Foreign Direct Investment: A Key to Overcoming the Crisis
Executive Summary

1. Countries as diverse as the United Kingdom, Chile, and Mexico have successfully utilized foreign direct investment (FDI) to overcome financial crises. FDI contributed to these economic turnarounds by creating jobs and facilitating technology transfers. Thailand and Malaysia are two Asian countries that have been active in promoting FDI by removing restrictions on such investment and selling off financial institutions to foreign investors.

2. A major advantage of FDI is that it induces stable foreign capital without increasing domestic debt. Furthermore FDI facilitates financial and corporate restructuring. Such factors not only quickly contribute to the financial and corporate health of countries, but recent empirical studies show that a higher level of FDI is associated with a lower incidence of currency crisis and IMF rescue loan arrangements.

3. FDI increases consumer welfare by enhancing competition and boosting productivity through transfers of advanced technology and management know-how, benefits not normally associated with portfolio investment. A list of the benefits of trade and investment liberalization appearing in a recent publication of the OECD include greater freedom of choice, an increased degree of specialization and exchange based on comparative advantage, downward pressure on the prices of goods and services, productivity gains, technology and knowledge spillover, and a more efficient allocation of resources

4. Among these benefits, the spillover effect of advanced technologies of foreign invested firms is particularly important for developing countries. In Korea, the foreign subsidiaries Motorola Korea and Du Pont Korea have contributed to the upgrading of the technological capacity of domestic subcontractors. Such transfer has taken place through the operation of technology assistance centers, on-the-job training of quality improvement, and technical and managerial guidance. These subsidiaries also assisted former employees in establishing their own firms by transferring machines and later purchasing their products.

5. Besides these technology spillover effects, FDI promotes competition in domestic markets, thereby raising efficiency, and increases consumer welfare through lower prices. FDI liberalization alone has the ability of transforming entrenched monopolistic domestic markets into strongly competitive centers of activity.

6. Some worry that FDI may tip the current account of a country into deficit due to imports of intermediate goods, upward pressure on local currency, income transfers and the repatriation of profits by foreign multinationals. While some of this may be true, in the long-term, FDI improves current account due to its tendency to foster increases in -locally produced contents of intermediate goods,-exports,-follow-up and new investment that follows initial FDI, and-export competitiveness realized through transfers of advanced technology and management know-how.

7. FDI also creates jobs and, according to a recent OECD study, is complementary to environment protection. The foreign invested firms in the Masan Free Export Zone created over 50,000 jobs in the mid-1970s. Yuhan Kimberly has been campaigning for forest conservation since 1984, the first large-scale corporate environment protection campaign in Korea.

8. In Korea there is a lingering view that the privatization of state-owned enterprises (SOEs) will bring in bids below actual value. However, case studies of other countries demonstrate that the sale of SOEs to foreign investors not only bring resources needed for restructuring but also induce additional foreign investment by raising international credibility. According to a study by the Foreign Investment Advisory Service (FIAS), every dollar of FDI through privatization fosters an additional 0.88 dollars of FDI.

9. The Korean government has been undertaking active promotion of FDI by liberalizing cross-border M&As and foreign land acquisition, announcing liberalization of foreign exchange transactions and enacting the Foreign Investment Promotion Act. Such efforts have made Korean investment laws as liberal as those in advanced economies.

10. Thus, Korea should now focus its deregulatory efforts on improving efficiency of the internal regulatory environment. The transparency of regulations need to be enhanced through making laws more clear, removing any contradictions. Korea needs to eliminate those laws that hinder targeted deregulation while boosting the efficacy of those regulations that promote needed restructuring. In particular, it is urgent to lift regulations which deter foreign investment in small- and medium-size companies.

11. Now that investment incentives have been strengthened, the remaining task is the efficient applications of these incentives. For this purpose, local governments must be supported in the attempts to acquire expertise in inducing investment and be given greater autonomy.

12. When privatizing SOEs, the additional indirect benefits cannot be overlooked. Thus the government should implement privatization programs with firm objectives and avoid putting too much emphasis on the actual sale price of the SOE.

13. The bilateral investment treaties (BITs), such as the treaty currently being negotiated with the United States, can reduce foreign investor skepticism of Korea's true commitment to liberalization. Such treaties also introduce an effective dispute settlement mechanism. Hence, in pursuing the establishment of such treaties, Korea should employ flexibility to promote implementation of BITs.

14. Meanwhile, it is necessary to remove all possible import restrictive measures which act as investment barriers. Customs procedures also need to be streamlined to reduce the delay on customs clearance. In addition, there should be continuous efforts to fight corruption and lower hidden costs in doing business.

15. Finally, the Korean government needs to promote awareness in the general public of the benefits of FDI. Public officials, consumers, and workers need to be shown that FDI is not a 'win-lose' but a 'win-win' proposition. In particular, our young must be educated in a way that fosters an open and rational mind.

As the once dynamic Northeast Asian economies have been recently slowed by the recent regional turmoil, resulting in a shrinking volume of intra-regional trade and investment, the need for intra-regional economic cooperation has become much more pronounced. The rise of globalism being rivaled by the rise in regionalism further underscores this need for closer Asian cooperation. Yet traditional intra-regional trade liberalism alone may not suffice. As the initial cause of the recent regional turmoil was financial in nature, this has highlighted the importance of financial cooperation and macro-economic policy coordination among Northeast Asian countries.

In response to this need, the Korea Institute for International Economic Policy held a forum titled Prospects for Economic Cooperation Between China, Japan and Korea on into the 21st Century. Suggested and discussed were concrete measures to enhance economic cooperation between China, Japan and Korea. To promote the most promising measures of economic cooperation put forth at the forum, the establishment of the 'Economic Cooperation Council' was proposed.

Non-Tariff Barriers in APEC Economies Jungshik Son, Hongyul Han When APEC was first established in 1989, there was little expectation that the organization would be able to produce meaningful results. The very reasons of such skepticism comes from two basic principles of the APEC. The first is "open regionalism," whereby all the benefits of trade liberalization accrue to those both within and outside the region. The second principle is, "non-binding cooperation," meaning that the APEC will not utilize standard integration processes such as negotiations and agreements.

The development of the APEC shows that the members are still searching for some mechanism that can promote liberalization on the unilateral basis. EVSL is an attempt to produce such mechanism in APEC. EVSL adopts a 'semi-negotiation process' in selecting sectors for liberalization and cooperation, which greatly transforms the nature of the APEC from a forum of cooperation to a market for exchanging commitments for liberalization.

The main purpose of this study is to identify non-tariff measures applied to the products included in the EVSL, in order to facilitate the process of EVSL by providing information on non-tariff measures in APEC economies. The characteristics of non-tariff measures on the EVSL products can be summarized as follows. First, though the frequency of non-tariff measures in the APEC developed economies is smaller than that of developing economies, those measures are applied in a manner to directly influence trade flows. For example, the incidence of import quota, anti-dumping and countervailing measures are relatively more frequently found in developed economies.

Second, APEC developing economies are applying more general type measures like import authorization, non-automatic licences and import inspections rather than applying product specific measures. This characteristic seems to undermine the transparency of trade environment of developing economies.

Finally we suggest that more balanced approach is necessary for the successful conclusion of EVSL. First, as one of the reasons for developing economies to participate in EVSL is the unbalanced development between TILF and Ecotech, EVSL has to proceed in a more balanced way by emphasizing Ecotech. Second, it is desired to harmonize the level and frequency of non-tariff measures applied by the regional economies.

Currency Crisis and Difficulities for Overseas Affiliates: A Case Study on the Restructuring of Korean Affiliates in the United Kingdom Dongwha Shin

Since 1990s, Korean firms have pushed active FDI moves to Europe. Especially the U.K., among other European countries, has attracted FDI most, owing to its well-developed investment climates and efforts of U.K. government. However, things are changing after the financial crisis of Korea. Korean companies' overseas affiliates operating in the U.K. come to unable to afford financing the necessary capital from the parent companies nor from the local banks in the U.K. In the extreme cases, owing to the parent companies' bankruptcy, some affiliates are stopping their operations. Other companies are moving production lines to Eastern Europe to reduce labor costs. Practically every affiliate has been undergoing restructuring in a way to adjust to the changed environment. Nevertheless, patterns and processes of restructuring were not identical across affiliates.

Factors determining those patterns and processes can be categorized into three levels: corporate level, industry level, and regional level. Firstly, factors in the corporate level can make a profound influence on the restructuring process. For example, if a parent company goes bankruptcy, then in most cases, foreign affiliates no longer continue their operation. In this case, they can not but to do sell their assets and withdraw from that country. Secondly, factors in the industry level also affect the restructuring process. For example microwave oven market conditions and prospects being favorable, affiliates in this sector can overcome the financial crisis or adverse parent company position, only by increasing their productivity and efficiency with more efficient management and inventory control. But companies in semi-conductor sector where exists oversupply and market prospect is dismal cannot easily circumvent the crisis. So they now put off their whole investment project indefinitely. Finally we can think of factors in the regional level.

Let's take the appreciation of sterling pound for example. Traditionally the labor cost in the U.K. is the lowest among the EU members, and is similar to that of Korea. But things are changing dramatically in the strong sterling pound era. For the Korean affiliate, the merits in operating in the U.K. are disappearing. In this case there are different patterns of restructuring, such as transferring production site to the Eastern Europe and automizing production processes.

Despite industrial countries concerted policy coordination efforts to prevent a synchronized deep recession of the world economy, there still remain several downside risks that might adversely affect the global economy. The most conspicuous and significant risks are the possibility of an international liquidity crunch, the potential instability of emerging markets, and the possibility of a further financial meltdown and continued depression in Japan. However, if appropirate policy measures are undertaken, the prospects for the world economy in 1999 are promising.

In 1999, the world economy is poised to bounce back from 1998? 2.0% economic growth to a more benign 2.4% growth. This optimistic forecast is based on a number of recent developments that potentially reduce the risks of a global recession. To begin with, the United States still shows quite strong economic fundamentals. The third recent interest rate cut by the Federal Reserve this year successfully ended the credit crunch triggered by the near collapse of Long-Term Capital Management which took place just after the Russia? de facto debt default in August. Furthermore, the Dow Jones industrial index, which plunged in late August and September has fully recovered. Waning U.S. consumer confidence also recovered in November on the back of the recovery of stock prices. As consumer spending is two-thirds of the nation's overall economic activity, the rise in consumer confidence indicates that the U.S. economy is unlikely to soon slide into recession.

The European Central Bank (ECB) also delivered an early Christmas gift by participating in concerted interest rate cuts. On December 3rd, ECB reduced the administered interest rates from 3.3% to 3.0%, despite continued denials that it would do so. Although the lower interest rates will not change short-term growth prospects, which are mainly influenced by the slump in foreign demand, they will have a positive influence on business confidence, especially in the financial sector. The successful launching of the Euro, bolstered by lower interest rates will also contribute to economic growth prospects for West Europe and peripherial economies.

The Japanese banking crisis remains one of the largest, if not the single largest, threat to the world economy. While the Obuchi government? financial rescue and fiscal stimulus packages are not fully satisfactory, they may be sufficient to bring at least a temporary end to the Japanese recession in 1999. Meanwhile, non-Japan Asian economies are expected to begin improving late this year or at least in the first half of 1999. Foreign investment is increasing, particularly in Korea and Thailand, and the current account crisis is literally over. The key issue is now whether the recovery will be characterized by a slow U-shaped or a strong V-shaped cyclical rebound.

Economic Effects of Early Voluntary Sectoral Liberalization on the Korean Economy Jai-Won Ryou, Honggue Lee
We examined the merits of the proposals for early voluntary sectoral liberalization (EVSL) as applied to Korea by considering their potential effects on welfare and trade flows. For that purpose, we took up 15 commodity sectors for analysis. (For nine of them, the liberalization plan is supposed to be implemented immediately, and, for the remaining six, their liberalization is to be carried out later.)

We first looked at the patterns of comparative advantage of these sectors. According to the revealed comparative indices calculated for the sectors considered, Korea has comparative advantage in fertilizers, automotive, fish and fish products, gems and jewellery. On the other hand, Korea has comparative disadvantage in chemicals, forest products, medical equipment and instruments, food, oilseeds and oilseed products.

Second, we considered the effects of EVSL on trade flows. By eliminating tariffs, EVSL is expected to increase imports in Korea. Our analysis shows that the increase in imports in terms of volume will be greater in automotive, energy, and chemicals sectors than any others, while automotive, food, fish and fish products sectors will experience a most rapid change in imports in terms of growth rates. At the same time, EVSL is likely to increase Korea's chances for more exports to the member countries as many of them constitute Korea's major trading partners and some still have substantial tariff barriers. We anticipate a substantial increase in automotive exports among other items.

Third, we made use of both the conventional surplus measures and the trade restrictiveness indexes in our welfare analysis. In our estimation of the positive effects on resource allocation of EVSL, food and automotive sectors turned out to have the greatest improvement. Yet the resource allocation improvement is relatively meager in the sectors such as forest products, gems and jewellery, fertilizers, natural and synthetic rubber. Scale and pro-competitive effects are substantial in chemicals, food, automotive, natural and synthetic rubber, whose importance is decreasing in that order.
We also examined the merits of EVSL by comparing the changes in trade restrictiveness indexes during the period between the time (dating back to 4-5 years ago) when the APEC process started and the hypothetical time of implementing the proposals for EVSL. According to our estimation, EVSL is likely to enhance welfare far more substantially than did the liberalization efforts for the past 4-5 years. It will be particularly so in food, fish and fish products, and automotive.

■ Following the outbreak of the foreign currency crisis in November 1997, the resolution of domestic debt has emerged as the primary task for restoring economic stability in Korea. A year of economic turmoil and efforts at reform have now passed and it seems to be a good time for a reflection; for this purpose, KIEP held an international seminar, focusing on the two most important and intertwined aspects of economic reform: financial sector reform and corporate restructuring.

■ The financial sector reform has been reviewed by Dr. Stijn Claessens of the World Bank, and corporate restructuring by Dr. Ira Lieberman, also from the World Bank. The papers provide updated information on the reform process, and identify the size of the debt and the size of funds to resolve it as the biggest and immediate problem to be taken care of.

■ Both argue that this should take priority to any long term measures, and that greater government role is paramount in setting the speed and providing a central guidepost through, for example, greater use of fiscal policy and setting up of funds or a special purpose vehicle (SPV) to purchase debt to turn it into equity.

Strengthening Compliance with APEC Agreement: A Study on Member States' Compliance with APEC Agreement Bark, Taeho·Woo-Sik Moon·Jin-Hyun Paik This study attempts to evaluate the effectiveness of the APEC mechanism by analyzing how and the extent to which member countries implement and comply with agreements adopted by the APEC. Since its launching in 1989, APEC has produced a variety of agreements and measures, though not legally binding, to promote economic cooperation and liberalize trade and investment among member countries. In particular, member countries in the 1994 Bogor meeting agreed to liberalize trade and investment by year 2010 in case of advanced economies and by year 2020 in case of developing countries. They have subsequently submitted their individual action plans (IAPs) to accomplish these goals.

However, the agreements are effective when, and only when, they are domestically implemented by member countries. Without better knowledge about the implementation of agreements and concomitant obligations, it is impossible to assess the effectiveness of the APEC in promoting the liberalization of trade and investment and economic cooperation. Thus this study examines how APEC member countries, in particular Japan, Korea, China and the United States have thus far implemented their IAPs and analyzes the factors that have affected their implementation. These factors include the character of activities, the character of agreement, country characteristics, international environment, and so on. The study has found, among others, that APEC has an inherent limitation as it does not impose a legally binding obligation on member countries and lacks a mechanism to secure the implementation of obligations. It is suggested, therefore, that for trade and investment liberalization, member countries should give a priority to the negotiations at the WTO whereas they should concentrate more on trade and facilitation at the APEC.

Making APEC's Open Regionalism to Consistent with the WTO Sung-Hoon Park Ever since Open Regionalism was adopted by APEC as its basic approach, it has been discussed extensively in the circle of academics and policy makers. Recently, the European Union officially adopted Open Regionalism as one of priority principles in its external economic policy as well. Furthermore, international organizations, such as the WTO and the OECD, have also been reviewing whether and how the concept can be utilized in overcoming the regionalistic tendency in the world economy. Despite this increased interest in Open Regionalism in the international community, APEC member countries so far failed to agree upon a single definition of the concept, thereby leading to a confusion with regard to concrete measures for its implementation. This implies that the envisaged goal of APEC to overcome ever-increasing regionalism in the 1980s and thereby strengthen the multilateral trading system has to wait long time to be achieved. Fundamental problems arose in the course of APEC's attempts to implement Open Regionalism: On the one hand, unilateral liberalization, which is suggested by the EPG as an option, could not effectively avoid the free-rider problem. On the other hand, the application of conditional MFN would have inevitably violated the 'non-discrimination' principle of the GATT/WTO. In this paper, the following two factors are identified as main inherent limitations of APEC, especially in implementing Open Regionalism. First, APEC lacks a concrete long-term vision. The long-term goal of APEC to achieve "free trade in the region" appears too vague, and there are no specifications regarding the relationship between this goal and the Free Trade Agreement (FTA). Second, APEC contains several sub-regionalism, such as AFTA, CER and NAFTA, and they differ substantially in the level and coverage of economic integration. Consequently, APEC has to solve both internal and external problems at the same time: Internally, APEC has to design measures to harmonize several sub-regionalism, while it wants to apply Open Regionalism towards non-APEC members. This paper suggests that developing APEC into an FTA is an option that member countries can resort to, in case APEC further sticks to the concept of Open Regionalism as its basic approach. Once adopted by APEC, this option will contribute to the resolution of the two problems mentioned above: free-rider problem and the violation of non-discrimination. It will also help to minimize the two main inherent limitations of APEC: a lack of a concrete long-term goal and the existence of several sub-regionalism within it. This paper concludes that a three-step approach could be adopted in developing APEC into an FTA. The suggested steps are: (1) establishment of an FTA for the Northeast Asian region and/or an FTA for the Asian APEC members; (2) consistent strengthening of cooperation and harmonization among several sub-regional integration bodies; (3) development of APEC into an FTA as a final step.