond market in Korea is not fully developed and credit risks of corporate bonds are still high, foreigners are rather reluctant to participate in the domestic bond market. One important indication, to support our presumption that the Korean government has intervened in the foreign exchange market, is the stability of exchange rates relative to that of stock prices.

Under the free floating exchange rate regime with free mobility of capital flows, why has the Korean government intervened in the foreign exchange market? We would like to focus on two reasons. One is related to the vulnerability of financial markets in Korea. In order to build a buffer to this vulnerability, the Korean government continued to accumulate foreign reserves even during the post-crisis period. While financial and corporate restructuring were still underway, events of Daewoo's bankruptcy and resultant ITC troubles increased the vulnerability in Korea's financial markets. To counter the financial vulnerabilities, the Korean government has undertaken various measures. Also recognizing the fact that the currency turmoil resulted in financial panic in Korea just two years ago, the Korean government is now endeavoring to strengthen the ex ante defensive measures.

A certain level of foreign reserves can be geared into a set of ex ante defensive measures. However, the recommended level of foreign reserves, which is equivalent to the value of three month imports, will not be adequate in times of free capital mobility. Taking short-term capital movements and possible reversals into account, it can be suggested that a minimum level of foreign reserves, which can finance short-term external liabilities plus capital outflows, should be maintained.

The Korean government is keenly aware of the important lesson from the recent crisis that, in the age of global financial integration, the financial sector is increasingly as important as the real sector. Based upon this recognition, the Korean government will pursue financial sector restructuring on a continuous basis. However, it will take several years to develop healthy financial institutions and markets such as those in industrial countries. A more flexible exchange rate system will definitely reduce the required level of foreign reserves, only if Korea has much sounder financial systems. The other important justification for the government's intervention in the foreign exchange market can be found in the vulnerable and underdeveloped infrastructure of the foreign exchange market. As the free floating exchange rate regime was introduced, the Korean government also endeavored to develop the infrastructure of the foreign exchange market through various means. First of all, policy makers pointed out the problem that market participants are limited in Korea's foreign exchange market.

In order to broaden the foreign exchange market, the government has lifted various regulations on the speculative trading. If the foreign exchange market operates freely from any intervention, volatility will increase and the necessity of hedging and speculative demand will increase. Volatility may be a necessary evil so as to induce more market participants. In this regard, it might be argued that the government should allow for some degree of volatility as a natural outcome of the free floating exchange rate regime, since foreign exchange market intervention seems truly inconsistent with the government's plan for foreign exchange market development. Nevertheless, there are many other obstacles in developing a more liquid foreign exchange market. That is to say, the government's non-intervention exchange rate policies will not sufficiently increase the volume of daily turnovers in Korea's foreign exchange market.

The basic transaction fees in the interbank market are surprisingly cheap: only KRW 4,000 per USD one million for spot, forward, and swap (beyond one month). The major factor restraining the market access of domestic banks into the interbank market is the inadequate provision of credit lines. While foreign branches play a role as market makers, domestic banks as foreign exchange traders do not receive enough credit from those foreign branches because the credit ratings of most domestic banks are still below non-investment grade. This limited access of domestic banks to interbank forward or swap transactions has even aggravated foreign exchange trading in the customers markets. Since domestic banks have to square the foreign exchange positions through, such as, swaps, they have been reluctant to provide forward contracts to domestic companies. Most companies should provide some form of guarantee such as deposits or securities. This extremely limited accessibility to the currency hedging markets has obliged the government to intervene in the foreign exchange market to stabilize exchange rate fluctuations. Nevertheless, the volume of transactions in the third quarter of 1999 has increased almost twice as much as that in the same quarter of 1998. This partly reflects the improvements in the creditworthiness of domestic companies.

Dr. Yung Chul Park is a professor of economics at Korea University. He previously served as the chief economic advisor to President of Korea, as president of Korea Development Institute, as president of the Korea Institute for Finance, and as a member of the Bank of Korea's Monetary Board. (ycpark@soback.kornet21.net)

Dr. Chae Shick Chung, associate research fellow at Korea Institute for International Economic Policy, earned his Ph.D in Economics from Duke University. His field of concentration mainly covers empirics of foreign exchange markets and foreign exchange regulations. (cschung@kiep.go.kr)

Dr. Yunjong Wang, Director of Department of International Macroecnomics and Finance at Korea Institute for International Economic Policy, earned his Ph.D from Yale University. His field of concentration mainly covers liberalization of trade, foreign direct investment, and capital markets in Korea. (yjwang@kiep.go.kr)

The main purpose of this study is to review the recently established Koeln Debt Initiative and to draw policy implications for the Korean government. The Koeln Debt Initiative, initiated by the G-7 in June 1999, extends and deepens in many important respects the HIPC (Heavily Indebted Poor Countries) Debt Initiative launched by the Bretton Woods institutions, the World Bank and IMF, in 1994. The Koeln Initiative is very likely to be a main framework for future debt relief mechanism of the Paris Club.

Under the Koeln Initiative, Korea would share the burden of debt relief in accordance with the amount of previous lending to the eligible poor countries. According to our estimates, the total amount of debt relief expected by Korea under the Initiative would amount to at most US$ 6 million in net present value terms. In addition to the burden, Korea has pledged to contribute US$ 20 million to the HIPC Trust Fund at the World Bank and to the special account at the IMF. Although, depending on possible change in cut-off dates for eligible debts, the amount of Korea's burden may change, it should not be too much for the world's 12th biggest economy to pay for good reason.

The study concludes that rather than passively following or seeking to evade the international trend of alleviating debt burden of heavily indebted poor countries, the Korean government should proactively approach the issue. It should actively consider participating in the Paris Club on a permanent basis.

This paper argues that the ongoing restructuring process and big bang acceleration in Japan's financial sector precipitate changes in the organizational structure and corporate governance of the 'kigyo-shudan,' or bank-centered, enterprise groups. It pays particular attention to the effect of the government restructuring policies on the enterprise groups as they deal with these changes, and maintains that their structural transformation can best be understood if equal emphasis is placed on examining both institutional and economic factors.

The organizational structure of Japan's six enterprise groups - Mitsui, Mitsubishi, Sumitomo, Fuyo, Sanwa, and Dai-Ichi Kangyo - was considered to have been well entrenched since having been (re)established after World War II.
Typically classified as organizational isomorphisms, they are characterized by the 'keiretsu' structure, meaning a vertical alignment of firms of different sizes. Each enterprise group consists of member firms that are connected horizontally, often active in different industries. A member firm maintains vertically aligned and affiliated subsidiary firms. These subsidiary firms are, in addition, affiliated with many medium and small sized subcontracting firms ranked as either primary, secondary, or tertiary, depending on size and closeness. Also, each enterprise group has its own banks, insurance companies, and trading firms for the common financial and distributive needs of the member firms.

Once established, the organizational structure of the postwar business combine is considered to have become entrenched thereafter, referred to either as an 'intermarket group' (Dodwell 1984), or 'financial keiretsu,' or 'kigyo-shudan (enterprise group).' However, with the implementation of the major financial reform policies of the Japanese government after the economic recession of the 1990s aimed at revitalizing the economy, the keiretsu structure is considered to have entered a phase of rapid transition. If ongoing financial reform measures are implemented successfully, the kigyo-shudan will no longer be able to preserve their current structures, because financial institutions have so far acted as their de facto holding companies.

The financial reform measures include the enactment of the financial system reform law, legalization of the financial holding company, withdrawal of the full-deposit protection scheme, corporate accounting reform and the boosting of foreign competition. As a result of these measures, the unwinding of cross shareholdings in the enterprise groups is being accelerated, the role of capital market financing is increasing, greater transparency is required, the 'national' identity of the enterprise groups is withering and their internal labor market is changing.

The above statement implies that the current structural transformation of the Japanese enterprise groups is attributable not only to their efforts at adapting to the changing market environment, but also to the legitimizing efforts of the crisis-ridden state under environmental uncertainties. The 'political repercussions' of the economic crisis threatened the state and caused it to respond with counter-crisis policies for legitimation, in the form of socio-political and economic reforms. The policies of the legitimacy-pressured state led to the institutionalized sanctioning of the business practices and economic activities of the Japanese enterprise groups, resulting in controlled market behavior. As a result, the possibility is greater than ever that the keiretsu structure of the enterprise groups, preserved throughout the postwar period, will finally be transformed or may even disappear completely.

ASEM, being still under probation in the sense that its action plans have not yet been transformed into real action, needs to be consolidated in terms of its goals and agenda. In this regard, this paper seeks to investigate the agenda setting for the 3rd ASEM summit that will be held in 2000. For more than just symbolic reasons, the year 2000 provides ASEM with an excellent occasion for both retrospect and prospect, allowing it to pursue a revision of its agenda and thereby articulate its goals. In addressing this topic, the focus is on testing Gerald Segal's 'subsidiarity question' for ASEM--which is to ask, 'what can best be done for ASEM?'-- taking into account the recent development of ASEM's economic dialogues.

Several features deserve attention. First, the progress achieved at ASEM does not yet meet the requirement dictated by the subsidiarity question. Consequently, ASEM will have to become more than a venue for verbal exchanges and ministerial rhetoric extolling its achievements if it is to survive in the new millennium. As for the future of ASEM navigation, there seems to be two broad scenarios: 'an APEC type evolution scenario' and 'ASEM's own pace of evolution scenario.' Second, as for the former, a more forward-looking strategy for ASEM would be aimed at achieving a goal matching trade liberalization measures and a non-binding regional investment initiative such as those in place in APEC. Under this scenario, especially concerning trade liberalization, it not only brightens ASEM navigation but also provides a decisive momentum to multilateral liberalisation. Third, under 'ASEM's own pace of evolution scenario' its agenda will be basically aimed at facilitating information networks. Much of the economic agenda can be left to the markets to manage.
ASEM would still remain a consultative forum. Consequently, It is questionable whether ASEM will truly be meaningful in the sense that it helps to develop and strengthen a more open multilateral trading system. Under this scenario, one possible agenda would be merely follow-up activities on ongoing works, namely: (1) concerted efforts for open multilateralism in general and investment liberalization in particular; (2) reinforcement of technology transfer combined with protection of intellectual property rights; (3) active transfer of knowledge, especially in areas such as education and human resource development; (4) improvement of infrastructure linkages; and (5) enhancement of business exchanges. One practical way to enhance such a network is to launch an Asia-Europe Trade Week (AETW). Fourth, taking into account the new initiatives agreed upon at EMM Ⅱ, including a non-binding study of the TFAP and a voluntary report and review mechanism conducive to FDI, a more plausible scenario will be somewhere in between the two. Fifth, whatever the case is, one should bear in mind that the Asian and European industrial sectors are primarily complementary, both in manufacturing and services and, thus, are expected to provide healthy potential for cooperation. Lastly, what is certain is that out of the current crisis comes a new opportunity to build a much stronger, more varied and longer-lasting Asia-Europe relationship. Now, the time has come.

Following the recovery from the financial turmoil in East Asia and the successful launch of the euro, the conditions have been improved for ASEM, allowing it to make great strides in the new millenium. For more than just symbolic reasons, the year 2000 provides an excellent occasion for building a more grandiose vision of ASEM which should serve as the foundation for a solid international economic order for the twenty-first century.

Since a global financial market and its potential volatility pose such a grave potential danger for most emerging economies, individual countries and the international community should find ways and build mechanisms, by which the systemic risk of global financial instability could be minimized. Most of all, at the national level, the old question on how market opening should be sequenced may need re-examination in a new perspective. The old wisdom holds that properly and orderly sequenced external liberalization should be from the current account to the capital account and capital account liberalization should be in the order of long-term to short-term. However, after the recent crisis, heated debates are not on how to get the sequencing right, but on how to deal with the volatility of short-term capital flows.
In fact, there are often-heard voices advocating temporary controls over capital inflows a la Chilean scheme, which should be introduced before a crisis occurs, or controls over capital outflows, a la Malaysian way, which should be applied after crisis arises especially if a country is in the transition period of strengthening the institutional and regulatory domestic financial institutions. At the same time, the argument for an enhanced disclosure requirement and changes in current bank lending procedures to hedge funds is also gaining force. Maybe, we had better get ready to see more emerging markets trying various mechanisms for controlling short-term capital inflows, including hedge funds, on the other hand and fostering long-term capital inflows, such as foreign direct investment, on the other hand.

This development of policy interests suggests that the question on sequencing should be dealt with in a rather broadened scope. Indeed, the main purpose of this paper is to argue that the scope should go beyond mere contemplation on carriers of capital flows and comprise considerations on incentives of domestic and international agents who make use of those carriers.

The most serious sequencing problem in Korea was to liberalize short-term financing through banks rather than long-term financing, and to underestimate the potential devastating impact on the economy when massive capital inflows have come to reverse. Although long-term capital inflows were rather repressed during the pre-crisis period, it would be an exaggeration to say that short-term capital movements were liberalized greatly. Neither firms nor banks could sell their short-term debt instruments in domestic currency to foreigners. Only liberalized were trade-related financing of firms and short-term foreign currency borrowings of banks.

The intention was clear: liberalize first capital flows that are only trade related. Then, how about short-term foreign currency borrowings of banks? Should the Korea government have restricted short-term borrowings of banks? Probably the answer is No. It is extremely costly to control short-term transactions of banks. What was lacking was financial supervision and appropriate risk management. Without strengthening banking supervision and enhancing corporate governance, corporate debt crisis will be an inevitable outcome. In this regard, the main lesson of the Korean crisis is not the sequencing problem in the capital market liberalization, but the structural deficiencies as prerequisites of capital market liberalization.

It has become increasingly clear in recent years that bad regulatory regimes can reduce economic growth by reducing competitiveness and openness while fostering distortions which encourage corruption or mismanagement of resources. For the last several years, OECD has engaged in a study of regulatory reform of its members with a view to cataloging the best and worst practices of the member governments, and suggesting possible improvements to the members' regulatory regimes.

To this end, OECD has issued an extensive report on regulatory reform in 1997, and issued recommendations to the ministers of the member governments. The ministers in turn, ordered the OECD secretariat and committees to engage in a comprehensive reviews of the regulatory reforms in OECD member governments. In 1998, as the first step, the OECD issued a report on regulatory reforms of four member countries: The United States, the Netherlands, Japan and Mexico. The report was completed and published in late 1999.

The country reviews took place in seven areas: The effect of regulatory reform on the economy; government capacity to assure high quality regulation; the role of competition policy in regulatory reform; enhancing market openness through regulatory reform; regulatory reform in the electricity sector; and regulatory reform in the telecommunications sector. At the end of the report, OECD also offered suggestions on further regulatory reform for each members.

This report summarizes the policy components of the OECD country reports. Due to space constraints, we concentrate on the historical and policy portions of the report and excludes the portions dealing with the electricity and telecommunications sectors.

We also look at the implications of the OECD country reports on the ongoing Korean regulatory reform. Korea is scheduled for OECD regulatory reform country review in 1999, and we also look at the possible problems which may come up in the 1999 OECD Korean regulatory reform review.