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Political economy of financial liberalization in emerging markets: A comparative study of South Korea and Taiwan in the 1990s

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Content POLITICAL ECONOMY OF FINANCIAL LIBERALIZATION IN EMERGING
MARKETS: A COMPARATIVE STUDY OF SOUTH KOREA AND TAIWAN IN
THE 1990s
Copyright 2002
by
Tsaubin Chen
A Dissertation Presented to the
FACULTY OF THE GRADUATE SCHOOL
UNIVERSITY OF SOUTHERN CALIFORNIA
In Partial Fulfillment of the
Requirements for the Degree
DOCTOR OF PHILOSOPHY
(POLITICAL ECONOMY AND PUBLIC POLICY)
December 2002
Tsaubin Chen
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UMI Number: 3093964
UMI
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UNIVERSITY OF SOUTHERN CALIFORNIA
THE GRADUATE SCHOOL
UNIVERSITY PARK
LOS ANGELES, CALIFORNIA 90089-1695
This dissertation, written by
under the direction o f h i.C dissertation committee, and
approved by all its members, has been presented to and
accepted by the Director o f Graduate and Professional
Programs, in partial fulfillment o f the requirements fo r the
degree of
DOCTOR OF PHILOSOPHY
/d irecto r
/
2
Date —‘ 2M —
Dissertation Committee
7
Chair
— 7 — ------------- --------------
A - 1 1 ^ t :
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ii
ACKNOWLEDGEMENTS
I would like to express my deepest gratitude to my parents, who always
encouraged and supported my academic career, but unfortunately did not have the
chance to share in my pleasure of completing the degree. I will always love you and
miss you very much.
The dissertation would never have been completed without my committee
members: Professors Robert Dekle, Saori N. Katada, and K. Ravi Kumar. Thank
you all; I really appreciate your valuable time and effort in providing numerous
suggestions and comments. I would like to express my deep respect for Professor
John Elliott for his great teachings in the program of political economy and public
policy, and also would like to express my deep appreciation to my advisor Dr.
Farideh Motamedi, for her tireless support during my graduate study in the program.
I also thank Professor Sunhyuk Kim for his assistance in explaining the politics of
South Korea.
In writing this dissertation, I have received much help and encouragement
from many friends. Thank you all. In particular, I would like to thank Leemen Lee,
Amy Liu, Hittie Chao, Karen Hwang, Charlie Lin, Scott Chen, and Ashley Liu. All
of you have provided me unforgettable sweet memories. I also profoundly thank my
editor Sadie Moore for her wonderful work and effort.
Finally, I am deeply grateful to Hsin-Yi, I-Chi, Ben-Hong and all my family
members. Without your love, patience, and sacrifice, I would never have completed
this writing. I will love you forever.
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TABLE OF CONTENTS
ACKNOWLEDGEMENTS..........................................................................ii
LIST OF TABLES.........................................................................................vi
LIST OF FIGURES.................. vii
ABSTRACT................................................................................................ viii
CHAPTER ONE: INTRODUCTION........................................................ 1
1.1 Introduction....................................................................................1
1.2 Shocks of capital mobility............................................................ 5
1.3 Framework of analysis..................................................................7
1.4 Research questions...................................................................... 14
1.5 Arguments....................................................................................16
1.6 Methodology................................................................................19
1.7 Quantitative evidence..................................................................21
1.8 Results..........................................................................................24
1.9 Financial liberalization and economic growth......................... 26
1.10 Financial liberalization and economic crises.......................... 28
1.11 Chapter structures......................................................................29
1.12 Summary....................................................................................30
CHAPTER TWO: HISTORIES OF DEVELOPMENTAL POLITICS IN
SOUTH KOREA AND TAIWAN, 1945-2000........................................ 32
2.1 Introduction..................................................................................32
2.2 The roots of centralized development in South Korea ............34
2.3 Conclusion from previous section............................................. 47
2.4 The roots of decentralized development in Taiwan.................47
2.5 Conclusion from previous section............................................. 61
CHAPTER THREE: DOMESTIC POLICIES OF FINANCIAL
LIBERALIZATION IN SOUTH KOREA AND TAIWAN IN THE
I980-90S.........................................................................................................62
3.1 Introduction..................................................................................62
3.2 The sequence of financial liberalization.................................... 65
3.3 Conclusion....................................................................................79
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CHAPTER FOUR: TIME-VARYING ESTIMATES ON THE OPENNESS OF
FINANCIAL LIBERALIZATION IN SOUTH KOREA AND TAIWAN IN
THE 1990S...................................................... 81
4.1 Introduction..................................................................................81
4.2 Modeling the openness of the capital account.......................... 82
4.3 Data and methodology.................................................................85
4.4 Time-varying estimates: Kalman filter approach..................... 91
4.5 Findings .......................................................................................95
CHAPTER FIVE: TIME-VARYING ESTIMATORS OF FINANCIAL
LIBERALIZATION AND ECONOMIC GROWTH IN SOUTH KOREA AND
TAIWAN IN THE 1990S.......................................................................... 101
5.1 Introduction................................................................................101
5.2 Did financial liberalization increase economic growth
in the 1990s?..................................................................................... 102
5.3 Modeling the time-varying effects of liberalization on
economic growth..............................................................................105
5.4 Empirical results and findings..................................................108
5.5 Conclusion.................................................................................. 112
CHAPTER SIX: DOMESTIC FACTORS AND THE RECENT ASIAN
FINANCIAL CRISIS.................................................................................114
6.1 Introduction................................................................................114
6.2 Literature review and debates...................................................115
6.3 Domestic factors: the crucial elements.................................... 120
6.4 Conclusion.................................................................................. 124
CHAPTER SEVEN: CONCLUSION..................................................... 126
7.1 Introduction................................................................................126
7.2 Lessons learned and policy implications................................. 127
7.3 Discussions and suggestions for future research.................... 129
REFERENCES............................................................................................131
APPENDIX A ..............................................................................................140
APPENDIX B...............................................................................................157
APPENDIX C ..............................................................................................159
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LIST OF TABLES
Table 1: Economic and financial indicators of Korea and Taiwan
at the end of 1997.......................................................................63
Table 2: The sequences of financial liberalization........................................... 69
Table 3: Inward and outward capital flow in South Korea and Taiwan,
1980-1996.....................................................................................75
Table 4: Contrasting characteristics of financial liberalization in South
Korea and Taiwan, 1980 - 1990 .............................................. 77
Table 5: Sources of finance in South Korea and Taiwan, 1990 -1 9 9 7........... 79
Table 6: Sources of funds for corporate borrowing, South Korea,
1991-1996 ..................................................................................123
Table 7: Sources of funds for corporate borrowing, Taiwan, 1990-2000..... 123
Table 8: Loans made by eight bankrupted South Korean Chaebols
in 1997 .......................................................................................124
Table 9: Loans made by the ten worst in-debt conglomerates, Taiwan,
2000............................................................................................ 124
Table 1A: Comparative processes of interest rate liberalization,
1980-1997...................................................................................140
Table 2A: Comparative processes of domestic financial deregulation,
1981 -1998 ................................................................................143
Table 3A: State-owned banks’ total shares of assets, deposits and loans
in market during 1990 -1 9 9 8 ................................................. 149
Table 4A: Comparative processes of exchange rate liberalization,
1978-1997...................................................................................150
Table 5 A: Comparative liberalization of capital flow, 1980 -1998 ..............152
Table 6A: Significant results to the crisis index...............................................158
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LIST OF FIGURES
Figure 1: Framework of analysis..........................................................................8
Figure 2: The index of financial openness, Taiwan 1987:3-2000:2.................94
Figure 3: The index of financial openness, South Korea 1990:3 - 1999:1.......94
Figure 4 Openness of financial liberalization by comparison...........................95
Figure 5: GDP and the time-varying index of liberalization adjusted with
lags, Taiwan................................................................................106
Figure 6: GDP and the time-varying index of liberalization adjusted with
lags, Korea................................................................................. 107
Figure 7: Korean foreign debts and portfolio investments during
1990-1997...................................................................................I l l
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ABSTRACT
This research explains how diversity in domestic politics and liberalization
policies differentiated the results of financial liberalization in South Korea and
Taiwan in the 1990s. Thus far, there has been no consensus among economists and
political scientists regarding the consequences of financial convergence to
international markets or how emerging markets will manage these transitions. Most
studies have analyzed these transitions and their results as consequences of market-
driven forces or hegemonic policies. Assuming a similar international context, the
theoretical and empirical focus of this comparative study is based on the view that
each country has unique internal political and economic structures that differentiate
its transition. Identifying linkages between liberalization and economic growth and
crisis, this work finds that the influence of diverse domestic structures and financial
policies may be as important as or even more important than international factors.
This study created a comprehensive framework of analysis combining both
qualitative assessments and empirical econometric measurements to understand
transitions. This analysis resulted in three major conclusions. First, South Korea and
Taiwan experienced different patterns of transition during the 1990s. Second, South
Korea’s liberalization resulted in more influential effects on economic growth than in
Taiwan, finding a fluctuating pattern of growth in South Korea compared to more
gradual growth in Taiwan. Third, different patterns of corporate borrowing led to
differing reactions to crisis; qualitative differences explain why Taiwan weathered
the 1997-98 currency crisis more successfully than South Korea. These conclusions
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give rise to several policy implications for avoiding crisis. The sequence of
introducing liberalizing reforms is vital; market-led liberalizations will not avoid
financial crisis if competitive industrial, bank and political structures do not exist
simultaneously. Most importantly, adequate prudential regulation and supervision
must be implemented before liberalization in order to eliminate rent-seeking
behaviors between banks and business conglomerates, common in emerging markets
after liberalization. This research thus suggests a new model for examining
processes of financial liberalization, finding that the internal structures of states can
be analyzed to explain subsequent economic growth and crisis. This is information
that can potentially be used for crisis avoidance.
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CHAPTER ONE
INTRODUCTION
1.1 INTRODUCTION
As the ascendency of capital mobility has increasingly shaken the world with a
succession of international financial crises1 , scholars have suggested numerous
approaches to analyzing how emerging markets will adjust to economic openness.
Some examine trends of deregulation, privatization and globalization under integrating
market infrastructures, while others are concerned with possible impacts from
hegemonic policies in terms of security, international trade and economic crisis
management. Recently, studies have focused on institutional arrangements to explain
governances’ different performances in adapting to the globalizing world. Assuming a
similar international context, this research explains how domestic diversity, in
developmental politics and liberalization policies, can differentiate results of financial
liberalization (i.e. patterns of transition, economic growth and corporate borrowing).
In particular, this study finds that the transition toward liberalization during the 1990s
was market-oriented in Taiwan but state-intervened in South Korea. The research also
identifies linkages between liberalization and economic growth and crisis, aiming to
demonstrate that the influence of domestic structures may be as important as or even
more important than international factors.
1 The major financial crises in the 1990s include the ERM crisis in 1992-1993, the Mexican/Latin
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2
In exploring this diversity, this research highlights variance in Taiwan and
South Korea’s timing, pace and sequence of liberalization policies as well as the roots
of govemment-bank-firm relationships. South Korea’s centralized presidential
leadership endowed the state with the political power to intervene in private sectors
and the financial markets, nourishing the growth of large, state-subsidized business
conglomerates (chaebols). In Taiwan, decentralized operations of faction politics led
to competitive private sectors, increasing the number of interest groups that were able
to constrain the state’s ability to intervene in the financial market. An analysis of these
relationships, along with analysis of variance in internal timing, pace and sequence of
financial policy implementation, results in a better understanding of South Korea and
Taiwan’s patterns of financial liberalization in the 1990s.
The role of domestic governance in these growing liberalizing markets has
become critical. Numerous academics have asserted that the incompetent governance
of domestic institutions in emerging markets, after removing the restrictions of capital
accounts, has not evidently increased economic growth but has caused the onsets of
financial crises (Demirguc-Kunt, Detragiache, 1998; Tomell, 1999; Corsetti, Pesenti,
& Roubini, 2000; Edwards, 2001; Arteta, Eichengreen, & Wyposz, 2001; Wade,
1998b; Pempel, 1999; Haggard, 2000). This ungovemed capital has raised the
concerns of both economists and political economists over how emerging economies
will adjust to the continuing trends of global financial liberalization. This research
crisis in 1994-1995, and the Asian financial crisis in 1997-1998.
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suggests a new model for examining these processes, finding that the internal
structures of states can be analyzed to explain subsequent economic growth and crises,
Information that can potentially be used for crisis avoidance.
Most analyses of domestic institution effects on financial liberalization have
been based upon the experiences of developed countries. John Zysman(1983), in
Governments. Markets, and Growth, examined the politics of finance and its
relationship to industrial policy among developed countries, arguing “ by knowing the
financial system one [could] predict the nature of the process of adjustment” (p.91).
In Zysman’s analysis, countries with strong and active capital markets will intervene
less, while countries with credit-based systems tend to intervene more. Zysman
identified three types of transition patterns: market-led, bank-led, and state-led. The
United States is closest to the market-led model, Germany are bank-led, and Japan is
the best state-led example.
Zysman’s analysis of adjustment processes serves as a useful model for our
comparative case studies of newly industrialized countries (NICs). In order to account
for the differences between developed countries and NICs, this study addresses three
major issues Zysman did not examine, including political context, economic context,
and international level impacts. First, since most NICs are only recently democratized,
political liberalization may interact with financial liberalization, exerting a powerful
influence on emerging markets. For instance, this research finds that the intensive
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financial reforms in the Taiwanese case are closely related to political power struggles
during the period of 1987-1992.
In an economic context, the governments of emerging markets may allow firms
differing access to new financial instruments and recently developed equity markets,
leading to varied impacts on their transitions. For example, Korean corporations tend
to borrow more from external and short-term debt markets, while Taiwanese
corporations tend to borrow more from the equity market. The integration of global
equity markets also complicated situations for emerging markets, although it did not
affect the transitions of state-led or bank-led liberalization in developed countries
during the 1970s and 80s.
Last, Zysman’s studies of developed countries neglect discussions of
international level impacts. Most emerging markets are subject to hegemonic market
regulation, and thus are forced to adopt pro-market policies. For example, due to U.S.
pressure in the late 1980s both South Korea and Taiwan liberalized their domestic
markets for foreign firms and significantly decreased tariff taxes.
Although Zysman neglects the experiences of developing countries, this
research uses his domestic focus for developing a framework examining transitions in
emerging markets according to state-led, bank-led or market-led categories. This
research further explains these processes of adjustment by scrutinizing the interaction
between domestic political developments (govemment-firm-bank relationships and
political liberalization) and the pace and sequence of financial policy implementation
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(interest rate, exchange rate, capital flow and deregulation of domestic financial
institutions), while recognizing the effects of capital mobility and U.S. policies.
Many scholars have agreed that states’ internal stmctures are vitally important
in understanding their adaptations to international situations. In Governance in a
Globalizing World. Robert Keohane and Joseph Nye (2000) emphasized that “the
internal structures of states will be crucial in their ability to adapt to globalization”
(p. 15). Their argument pointed out that domestic structures influence the capability of
governance to adjust to financial liberalization impacts. This research finds that
although domestic policies may buffer the effects of liberalization, considerable
diversity in national policies may continue. As Geoffrey Garrett (1998) argued,
“globalization has not prompted a pervasive policy race of the neoliberal bottom
among the OECD countries, nor have governments that have persisted with
interventionist policies invariably been hamstrung by damaging capital fights” (p. 183).
For emerging interventionist nations, the most influential impacts of financial
liberalization are strategic governmental controls over credit allocation, which are
constrained particularly by converging interest rates and weakening monetary
autonomies.
1.2 SHOCKS OF CAPITAL MOBILITY
Traditionally, neoclassical economists have argued that liberalization leads to
economic growth. Although the flow of capital across national borders has increased
enormously in recent decades, current analysts now debate the stability of global
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financial integration, exploring the shocks of capital account liberalization to emerging
markets.
After the breakdown of the Bretton Wood system of fixed exchange rates in
1973, the United States and Germany began to remove their capital controls. It was not
until the end of the 1970s that the United Kingdom and Japan followed suit. Most
other European countries did not open up to international capital transactions until the
end of the 1980s, and many emerging economies did not liberalize until the 1990s. As
this is a fairly new phenomenon, there is no consensus regarding methodology in the
analysis of the effects of capital shocks on financial liberalization. Researchers
exploring topics such as “Capital mobility and economic performance: are emerging
economies different?” (Edwards, 2001), or “When does capital account liberalization
help more than it hurts?” (Arteta et al, 2001) conducted their analyses from an
econometric perspective. Economic evidence is useful in measuring the degree of
global financial integration and its relationship to economic growth; however,
economic indicators are unable to fully explain the dissimilar patterns of financial
transition among emerging markets.
In contrast to the neoclassical analysis or neoliberal economic evaluations, the
political economy perspective, which incorporates factors such as policies of
international superpowers and individual domestic diversity, is more comprehensive in
understanding how emerging markets make their choices regarding macroeconomic
policies and sequences of liberalization. Many political scientists have challenged the
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neoclassical view that “competition, imitation, diffusion of best practice, trade, and
capital mobility naturally operate to produce convergence across countries”, with
“countries distinctions giving way to common economic structures whose efficiency
and universality produce superior strength in the market” (Berger, & Dore, 996).
Beyond an approach that utilizes measurements only, this research includes qualitative
analyses of different dynamic patterns in emerging market experiences to provide a
comprehensive framework of study.
1.3 FRAMEWORK OF ANALYSIS: A POLITICAL ECONOMY APPROACH
This research utilizes a comprehensive framework of analysis that includes
international market forces, hegemonic policies, national liberalization policies and
national developmental politics as dynamic factors in understanding processes of
financial liberalizations, especially it emphasizes the importance of domestic diversity
that differentiates the results of financial liberalization (i.e. the patterns of transition,
economic growth, and corporate borrowing). The framework of analysis is illustrated
in figure 1.
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Figure 1. Framework of Analysis
Market Forces
{deregulation/ privatization/globalization)
Hegemonic Policies
{security/trade/crisis management)
International Context
Liberalization Policies
(sequence/pace:
competition in financial sectors)
Developmental Politics
(government-bank-firm relationship:
centralized/decentralized development)
Domestic Diversity
Patterns of Transitions
{market-oriented/state-intervened)
Patterns of Economic Growth
{gradual / fluctuating)
Patterns of Corporate Borrowing
{loan/ equity m arkets)
Results of Liberalization
A market-centered interpretation explains financial liberalization as the
outcome of increasing international trade, adopting floating exchange rates, hedging
the risk of holding assets, and diversifying equity portfolio investments in global
markets. Economists trace the origin of global financial liberalization to the
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development of the Eurocurrency market in the late 1950s and early 60s, when the
development of international trade grew enormously and the demands for commercial
credits in foreign currencies increased. The supply of such foreign currencies, mainly
the U.S. dollar, was subject to government controls; credits were usually rationed and
difficult to obtain domestically. As a result, private banks sought profits by
establishing offshore branches that avoided domestic regulatory control. This was the
beginning of the Eurocurrency market, the market for credit in currencies other than
the national currency of the borrowers (Loriaux, 1997, p.7).
Deregulation trends were strengthened by several international financial events
in the 1970s. The 70s oil crisis diminished credit demands in developed countries, and
banks turned to the Euromarket to search for prosperous foreign borrowers, many
located in developing countries. In 1973, the breakdown of the Bretton Woods fixed
exchange rates system reinforced the increasing need of banks to hold foreign assets to
hedge the risk of holding assets only in a single currency. Investors began to compose
risk-minimizing portfolios by mixing assets denominated in a variety of currencies and
interest-bearing foreign bonds. New instruments such as American depository receipts
(ADRs) and global depository receipts (GDRs) further integrated emerging economies
into the international capital market. Diverse portfolio investments such as mutual,
pension, and hedge funds also contributed to the accelerating flow of capital mobility.
These increased demands for non-national currency enabled domestic banks to
press for deregulations. With relentless transformation processes driven by the
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development of these new technologies and sophisticated financial instruments,
regulatory frameworks no longer provided the states with much control over financial
transactions. The market thus required privatization to meet diverse needs and to
generate more efficient outcomes.
Analyses focused on hegemonic forces interpret processes of financial
liberalization as subject to the regulatory policies of financially powerful nations,
mainly the United States. This approach focuses on the international regimes that
govern monetary and capital movement in the post-World War II era. Henry Nau
(1990) argued that it was not through negligence but by design that the United States
has used its hegemonic influence to promote the development of free markets and
force other countries to pursue pro-market policies. During the Cold war era, the
United States played a central role in promoting an open and interdependent
international economy with its allies in order to cope with Soviet-led communism.
With the collapse of the Soviet Union, the United States devoted more energy to
promoting free trade and protecting U.S. intellectual property rights than to military
and security concerns. Influences on emerging markets include the pressure of
GATT/WTO, the “Washington consensus”, and IMF ideologies of crisis management,
all heavily swayed by U.S. policies.
Both international relations and economics scholars agree that hegemonic
stability is desirable. According to Keohane (1984), an international relations scholar,
international regimes are necessary for the preservation and stabilization of the
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11
international economy. Among the tasks performed by these regimes are reduction of
uncertainty, minimization of transaction costs, and prevention of market failures.
Hegemonic stability also gains considerable support among economists (Gilpin, 2001,
p.94-97). Nobel laureate Robert Mundell argued that the international monetary
system’s stability is dependent upon a dominant power. Robert Baldwin (1993) and
Bruno Frey (1984) support this idea; Frey (1984) suggests that the stability of the
international system is similar to the public goods that may not be provided without a
hegemony. To explain why a hegemony facilitates international cooperation,
Eichengreen (1995) used cartel theory, saying that it is possible to deter defection from
a cartel containing many members only when there is a dominant firm capable of
acting as enforcer. Powerful U.S. policies act as enforcers of market regulations,
thereby affecting emerging markets’ liberalization.
This study does not reject possible impacts brought by market forces and
hegemonic policies. However, for the purposes of analysis, the study assumes these
parameters as constant or exogenous in order to evaluate how domestic variables
influence the differing patterns of financial liberalization between South Korea and
Taiwan. Since both economies have a similar and close relationship with the U.S. and
face similar conditions and forces of international markets, this study will primarily
focus on the domestic structures most related to financial liberalization adjustments.
The Cold War alliances and the post-Cold War relationships with the U.S. may justify
the constant assumptions of international factors in both countries.
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An analysis of national policies necessarily involves studying the mixed effects
of the sequence and pace of interest rates, domestic financial markets, exchange rates,
and international capital flow. Many studies indicate that the sequences of fiscal,
monetary and foreign exchange policies are critical to the consequences of financial
liberalization. However, there is no consensus of support for one particular sequence in
the literature. Harwood (1997) argues that diverse domestic structures can impact
sequence, “A country’s particular conditions and circumstances.. ..will influence the
steps it should take and govern the order and speed of the policy steps in any reform of
the financial system” (p. 15). Thus, there are many options to select from. Cole
(1997) concurs, stating that no one “rigid approach” works for all. Rather, he claims
that “to implement a mix of [policy] regimes that suits the country’s circumstances at
the given time, and to move the regimes over time to fit the long-run needs of the
country” should be the goal. He supports using other countries’ experiences as a
guide, not as a strict set of rales. McKinnon (1991), however, argues that it is
preferable to begin with the real sector and then extend reforms to the external
financial sector.
Apart from sequencing, the speed of reform is critical, as the foundation of
financial liberalization lies in establishing adequate institutional capacities for
regulation and risk management before subjecting the domestic economy to the
volatile forces of capital flow. Thus, analyses of national policies examine the costs
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and benefits of a liberalizing pace, exploring the effects of gradual or faster
implementation of financial reforms.
Overall, this study finds that domestic policies of financial liberalization in
South Korea and Taiwan did not follow a theoretically stable sequence. The processes
were complicated by various motives from political calculations, leaders’ personalities,
hegemonic policies, and market pressure. Domestic structures played equally
important roles in formulating policies of financial liberalization. For instance, the
most striking difference between the Korean and Taiwanese models lies in the
sequence of financial market deregulation. The early-deregulated financial market
significantly fragmented the Korean financial system, while the more recent
deregulation of Taiwanese financial sectors created a robust retail banking market.
The sequence and pace of liberalization had direct impact on corporate borrowing
behaviors; Korean corporations tend to borrow more from external and debt markets,
while Taiwanese corporations tend to borrow from the equity market.
Analysis of national developmental politics involves changes in govemment-
bank-firm relationships. Recent political studies of the Asian financial crisis have
proven that close govemment-bank-firm relationships generated moral hazards,
distorted the liberalization process, increased vulnerability to shocks, and complicated
the adjustment process once the crisis hit (Haggard, 2000; Wade, 1998 a, b, & c).
Stephan Haggard (2000), in The Political Economy o f the Asian Financial Crisis.
emphasized that “rapid lending growth, an increase in corporate leveraging, declining
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returns on capital, and weaknesses in the financial sector contributed to the
vulnerability of the most seriously affected countries well before the Asian financial
crisis actually broke. Even if we acknowledge the central role of capital movements
in triggering the crisis, any full account of its onset and depth must encompass these
domestic conditions” (p. 15).
1.4 RESEARCH QUESTIONS
Since the 1997 Asian financial crisis, the degree of states’ capacity to adjust to
the integrating global economy has been much debated. How emerging markets will
manage their transitions in ascending economic openness is still without consensus.
This research examines the cases of South Korea and Taiwan, aiming to identify the
various institutional arrangements that explain their governances’ different
performances in adapting to the globalizing economy.
In earlier research, Zysman (1983) tried to establish linkages between domestic
financial systems and the capacity of the state to intervene effectively in the economy;
he argued that where there is a high degree of state autonomy, a credit-based state-led
financial system would contribute to long-term economic growth (e.g. the case of
Japan in the 1970s). Nancy Auerbach (2001) adopted a similar view when analyzing
the cases of Mexico and South Korea, arguing that the weakening of state autonomy
due to growth of bank-led conglomerates was the main cause of their financial crises in
the 1990s (p. 140).
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Other scholars have analyzed the weak capacity of the state to explain different
consequences of adjustment. Linda Weiss (1999) asserted that South Korea was
pulled into financial turmoil not because it deviated too much from the free market but
because it had abandoned too much of its developmental capacity. However,
“Taiwan’s ability to liberalize its financial system in the 1990s without abandoning its
developmental project of promoting industrial upgrading and productivity
enhancement...” offers important instances of institutional capacity to manage
openness (p. 126-140).
Although an examination of the degree of state capacity for adjustment may
explain some consequences of liberalization, it cannot explain under what conditions
the state will relinquish control and favor market-oriented policies; thus, it offers few
clues to fully understand transitions. This research aims to fill this gap, analyzing
variance in competition in political, industrial and financial sectors to explain the
different consequences of financial liberalization.
This research addresses the following questions: Under what conditions does
the state relinquish its control over the allocation of credit in favor of a more market-
oriented system and thus potentially avoid crisis? Why did Taiwan choose a set of
more market-oriented policies of financial transition than South Korea did in the
1990s? Why did Taiwan weather the currency crisis of 1997-1998 more successfully
than South Korea? Is there a linkage between financial liberalization and economic
growth?
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1.5 ARGUMENTS
With the ascendancy of capital mobility and the pressure of
internationalization, the capacities of the state in all emerging markets are weakening.
However, the state can still heavily influence financial matters in its sequence and pace
of reform. In Taiwan, the timing of rapid and intensive financial reforms between
1987 and 1992 was highly related to the consequences of the liberalization of political
and social controls; after 1992 the reforms were mild and gradual. In South Korea,
gradual reform was found between 1980 and 1990; more rapid and intensive reforms
were related to the implementation of Kim Young Sun’s globalization policies. The
major differences in the sequences of financial sector reforms lie in the order of
deregulation and privatization of the banking sectors. In Taiwan, deregulation in the
late 1980s contributed to a prosperous and competitive financial sector that since 1998
has forced state-dominated banks to privatize themselves. In South Korea,
privatization of state-owned banks in the early 1980s was not supported by a
competitive financial sector, and later deregulations of the banking sector had limited
effects on increasing competition in financial markets. My research concludes the
transition toward liberalization during the 1990s was market-oriented in Taiwan but
state-intervened in South Korea.
This research argues that, by tracing the histories of government-bank-firm
developments, centralized/decentralized relationships may be key in explaining the
different performances of South Korea and Taiwan’s liberalization and their resulting
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vulnerability to crisis. The govemment-bank-firm relationships have been very
different between the two cases. These differences are embedded in state industrial
policies, market structures and social structures. In general, presidential power and
leadership has been stronger in Korea; thus, Korean structures are more centralized
while Taiwanese structures tend to be more decentralized, with less state control. In
Korea, the state played a central role in directing domestic resources and foreign
investments to favor a few chaebols; in Taiwan, no such dominant conglomerates were
developed by the state. Instead, networked export-led small and medium size
enterprises (SMEs) were prosperous.
Taiwan’s market-conforming policies are tied to a decentralized style of
development. This development originated from faction politics. Unlike South Korea,
nationalized enterprises and tight control by a dominant one-party system limited the
chances for early development of large business conglomerates. With the increase of
economic rents and the accumulation of factions, anti-KMT sentiments grew;
ultimately Chiang Ching-kuo decided to oust corrupt factions. Under resistance from
these factions, Chiang’s policies failed. However, he accidentally opened the door for
democratic transition. This propelled the formation of a number of interest groups
from different factions, further weakening the government’s ability to control the
financial market. Business conglomerates formed to exploit new markets that the new
democracy had just brought. In the early 1990s, the emergence of new banks,
financial and security companies and the privatization of state-run enterprises typified
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the fast growth of decentralized and competing interest groups in the markets. The
government under Lee was no longer able to control the private sectors as his
authoritarian predecessors did; instead the government began to seek political alliance,
using liberalizing policies gain support. Thus, Taiwan’s policies remained directed
more by the market than the state.
Further evidence demonstrates that South Korea’s liberalization policies were
less market-oriented than Taiwan’s. First, retail banking development was highly
repressed and almost exclusively dominated by nationwide banks. These nationwide
banks were under considerable government influence, directly through complete or
partial ownership and indirectly by approval of key executive appointments and
lending instructions. The priorities of the banking business were set not on profit-
making but on supporting chaebol expansion and development. Policy loans and
preferential credits were not phased out until 1997; at that time eight dominant
nationwide banks controlled 72 percent of total market asset and 75 percent of total
loans.
In Taiwan, in 1991, market competition generated by the participation of newly
established commercial banks revitalized financial institutions and retail banking
markets. This also forced several state-owned banks to begin privatization in 1998.
The rate of total market asset shares of state-owned banks dropped from 63.98% in
1990 to 54.91% in 1997, the market shares of total deposits dropped from 55.67% in
1990 to 44.88% in 1997, and the market shares of total loans dropped from 65% in
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1990 to 58.75% in 1997. After setting up operation in the early 1990s, by 1997 16
new banks owned about 19% of market assets, 20% of the loans market, and 21% of
the deposit market. In addition to financial deregulation, interest rate and foreign
exchange rate controls also indicate that Taiwan’s financial policies were market-
conforming. For instance, interest rate controls were completely phased out in 1989
and Taiwanese banks were allowed to set their own loan and deposit rates, whereas in
South Korea short-term lending rates were liberalized first, and deposit rates were
heavily regulated. Controls on interest rates were not completely abolished there until
1997.
1.6 METHODOLOGY
Despite the evidence from this study showing that South Korea and Taiwan
have the tendency to converge toward international financial markets, very little
integration has indeed taken place at the domestic structural level. Convergence is
subject to histories of development, and the effects of financial liberalization are
largely determined by the domestic structures themselves. The theoretical and
empirical focus of this comparative study is based on the view that each country has
unique political, economic, and social structures that differentiate its transition toward
financial liberalization. Therefore, the developmental history of domestic structures
can be applied to understanding subsequent economic growth and crisis. This study
has identified qualitative features such as a centralized/decentralized style of
development as crucial linkages to the patterns and consequences of financial
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transitions (Chapters 2 and 3). This research attempts to find quantitative evidence that
supports these qualitative characteristics (Chapter 4), and apply similar tactics to
interpret these qualitative impacts on subsequent economic growth (Chapter 5) and
crisis (Chapter 6) during the 1990s in South Korea and Taiwan. Qualitative analyses
help establish the hypothesis, and are validated by quantitative evidence.
The inquiry begins with the question of how to measure the openness of the
capital accounts of South Korea and Taiwan in the 1990s. In addition to static
regression coefficients that indicate how domestic financial markets are integrated into
the international market, measurements generated should also be able to evaluate
dynamic processes of adjustment. This quantitative evidence supports the qualitative
differences discussed in Chapters 2 and 3. This combination of
quantitative and qualitative analysis is useful to gaining insights into the evidence
presented by the variables.
This research uses both comparative case studies and quantitative empirical
econometric tests. The case studies of South Korea and Taiwan concentrate on their
development between 1945 and 2000, focusing on the evolution of the govemment-
bank-firm relationship. Financial liberalization policies are investigated primarily
from 1980 through 2000 in the areas of interest rate, exchange rate, capital flow, and
financial deregulation.
The methods of the quantitative research used here include both a time-series
regression model applied with the Kalman filter technique and cross-country panel
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data analysis. The time series regression model uses quarterly data of Taiwan (1987-
2000), and South Korea (1990-1999). The cross-country panel data analysis uses the
annual data of eight Asian countries from 1990 to 1997. This research employs
TSP4.5 as the computer software for processing and analyzing econometric data.
1.7 QUANTITATIVE EVIDENCE: MEASUREMENTS OF CAPITAL
MOBILITY
As measuring the real degree of capital mobility or financial openness is
difficult, economists have explored several approaches. A comprehensive survey of the
measurements of capital mobility is well summarized in a paper by Sebastian Edwards
(2001). In general, Edwards identified three basic approaches in measurement:
estimating the correlations of national investments and savings, estimating the interest
rates differentials, and estimating with the indexes from IMF’s data or Quinn’s
indicator (Quinn, 1997). Other studies have been conducted according to the
Feldstein and Horioka model. Feldstein and Horioka (1980) argued that if there is
perfect capital mobility, changes in savings and investments will be uncorrelated in a
specific country. After they conducted empirical tests for 16 OECD countries, they
concluded that net capital flows were far smaller than one would expect them to be in a
world of perfect international capital mobility. The country that suffers a shortfall in
national savings tends to experience an almost equal fall in investments, rather than
making up the difference by borrowing from abroad.
Frankel (1989) conducted tests similar to those of Feldstein and Horioka but
included many Latin American countries. He claimed that savings and investments
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had been significantly positively correlated in most countries. Montiel (1994)
estimated a series of Feldstein-Harioka equations for emerging countries. He argued
that the estimated regression coefficient for industrial countries could be used as a
benchmark for evaluating whether a particular country’s capital account was open or
not. After analyzing several studies, Montiel suggested that if there is a savings ratio
regression coefficient of 0.6, a nation can be classified as having a closed capital
account; if the coefficient is lower than 0.6 it has a rather high degree of
capital mobility. Montiel concluded that many emerging nations exhibited a
remarkable degree of capital mobility.
In another series of studies, Edwards (1985) and Edwards and Khan (1985)
argued that a time series on domestic and international interest rates could be used to
assess the degree of capital account openness. They confirmed that openness in
emerging markets is greater than what the legal restrictions approach suggests. Haque
and Montiel (1991), Reisen and Yeches (1993), and Chinn (1996) expanded the model
to estimate the openness of a financial account by measuring interest rate differentials
or applying Kalman-filter techniques to capture time-varying coefficients. In general,
they reported significant increases in the degree of capital mobility in emerging
markets.
More recent studies have adopted IMF’s Exchange Rate and Monetary
Arrangements to construct indexes on capital controls for panels of countries (Alesina,
Grilli, & Milesi-Ferreti, 1994; Rodrik, 1998; Klein, & Olivei, 1999). Quinn (1997)
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uses a scale of 0 to 4 rather than an IMF binary classification to classify a nation’s
liberalization data, while others have adopted mixed approaches by adjusting IMF or
Quinn’s indexes (Quinn, 1997; Edwards, 2001; Arteta et al, 2001). Researchers have
claimed different results and interpretations; however, in general they try to recognize
possible relationships between the liberalization of capital accounts and economic
growth in emerging markets.
In this study, the degree of capital mobility is measured by estimating the
openness of capital accounts with interest rate differentials; that is, to measure the
relative influence of foreign and domestic interest rates according to derived equations
of money demand. Interest rate differentials are the most commonly used indicators to
approximate capital account liberalization. For emerging economies, however, due to
their thin forward exchange markets, tests of uncovered interest parity are more
feasible than covered interest rate parity. Therefore, in this research, uncovered interest
rate parity is adopted to estimate the openness of capital accounts.
In order to reflect dynamic processes of adjustment and detect particular
patterns of liberalization, this study uses time-varying estimates by applying the
Kalman filter technique. The Kalman filter method is an updating method that bases
the regression estimates for each time period on last period’s estimates plus the data
for the current time period. Therefore, the technique enables us to capture the
characteristics of the dynamic and evolutionary pattern of financial liberalization. In
sum, the purpose of time-varying estimates on the degree of capital mobility is to
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recognize particular patterns of financial liberalization in South Korea and Taiwan
quantitatively. However, quantitative results need to be supported by qualitative
findings from analyses of domestic policies and developmental politics.
To evaluate the results of time-varying estimates in terms of states’ market-
intervening capacities, two assumptions are made for the sake of analytical simplicity.
First, strongly intervening policies would be reflected in the form of shocks in the
pattern of time-varying estimates. Second, if the state adopted market-confirming
policies, the curve of the time-varying estimates would be smooth or gradual.
1.8 RESULTS
The study’s quantitative results produced several interesting points (see
Chapter 4). First, the degree of financial integration in both South Korea and Taiwan
is higher than it was in the 1980s. Reisen and Yeches (1993) reported 0.353 and 0.594
respectively as their estimates of financial openness during the 1980s for Taiwan and
Korea. The econometric results of this study show that the estimates of financial
openness were 0.780333 for Taiwan and 0.769223 for South Korea in the 1990s;
therefore, the financial sectors in these two countries exhibited a trend of convergence
toward the global financial market.
Secondly, by comparing these evolutions, this work detects different patterns
of financial liberalization. Dramatic shocks seem to be more frequent in the case of
South Korea, whereas in Taiwan the pattern of transition is more gradual. These
characteristics are consistent with this research’s argument that in South Korea, the
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state was still intervening, while the state in Taiwan had adopted more market-
conforming policies. The fluctuation observed between 1987 and 1992 in Taiwan is
consistent with unstable social orders provoked by political liberalization following the
presidency of Chiang Ching-Kuo and intensive financial reforms following the
political power struggle of Lee Teng-hui during his early presidency. After that,
Taiwanese financial policies were generally mild and market-oriented.
A pattern of dramatic shocks continued to exist during Korean transition in the
1990s. Quantitative results are consistent with intervening policies adopted. Dramatic
shocks can be visibly identified in the periods of 1990 - 1992, 1993 -1994, and 1997-
1998; these periods correspond with the implementation of strong state-led policies.
For instance, during 1990 and 1991, the state deregulated most short-term lending
rates of banks and non-bank financial institutions, and liberalized interest rates on
money and capital market instruments (i.e. issue rates on corporate bonds with
maturities of over two years). The market was opened for approved top foreign
investors, allowed to invest directly in Korean stocks subject to ceilings. However,
progress on liberalization took a step backward in the late 1990s, when the Finance
Ministry ordered short-term finance companies to cut their interest rates. These short
term finance companies were far more market-oriented than state-manipulated banks;
the authority wanted to shut them down. Afterwards, the Roh administration
announced a four-stage plan to deregulate various interest rates in 1991. These
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inconsistent policies in liberalizing the financial sector show the authority’s
ambivalence over market-oriented deregulation.
Dramatic fluctuation in 1993 can be associated with liberalizing measures
promoted by Kim Young Sam’s globalization policies. To bolster Korea’s chances of
joining the OECD, in July 1993 Kim announced a five-year plan of accelerated
financial liberalization, with schedules for the completion of deregulation in key
areas of the financial system, including interest rates, deposits, policy loans, and
external capital accounts.
The third surge of financial openness is consistent with the IMF reform plan for
resolving the 1997 financial crisis and the succeeding structural reforms adopted by
Kim Dae Jung. Following the steps of the IMF’s plan, the Kim Dae Jung
administration liberalized capital accounts ahead of the schedule stipulated by the
IMF. In April 1999, Kim Dae Jung implemented a new Foreign Exchange Transaction
Act; the law liberalized corporate overseas borrowing and established a futures market.
Empirical tests indicate a structural break after the second quarter o f 1999; no
significance of the parameters could be found after this.
1.9 FINANCIAL LIBERALIZATION AND ECONOMIC GROWTH
The impacts of financial liberalization on economic growth in emerging
economies are subject to intense debates. Though many studies have been conducted
on the relationship between financial development and economic growth, few analyzed
the time-varying effects of financial liberalization on economic growth, and very few
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noticed how individual domestic structures differentiate the effects of such
relationships. This research tries to evaluate these controversial relationships using
both quantitative evidence and the qualitative differences embedded in their domestic
structures.
In addition to the positive relationship between time-varying coefficients and
the rates of economic growth in both cases, the data suggest the effect of Korean
financial liberalization on economic growth is more sensitive than that of Taiwanese
liberalization. For Korea, with each increase of 0.1 on the scale of financial openness,
we see an increase of 0.55% of economic growth rate per year; it increases only 0.3%
in the Taiwanese case. This implies that the rapid increase of foreign capital inflows
has contributed to Korean economic growth. Indeed, the dramatic increase of foreign
debt and portfolio investments was remarkable after 1993; the amount of Korean
foreign debts in 1997 had at least tripled from the amount during the early 1990’s, and
portfolio investment in 1996 had grown at least eight times since 1990. The dramatic
influx of foreign capital in South Korea is consistent with state-led economic
developments, such as the Segyehwa plans. The state directed domestic resources and
foreign investments to favor chaebols and the chaebols produced according to the
state’s plans. Thus, it can be stated that the consequences of economic growth were
related to centralized power in South Korea. These linkages between patterns of
financial transitions and economic growth suggest that impacts of capital mobility on
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economic growth were more dramatic in South Korea than Taiwan. Few other studies
have identified these linkages.
1.10 FINANCIAL LIBERALIZATION AND ECONOMIC CRISES
After the Asian financial crises in late 1997, many analysts believed that the
increasing mobility of capital significantly increased the financial fragility of domestic
economies in emerging markets. However, the nature of these domestic structures
themselves may be as important as, or even more important than, international capital
mobility in making these economies highly vulnerable to a financial crisis.
A cross-country analysis of the Asian financial crisis yields support. Empirical
econometric tests confirmed that excessive corporate borrowing is one of the most
important factors contributing to the recent crisis. These borrowing behaviors are
subject to domestic structures; such behaviors differ in South Korea and Taiwan. In
South Korea, excessive borrowing developed via foreign and short-term debts made by
chaebols under the government’s explicit guarantees. In Taiwan, excessive borrowing
increased via newly liberalized banks and bill and securities companies, liberalized as
a result of contemporaneous political power struggles.
Qualitative differences are especially useful in explaining why South Korea,
but not Taiwan, was seriously affected in the currency crisis of the 1997-98. The state
directed domestic resources and foreign investments to favor chaebols; the chaebols
borrowed excessively in external short-term debt markets, making many non
producing loans. In Taiwan, the decentralized govemment-bank-firm relationship
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made the Central Bank of China (CBC) more independent and conservative, diffused
interest groups facilitated the development of competitive, newly deregulated financial
markets, and excessive borrowing behaviors were limited to the domestic level.
1.11 CHAPTER STRUCTURES
The study consists of seven chapters. Chapter 1 introduces the general ideas
and the approach of the research. Chapters 2 and 3 are concerned with “domestic
level” analyses, performed according to the proposed framework of analysis. Chapter
2 outlines the histories of developmental politics in South Korea and Taiwan, tracing
the roots of their qualitative characteristics lfom the perspective of govemment-bank-
firm relationships. The findings of Chapter 2 will serve as a benchmark for the rest of
the chapters in differentiating patterns of financial liberalization. Chapter 3 compares
and contrasts the sequence and pace of liberalization adopted by the two countries.
Differing features of financial market development are also identified.
After the descriptive analysis of Chapters 2 and 3, Chapter 4 establishes a
quantitative model to measure the degree of capital mobility. Time-varying estimates
are applied to plot dynamic patterns of liberalization. Chapter 4 identifies the gradual
growth pattern of Taiwan versus the dramatically fluctuating pattern of South Korea,
supporting the qualitative findings of Chapter 2 and 3.
Chapter 5 evaluates the relationship of economic growth and financial
liberalization in emerging markets. Qualitative characteristic analyses are applied in
the interpretation of quantitative findings. Chapter 6 surveys common causes in the
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recent Asian financial crisis, showing that excessive borrowing behaviors have a close
relationship with the crisis. This chapter demonstrates the consistency of domestic
factors’ effects on different methods of excessive borrowing. Finally, chapter 7
concludes the whole discussions.
1.12 SUMMARY
In sum, this work has tried to propose a method to study under what conditions
the state will relinquish control in favor of a more market-oriented financial
liberalization. Using an analytical framework to understand the political economy of
financial liberalization on both international and domestic levels, this study concludes
that in the cases of South Korea and Taiwan, domestic factors exerted significantly
greater impacts on the effects of transition than international factors. Though
voluminous studies of financial liberalization have noticed that the liberalizing
experiences between developed countries and emerging markets are different, few
studies have recognized particular politics of finance in emerging markets. The
primary task of this research is to discover unique patterns of financial liberalization
by comparing the cases of South Korea and Taiwan, considering that these two
countries have shared similar pressures of increasing capital mobility and imperative
U.S. policies. The analytical contribution of this work is to recognize that transitions
during the 1990s were market-oriented in Taiwan but state-intervened in South Korea.
This research indicates that the currency and banking crises of 1997-98 in
South Korea can be correlated to the excessive borrowing of foreign currencies by
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large business conglomerates. In Taiwan, excessive borrowing in the 1990s was
related to rent-seeking behaviors, and was due to newly liberalized financial markets.
There were fewer large business conglomerates, and these borrowed mostly from
domestic banks. As a result, Taiwan successfully weathered the 1997-98 currency
crisis, and the banking crisis in late 1998 was limited primarily to the domestic sphere.
Few studies have identified the notion that transitions of financial liberalization
and patterns of economics growth may be associated, and can be differentiated by
analysis of centralized or decentralized structures. This study has tried to prove this by
comparing the evolution of domestic structures and conducting empirical econometric
analyses. The methodology adopted in this research is innovative in that it combines
both historical comparative analyses and time-varying Kalman-filter techniques. The
usefulness of this methodology lies in its advantages for explaining the consequences
of financial liberalization, namely economic growth and financial crisis. Results of
analyses such as these may be useful in implementing policies directed toward
avoiding future financial crisis.
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CHAPTER TWO
HISTORIES OF DEVELOPMENTAL POLITICS IN SOUTH KOREA AND
TAIWAN, 1945-2000
2.1 INTRODUCTION
Though there are similar backgrounds shared between South Korea and Taiwan
(e.g. the Japanese colonization, communist rivalry, American alliance, rapid economic
growth, and Confucian thoughts), their outcomes of developments are very different.
The differences are primarily characterized by their domestic structures. Politically,
the Korean system is very centralized, while the Taiwanese system is more
decentralized. For instance, the local elections are not implemented until the early
1990s in Korea, while the local elections in Taiwan were held as early as the 1950s.
The civil societies in Korea are developed very early and are very resistant to intrusion
of the state, while the civil societies in Taiwan were organized by the state and they are
comparatively weak in political activities. The Korean market structures are
characterized by oligopolistic chaebols, while the Taiwanese markets were
characterized with many SMEs.
The central focus of this research revolves around the influence of domestic
diversity on patterns of transition. This chapter outlines the histories of developmental
politics in South Korea and Taiwan, examining their qualitative characteristics from
the perspective of the govemment-firm-bank relationship and finding that the
consequences of state-intervened or market-oriented patterns of transitions are highly
related to the evolution of domestic structures. This chapter argues that centralized or
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decentralized elements in govemment-bank-firm relationships may be key to
explaining the different performances of financial liberalization in South Korean and
Taiwan, and resulting vulnerability to crisis.
Some scholars have emphasized the diplomatic isolation is the key to explain
various vulnerability to economic crises between the cases of South Korea and
Taiwan. These arguments mainly concern the threat of China that made the authority
of Taiwan more conservative and hence preserve the capacity to guard against large
speculative inflows, particularly in foreign exchange (Weiss, 1999, p. 126-140; Chu,
1999, p.l 84-202). In addition, Taiwan has not been a member of the IMF or the
World Bank since 1978 thus could not count on an international rescue package during
the crises, therefore, CBC in Taiwan has consciously built up shock-absorbing
capacity to withstand potential diplomatic shocks, military tension, or economic
sanctions (ibid).
This research agrees on the possible impacts from China that make Taiwanese
authority more conservative in financial policies, but these arguments can not fully
explain the intensive financial reforms adopted in Taiwan during 1987-1992 and the
similar degree of financial openness in 1990s between the cases o f South Korea and
'y
Taiwan . The study argues the differences are embedded in state industrial policies,
market structures, and social structures. In general, presidential power and leadership
has been stronger in Korea; thus, Korean structures are more centralized while
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Taiwanese structures tend to be more decentralized, with less state control. In Korea,
the state played a central role in directing domestic resources and foreign investments
to favor a few chaebols; in Taiwan, no such dominant conglomerates were developed
by the state. Instead, networked export-led SMEs were prosperous.
In this chapter, I will illustrate the historical factors that explain the differences
in the outcomes of developments between the two countries. Tracing back to the
histories of the developmental politics, in particular the govemment-bank-firm
relationship is crucial for us to recognize why the patterns between South Korea and
Taiwan are different. In the following sections, I will explore on historical economic
and political developments in South Korea and Taiwan since 1945 respectively.
2.2 THE ROOTS OF CENTRALIZED DEVELOPMENT IN KOREA
After its liberation from the Japanese colonization in 1945, the Korean
peninsula was trapped with two confronting ideologies, the capitalist model led by the
United States, and the communist system led by the Union of Soviet Socialist
Republics (USSR). Ultimately, North Korea followed the communist lines supported
by USSR, while South Korea adopted the capitalist model backed by American
Military Government. During this period, American Military Government in the South
supported the interest groups such as landlords and capitalists as the countervailing
forces to the North. During 1945-1948, the American Military Government did
attempt to establish the capitalist economic system by privatization of Japanese
2 Please refer to the econometric evidences found in Chapter 3. In fact, I find the degree o f financial
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resources, and some 20% of Japanese capital in South Korea was sold to the capitalist
supporters of the American Military Government (Kwon, & O’Donnell, 2001, p. 18).
In 1948, Syngman Rhee, who was also the interest group supporters, was elected as the
president of the First Republic of Korea. Lots of American funds and various aid
programs were given to the Rhee government to cope with the severe economic
recession due to the repatriation of Japanese resources and the Korean War during
1950-53. Except for the American aid programs, the first economic imperative for the
Rhee government was to boost private capital accumulation and productive
investments and this was done by distributing the Japanese legacy of factories and land
to the capitalist supporters in exceptional favorable terms (ibid, p. 19).
Two of the current largest caebol, Samsung and Hyundai, were the typical
representatives of the emerging enterprises from this period. Samsung started its first
business with the Jaeil Sugar Company in 1953 and expanded into spinning, banking
and retailing industries in the late 1950s, while Hyundai owed its initial growth to
construction contracts awarded by the Rhee government and American military (p. 19,
ibid). The Rhee government not only channeled the American funds towards these
chaebols, but also established the cartels that determined market prices of raw material
for productions. In return, the chaebols donated political funds. In short, the
formation of the chaebol during 1940s-1950s was facilitated by corrupt redistribution
of Japanese factories and foreign aid by the Rhee and American military governments
openness of Taiwan is a little bit higher than the openness in South Korea during 1990s.
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in exchange for political contributions under the name of coping with the communist
North, and this corrupt relationship was the major excuse that led to the Park
revolution in 1961.
During his 12 years of ruling, Syngman Rhee was often criticized for his
dictatorial style. Indeed, Rhee not only centralized his political power by allocating
limited economic resources to boost growth but he believed it were needed measures
before the democracy can be built. Rhee also manipulated through political coercion
for his president reelection and eventual life-long tenure of power. In order to pass the
amendment of constitution for reelection in 1952, Rhee imposed marshal law around
the temporary capital city of Pusan, and the national assemblymen were subjected to
political terrors. In 1954, two days after the announcement of the rejection of Rhee’s
third-term presidency, the government corrected the announcement and passed it by
the “round-off’ rule (Kim, 2001). In 1960, the rigged election of Rhee’s fourth-term
presidency led to the street demonstrations throughout the country, an event known as
the April 19 revolution. A transitional government was set up after the uprising, and
the third constitutional amendment was passed as a result that transformed the
presidential system to a parliamentary system. The election was held on July 29, and
Chang Myeon was elected as the prime minister but the government was taken over by
Park Chung Hee’s military coup in May 1961.
After the coup, Park formed a Supreme Council for National Reconstruction.
Politician, and businessmen were jailed and accused as illicit wealth accumulators
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during Rhee’s government, and many were stripped off their wealth. The military
government arrested about two-dozens of the nation’s leading businessmen almost
immediately. During the time when Park government suppressed all political
institutions and arrested business leaders in 1961, Lee Byung Chull, the founder of
Samsung was still staying in Japan. Lee was summoned by Park and escorted back to
Korea. Park skillfully forced Lee to cooperate with his economic development and
also chose Lee as the leader to persuade the rest of business community to work with
him. In June 19, Lee “voluntarily” donated his entire fortune to the government, and
within the next eight weeks, other prominent businessmen followed suit (Clifford,
1998, p.37-38).
However, the military coup faced ongoing opposition for the manner it
assumed power. Therefore, rapid industrialization was chosen as the strategy to
legitimize Park’s regime. Park was one of the Korean soldiers went to the Japanese
puppet state of Manchukuo (Manchuria) during the 1930s and early 1940s. In
Manchuria, Park witnessed the role that a military government could play in
development by massive economic planning and this perhaps made Park realize that
the Japanese model was what Korea could adopt. Later, Park was well trained at the
job of organizing logistics in Pusan where he served. With his developmental vision
and organizing talent, Park’s entire career had equipped him to build and run an
organization like Korea, Inc (ibid, p.47). In June 1961, only a month after the military
coup, the Economic Planning Council, later known as EPB, was established to serve as
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a quasi-think tank for Park’s control. The EPB centralized all economic information
and managed every economic activity from price policy, fair trade administration, to
the review of development projects. Later the Ministry of Commerce and Industry
(MCI), later known as Ministry of Trade and Industry (MTI), was dedicated to the
strengthening of industrialization. With the nationalization of commercial banks and
the centralization of the financial system, the Ministry of Finance (MoF) became
extremely powerful. It was the MCI and MoF officials who had day-to-day contact
with the chaebols who wanted approval for their projects (p.49, ibid). So far, the
prototype of centralized development was built up. During the first five years of the
economic development plan (1962-6), labor-intensive light industries were developed
and the industrial policies had successfully increased economic growth rate from 1.1
per cent to 7.8 percent. Following the success of the first economic plan, the second
five-year plan (1967-71) increased additional export-led industries, and the third and
fourth plans (1972-76 and 1977-81) aimed at further transforming the industrial sector
toward heavy and chemical industries based on previous infrastructures.
Park’s decision of promoting general trading companies during 1975-76 for
exports further institutionalized the centralized govemment-chaebol relationship. The
general trading company system was designed to enhance the international
competitiveness of large-scale trading companies. Most of today’s largest chaebols
were licensed as general trading companies that enabled them to receive contracts from
overseas buyers, and the state-run banks provided the necessary loans to fulfill their
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orders. The chaebols also expanded their business by buying up small-and-medium
size firms for their vertical integrations, which were consistent with Park’s industrial
policy of concentrating production facilities and maximizing monopolistic economic
power. Most of today’s leading chaebols built their monopolistic bases between 1960s
and 1980s (Kwon, & O’Donnell, 2001, p.23).
Park’s centralized rule was not only limited to his economic power. In
December of 1972, Park put the notorious Yushin constitution into effect through the
seventh constitutional amendment which allowed him to remain as president
indefinitely by not only abolishing the three-term limit, but also by institutionalizing
indirect election of president through the National Council for Reunification. The
Yushin constitution not only granted Park the power to nominate one third of National
Assemblymen, but also the extreme power to dissolve National Assembly (Kil, 2001,
p.49). Park also exerted his social control through the KCIA, which was explicitly
designed to spy on her own citizens, businessmen, political opponents, and even
cabinet ministries, both domestic and overseas operations. The KCIA and local police
had a network of informers throughout private companies, as well as on campuses, in
political organizations, and in the media. However, ironically, the director of KCIA
assassinated Park in October 1979 when the antigovemment demonstrations broke out
near the cities of Masan and Changwon.
After the demise of Yushin regime, the transitional government was weakly led
by Choi Kyuhah. The internal division among political leaders, and the social and
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economic crises provided good excuses for the military coup led by Chun Doo Hwan,
who extended the marshal law in May 1980. In contrast to Park’s coup in 1961,
Chun’s coup faced strong opposition, which led to the Kwangju Uprising later. Chun
brutally repressed the Kwangju Uprising, and held the National Council for
Reunification in an effort to elect him as the president. With the eighth constitutional
amendment, Chun was given the power to form the temporary National Security
Legislative Council, which later passed the Reform Law of Political Climate to ban
any political activities. Meanwhile, the formation of large conglomerates which
accounted for almost half of Korean output in 1980 already made the highly leveraged
chaebols “mutual hostages” with the state (Kang, 2001, p.91). In an economy as
highly leveraged as Korea’s, control of the financial system gave the government
extraordinary power over the economy. Credit controls and loans from the
government became the best strategy in controlling the chaebols. An episode
illustrates how the state made chaebols cooperative. In 1985, the Kukje group, the
largest chaebol in Korea with its 38,000 employees, was troubled with deep debts and
inefficient operations. Kukje’s founder, Yang, who supported the opposition
candidates winning in the Pusan election with his donation of “only” 300 million to the
Saemaul movement, refused to cooperate with Chun’s Ilhae foundation3. This
offended Chun and his advisers (Clifford, 1998, p.222; Kang, 2001, p.93). Ultimately,
3 Ilhae Foundation was set up by Chun as his quasi-institution to accept political “donations”. Chun
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the state refused to loan money to Kukje and honor its checks. Within weeks, Kukje
could not service its debt and had to declare bankruptcy.
In addition to centralizing his economic plans, like his predecessors did, Chun
also deliberated on extending his presidential tenure through the constitutional
amendment toward the end of his term. However, Chun’s moves provoked an
avalanche of public protests. The protests were soon intensified with the coalition
among opposition politicians, students, and antigovemment activists. Radical
antigovemment protests of students in 1986 and 1987 further escalated the
antigovemment movements. Finally, the silent majority of Korean civil society joined
the movements. As a consequence, Chun’s regime yielded to and accepted Roh Tae
Woo’s proposal, the June 29 Democratization Declaration, in 1987. The ninth
constitutional amendment for direct presidential election was passed. Ultimately, Roh
was elected as the president of the sixth Republic.
The shift in Korean political economy away from authoritarian military rule
and toward a more democratic practice, which came as a result of antigovemment
protests in large scale in late 1980s, has also shifted the relationship between the
chaebols and the state significantly. Roh had pledged a sweeping privatization
program as part of his effort to free the economy from the heavy control that had
characterized it for nearly thirty years, but the deeply entrenched centralized state-firm
heritage could not be given away so easily. During Roh’s presidency, minority shares
took a further explicit step than Park did in his times.
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were sold in the state-owned steelmaker, Posco, and in the electricity monopoly,
Kepco, and nothing changed in the practices of theses companies (Clifford, 1998,
p.312). Financial reform was another failure. The plan to decontrol interest rates was
only done by paper and lip services. In fact, the MoF enforced a cartel freezing rates
slightly above where they had been for more than three years. In 1990 MoF ordered
short-term finance companies to cut their interest rates, which were far more market-
oriented than the banks’, and these short-term finance companies were doing so good a
job at competing that they were taking business away from the big, slow-footed banks;
ultimately, they were effectively cut in number and became either banks or securities
companies in 1991 (ibid, p.312).
The 1992 presidential election was indeed like a re-match of the 1987
campaign, but this time, Kim Young Sam had dramatically switched sides. In 1990,
Kim Young Sam joined with Roh’s ruling party in a move, which virtually ensured his
subsequent nomination as the presidential candidate of the ruling party (DLP). With
the backing of Roh and Kim Jong Pil who had also joined the ruling party in 1990,
Kim Young Sam was easily able to defeat Kim Dae Jung easily (Bridges, 2001, p.33).
Following the political alliance, Kim Young Sam was elected as the president of the
seventh republic in 1993. The seventh republic was the first non-military civilian
government directly elected by the citizens in Korean history. However, the
centralized tradition of development seemed to have died hard. Immediately after
Kim’s inauguration, he launched the seventh five-year plan (1993-1997) which aimed
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at facilitating further economic growth and changing the corrupt economic activities
through banking and business reforms (i.e. the real-name financial transactions and the
clean politics campaigns). The most important policy initiated by Kim was his
globalization plan in May 1994 in which he stressed the necessity for Korea’s urgent
need for globalization and its preparation to join the OECD. Kim’s strategy was to
further open up the domestic market to international competition in an effort to
facilitate increased foreign direct investments. In December 1994, the government
announced an important cabinet reshuffle. An administrative reorganization was
specifically intended for the pursuit of globalization strategies, and the EPB and MoF
were merged into a new agency called the Ministry of Finance and Economy (MOFE)
to assist in the formulation of globalization policy(Kim, 2000, p.57).
The collusion between the state and chaebols nevertheless had its deep
historical roots and the corruptions replayed again and again with no exception in
Kim’s administration. In the fall of 1995, the public was outraged by the scandal of
the ex-presidents and their relatives. In the beginning of the investigation, Roh
admitted to having collected over $650 million in corporate contributions that he had
used in setting up a personal political slush fund, and later the scandal was widened to
include Chun and the leading business people, and even Kim Dae Jung admitted to
accepting $28 million from Roh in 1992 (Kang, 2001, p.93). Ultimately, Kim Young
Sam’s second son, Kim Hyun Choi, and his most trusted aides including Hong In Gil
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were convicted and put into jail under corruption charges in the wake of the Hanbo
scandal in early 1997 (ibid).
The centralized rule of Korean government was also involved with regionalist
politics. Park, Chun, and Roh all came from the city of Taegu in the province of
Kyongsangbuk, and they all recruited and appointed people from the Taegu-Kyongbuk
area to important political and administrative posts, resulting in the formation of the T-
K mafia during the third through sixth republics (Kil, 2001, p.59). After Kim Young
Sam was elected as president, he also recruited heavily from Pusan-Kyongsangnam
region. As a result, the P-K mafia replaced the T-K mafia, even though Kim had put in
an intense effort in reforming the practice of regionalism during his term (ibid).
Even during the 1997 presidential election, the calculation of regionalism in
voting behavior could not be ignored. In the 1997 election year, the atmosphere in
Korea became increasingly intense and there was no one who was more aware of the
dangers of splitting the opposition vote than Kim Dae Jung himself. After his private
meeting with Kim Jong Pil, Kim Dae Jung promised Kim Jong Pil that, if elected, he
would change the presidential system into a parliamentary system by the year 2000
and Kim Jong Pil would become the prime minister in exchange for Kim Jong Pil’s
alliance. Obviously, the alliance was made in convenience in order to win the
presidency under the two Kim’s political calculation. In fact, Kim Dae Jung and Kim
Jong Pil had long been at opposite ends of the political spectrum. Kim Jong Pil was
the conservative hardliner who had worked for the Park government, and Kim Dae
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Jung was the radical and perennial figure of the opposition. Back in the 1970s, Kim
Jong Pil had run the KCIA for the Park government and even had even been actually
responsible for the anti-Kim Dae Jung missions (Bridge, 2001, p.37). For Kim Jong
P il, the deal was a realistic political step to prolong his political career. For Kim Dae
Jung, in addition to his original support from his home, the Cholla province, the
alliance was a means to broaden his political support from the the Chungchong
province, where Kim Jong Pil came from. The alliance also kept Kim Jong Pil from
supporting Lee Hoi Chang who was the most competitive rival to Kim Dae Jung at that
time. The split of the ruling party further boosted Kim Dae Jung’s prospects. In
September 1997, Rhee In Je, who was the main challenger defeated by Lee in the
ruling party’s candidate election, left the party and set up his own party and ran for the
presidency. Ultimately, Kim Dae Jung secured 40.3% of the vote and won the
election; Lee acquired 38.7% and Rhee 19.2%. Analysis of the electoral data shows
that regionalism and the split of the ruling party were important factors for Kim Dae
Jung’s victory, and for the first time in nearly forty years a president from outside the
Kyongsang region had risen to power. Also, for the first time in South Korean
political history a peaceful transfer of power to the opposition had occurred (ibid,
p.40).
Just like his predecessors, centralized rule was important for Kim Dae Jung’s
reforms. But this time, plans for debt restructuring and structural reforms replaced
expansion and globalization. The first priority of the new Kim administration was to
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restore financial stability, which aimed at securing foreign currency liquidity to
alleviate the immediate liquidity crisis. Next, dramatic financial restructuring was
conducted: 5 out of 25 commercial banks had been ordered to close, while 16 out of
30 merchant banks, 6 out of 34 securities companies and 4 out of 50 insurance
companies had had their licensees either revoked or suspended (Brdiges, 2001, p. 72).
Ironically, The financial restructuring process actually did not reduce the government
intervention in the financial market as the Kim administration claimed earlier.
However, the impact of resolving the crashing financial institutions made the Kim
administration assume greater control over the financial system.
The control of the financial system further allowed Kim’s administration to fix
the problem of large chaebols. In October 1998, the government appointed the Fair
Trade Commission to take action in fining the five largest chaebols for violating fair
trade regulations by diverting profits illegally into troubled subsidiaries. Credit lines
were cut and financial assistance from the affiliates was prohibited. The reduction in
the overall number of their subsidiaries by the end of 1999 were impressive: Hyundai
down to 32 from 63, Samsung to 40 from 65, Daewoo to 10 from 41, LG to 32 from
53 and SK to 22 from 49 (Bridges, 2001, p.75). Once again, Kim’s “Big Deals” for
chaebol restructuring in the end of 1998 highlighted the traditional interventional
approach under the centralized leadership in coping with the crisis, and such
intervention opened itself up to the accusation that it was in practice no different from
its predecessors (ibid, p.81).
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2.3 CONCLUSION FROM THE PREVIOUS SECTION
According to the analysis of Korean history, the centralized style of
development was found in the Rhee and American military government as the measure
to counteract their communist rivals. The govemment-bank-firm relationship was
further developed and institutionalized by Park during his almost twenty years of rule
under the nationalized financial system. Chun, Rho, and Kim Young Sam used bank
loans and credit lines as their best strategies for manipulating chaebols to implement
their developmental plans as long as the chaebols were over-expanded and highly
leveraged. The development of the centralized presidential power seemed to be
inevitable under the strong regionalism, rigid political hierarchy, and weak congress
and party loyalty. Even after the economic crisis, strong government interventions for
banks and corporate restructuring were still following the traditional style of Korean
solution that Kim Dae Jung’s predecessors chose. The method of the centralized style
of development is to endow the state with more political power to intervene in the
financial market, and this may have important implication in understanding the
processes of financial liberalization. This will be discussed in the following chapter.
2.4 THE ROOTS OF DECENTRALIZED DEVELOPMENT IN TAIWAN
Though Chiang Kai-shek’s troops had successfully reunited the Mainland
China and defended the Japanese attacks during World War II, Chiang had little
connection with the Taiwanese society before 1945. As a way of taking over Taiwan
after the Japanese retreat, Chiang adopted faction politics that had been developed
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within KMT as the strategy for governing the politics of Taiwan. Before the Japanese
retreat, Chiang had intentionally supported the local factions developed by those elites
who had worked with KMT and come back to Taiwan from China. Mixing with the
KMT’s mainland factions and the local elites of Taiwan, Chiang hoped the checking
powers among the factions could reach political balance and also eliminate the gap
between the “emigrant regime” and Taiwanese civil society.
After the retreat of Japanese troops, Chiang Kai-shek appointed a committee
headed by Chen Yi to take over the island’s administration in 1945. The first troops
Chiang had sent to help Chen’s takeover were poorly trained and undisciplined since
most of the finest forces were still fighting with the growing communist insurgency in
Mainland China. In fact, KMT had already developed five different factions in China,
and Chen Yi was one of the leading figures of his faction, while there were also three
local factions developing in Taiwan at that time, and the largest one belonged to those
who had worked with and supported by KMT (Chen, 1995, p.38-51). Cheng Yi, who
was educated in Japanese military academy and had visited Taiwan in 1935 when he
was the chairman of Fujian province, was chosen by Chiang as his delegate to
administer the government of Taiwan. However, not only the members of Chen Yi’s
faction were chosen to serve in the Taiwanese government, but many important
positions were also assigned by Chiang to the local elites who had worked with KMT
in China and come back from China after the Japanese retreat.
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After Chen’s government was established, Chen began to take over the
Japanese assets and legacies. In sum, Chen took over almost 20% of the farming land,
90% of the forest, 33000 buildings, and about 5.82 million hectares of land (ibid).
Chen nationalized all the Japanese production facilities and transformed them into
state-run or KMT-run enterprises. The government monopolized all the trading of
ordinary commodities such as wine, cigarette, salt, and matches. Transportation such
as railroad, airlines, and buses were all nationalized. Even the financial system and
currency issued in Taiwan were isolated from the financial system in mainland China.
However, there were few qualified persons that Chen could really assign to the task of
managing the huge volume of Japanese assets and legacies that the Japanese left
behind. Under the politics of faction, those managerial positions of the newly
nationalized enterprises were allocated as rewards to members of Chen’s faction and
also the local elites who had worked with KMT. Meanwhile, the members of four
other factions, offended by Chen in mainland China and the two Taiwanese factions
who were excluded from Chen’s coalitions in Taiwan, were so annoyed with Chen’s
political loots and had seriously attacked Chen’s corrupt regime. Ultimately, the
chasm between factions escalated into the notorious Feb 28 Incident (ibid, p.64-82).
On the morning of February 27th, 1947, four policemen and ten official
investigators from the government (most of them were mainlanders) were informed to
investigate the smuggling of cigarette. In that evening, the police were informed that
the smuggled cigarettes were sold in the Taiping Ting section of Taipei. Later, an old
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woman was interrogated by the police. She had been injured while protesting against
the expropriation of the untaxed cigarettes she was selling. The noisy quarrel suddenly
attracted hundreds of local citizens who yelled at and besieged the policemen and
investigators, and one of the investigators fired his gun when he tried to run away from
the scene. A passerby was killed in the commotion by the gunshot of the investigator,
who was given shelter in a nearby police station that night. The public was deeply
angered and next morning, the Tobacco & Wine Monopoly Bureau (TWMB) was
besieged by thousands of local citizens demanding the punishment of the murderer.
When it became apparent that no official response was forthcoming, the crowd began
to attack the TWMB and rioting soon spread throughout the island. Two mainlanders
who worked for TWMB were killed in the riots, and students and other social groups
soon gathered and joined the protests; at the same time, the police and soldiers began
to shoot at local citizens in public, and hundreds of people were killed in the riots. The
chasm between mainlanders and local citizens was soon growing, though on March 2,
local Taiwanese elites from different factions gathered and organized the February 28
Incident Management Committee. The committee was the last chance that Chen could
conciliate the social unrest, but unfortunately, the mixture of conflicting faction
interests ultimately escalated into a series of radical proposals for Chen’s government.
In the proposals, the committee suggested democratic elections for county chiefs and
city mayors; the abolition of government monopolies; and protection of the freedom of
speech, publication, and assembly, etc. However, more radical proposals, which
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included the release of Taiwanese political prisoners, the assignment of chiefs of local
juridical institutions and top prosecutors to only Taiwanese, offended Chen and the
committee was dissolved under the accusation of rebellion (Chen, 1995, p.81). Soon,
Chen asked military supports from Chiang. On March 9, the army arrived at Keelung
harbor, Chiang’s strong military forces repressed the riots and thousands including
landowners, entrepreneurs, doctors, and teachers were killed and arrested. The
impacts of the February 28 Incident were significant in Taiwanese society and also the
faction politics.
On May 19, 1949, the martial laws were proclaimed in Taiwan and Chiang was
later defeated in mainland China by his communist rivals, and was forced to move his
KMT government to Taiwan in December. The government of KMT under Chiang’s
quasi-Leninist regime ruled by three authoritarian mentalities: the mentality of
recovery and reunion with mainland China, the mud-slings on the “communist
thieves”, and the teaching of “Three Principles of the People” written by “the father of
the nation”, Dr. Sun Yat-sen (Chen, 1995, p.93-117). These mentalities were not only
sacredly promoted and broadcasted in the mass media, but also intensively preached
everywhere from elementary schools to universities. Under the terror of February 28
Incident, the centralized power of military, police, party, media, intelligence agency
and government bureaucracy made KMT successfully dominated the government for
almost forty years under the ruling of Chiang Kai-shek and his son, Chiang Ching-kuo.
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However, the extreme centralized rules were conducted with both stick and
carrot. Faction politics was still played as the strategy to legitimize Chiang’s
authoritarian rule and economic rents were the rewards of patronism or clientelism. As
early as 1950, the first local elections, which included county and city councilors,
county magistrates, provincial and municipal mayors, chiefs of rural and urban
township, etc., were held. Economic rents were granted to local factions recruited by
KMT through four types of implicit privileges: first, the privileges of monopoly of
local economic resources in local banks, local financial institutions such as the credit
co-operative associations, credit department of Farmer’s associations, credit
department of Fishermen’s association and local passenger transportation business;
second, the privileges of receiving loans from state-owned banks, provided the factions
were elected as county and city councilors; third, the privileges of acquiring contracts
of public purchasing and constructions in local areas; fourth, the privileges of
exchanging economic benefits with local governments such as exerting political
maneuvers to acquire insider’s information on the plans of urbanization so as to
arbitrage by manipulating the prices of related real estate in the plans (Chen, 1995,
p.108).
To consolidate and rebuild his authoritarian prestige after the mainland retreat,
Chiang Kai-shek began to purge other members of KMT factions whom he saw as a
political threat, e.g. Wu Kuo-chen, Sun Li-jen, and Chen Cheng, etc. On the other
hand, Chiang Kai-shek gradually strengthened his own faction and paved the way for
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his son Chiang Ching-kuo’s succession. In general, most of the KMT or mainlander
factions were assigned either the top positions in the central government or in the
state-owned banks or nationalized enterprises as long as they did not offend Chiang
Kai-shek and as long as they followed Chiang Ching-kuo’s leadership.
On the other end, with the growth of local Taiwanese factions, KMT in general
adopted three principles to keep local factions under tight control. First, it limited the
scope of development only in local areas and any connection with the members of
KMT factions were prohibited, except for Chiang Kai-shek and Chiang Ching-kuo as
their sole patrons. The connections among other local factions such as the organizing
sub-groups in county or city councils were also prohibited (Chen, 1995, p. 151).
Second, it supported at least two different local factions in the same region and
recruited them for local election in turns. This strategy prohibited any local faction
from accumulating and monopolizing regional resources for continuing growths, and
the balance had to be checked by routinely switching political supports in regional
elections and developing countervailing powers among local factions. Third, it
controlled the local factions by implicitly granting them the economic privileges to
exploit public goods and seeking rents, and by this type of clientlism, the KMT had
successfully controlled the local factions between 1950s and 1970s.
In 1950s, the state primarily supported import-substitution industries such as
textile, fertilizers, cement and agricultural products. The state had the absolute power
to lead the planned economy. Since 1960, the import-substitution strategy was
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switched to export-led industries. The newly established light industries demanded a
lot of raw materials from the petrochemical industries. However, in the beginning the
state did not seriously plan on the petrochemical industries and this offered the first
opportunity for private capitalists to pioneer in the petrochemical related industries.
The first petrochemical plants producing ethylene was first built in 1968 by the state,
and from then on, the petrochemical industries gradually incorporated a number of
strategic developmental economic plans, which aimed at offering enough
petrochemical materials to support export-led industries such as textiles and plastics,
etc. During the 1970s, the state-led petrochemical industries were heavily invested by
private capitalists, as well as KMT-owned enterprises. However, after experiencing
two oil shocks in late 1975 and 1980, the high-tech industries gradually challenged the
importance of petrochemical industries in their strategic developmental plans. But the
petrochemical business, which was heavily invested by private capitalists, did not
withdraw from the subsidy programs. In the early years of the Chiang Chin-kuo
administration, Chiang’s technocrats inclined to develop high-tech industries.
However, after 1984, the petrochemical business regained its preference, and since
then, the capitalists were included in the economic planning (Wang, 1996, p. 106).
On the other end, during the 1970s, the domination of regional resources that
KMT distributed to the local factions was heavily criticized and citizens were offended
by those illegal privileges and economic loot that KMT was implicitly granting to the
local factions (Chen, 1995, p.181). After his tenure as the Minister of Executive Yuan
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in 1972, Chiang Ching-kuo had noticed the dangers of indulging local factions;
therefore, he began to recruit non-factional Taiwanese candidates to run for local
elections and tried to replace the existing local factions. In 1977, the third year after
Chiang Kai-shek passed away, Chiang Ching-kuo succeeded as chairman of KMT and
became the president of Taiwan next year. Under the rulership of Chiang Ching-kuo,
which targeted at eliminating local factions, the faction policies of KMT were
reversed. Therefore, in the local elections of 1977, among the twenty KMT-nominated
candidates running for city mayors, seventeen of them were non-factional at that time
(Chen, 1995, p. 184).
However, the new policies offended existing local factions and induced their
strong resistance, ultimately, KMT lost four seats of city mayors and twenty one seats
of county magistrates, and this was the first time KMT lost so many seats in local
elections. In addition, the discontent triggered the Chungli Incident. On November 19
of 1977, the county magistrate elections were being held and in Taoyuan County, the
KMT-nominated candidate Ou Hsien-yu was running against Hsu Hsin-liang, who was
an ex-KMT member. While the ballots were being counted, rumors of cheating
spread; in response, the residents of Chungli surrounded the polling stations and set
fire to the Chungli city police station, thereby sparking the Chungli Incident. After
that the anti-KMT forces began to grow, and anti-KMT magazines were published
with harsh criticism. In 1979, the first anti-KMT supporters established the Taiwan
Tangwai People’s Representatives Coalition Office, and on August 24, 1979, anti-
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KMT supporters set up the Formosa Magazine to serve as a common mouthpiece;
soon, the magazine was being touted as the magazine for democratic movement.
Ironically, Chiang Ching-kuo’s policies of replacing local factions in the late 70’s had
accidentally opened up the doors for anti-KMT movements.
Though during Chiang’s term in 1980s, he still explicitly supported the
eliminations of regional monopolies. However, the factional strife, economic
disorders and the increasing social movements, and Chiang’s sudden death all
contributed to his political failure. Actually, the local factions had strengthened their
powers by participating in the elections for the member of Legislative Yuan, which
was partially liberalized since 1969. Members of factions allied together to push and
pass those bills favoring themselves. The most famous example was “the thirteen
brothers”, which was led by Tsai Cheng-nan, who was elected in 1983 and notorious
for the “Shi-Shin Incident”. The incident involved the conflicting financial interests
between the state-owned banks and the private trust companies, many of which the
local factions ran. In 1984, Tsai was pushing for the permission of trust companies to
run the short-term capital markets Tsai not only allied with other 12 Legislative
members of the local factions but also KMT faction, which was led by General Wang
Sheng, who was the leading KMT figure planning to succeed Chiang’s position at that
time (Wang, 1996, p.l 17). The bill proposed by Tsai faced strong oppositions in
Legislative Yuan, and in February of 1985, Chiang ordered to purge Tsai and Wang.
Tsai’s financial business was shut down and he was interrogated and accused by the
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Intelligence Agency, while General Wang was expelled from the power center. In
short, the “Shi-Shin Incident” represented the beginning of the local factions’ attempt
to gain power over the ruling state, and the factions were no longer satisfied with their
local interests.
Since the mid 1980s, the repressed financial system and excessive foreign
reserves had created excessive domestic capital that ultimately arbitraged in the stock
and real estate market. The influx of capital was further exacerbated by the currency
appreciation under U.S. pressure. Between 1985-1989, the currency at least
appreciated 50%. The bubble economy was formed and the underground investment
companies began raising funds from the public to speculate in the stock and real estate
markets. The economic disorder had also challenged the repressed structure of
financial system, and ultimately Lee Teng-hui made a number of policies in financial
liberalization during his power struggle with the conservative KMT factions after
Chiang’s death. The losing popularity of KMT was also reflected in the results of the
local elections. In the local election of November 1985, Tangwai candidates were
elected to many important posts, which included one county magistrate, 11 provincial
assemblymen, 11 Taipei city council members, and three Kaohsiung city council
members. Witnessing the growing anti-KMT forces from civil society, Chiang
decided to lift the martial laws in 1986, and in the same year, the Tangwai supporters
organized the first opposition party, Democratic Progressive Party (DPP). After the
DPP’s establishment and Chiang’s political liberalization, social movements began to
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58
increase rapidly, especially in the movements of labor and environmental protections.
For instance, the number of pro-environmental organization grew from 5 in 1985 to 25
in 1988, and the number of environmental protests increased from 6 in 1987 to 108 in
1989 (Her, 2000). Autonomous organized unions led the labor protests and labor
strikes peaked in 1987, and 1988-1989 respectively (Wang, & Feng, 1992).
Chiang Ching-kuo’s policies to eliminate the connected factions soon ended
after his sudden death in early 1988. Though Lee Teng-hui had succeeded his
presidency less than one day after Chiang’s death, the split and power struggle within
the KMT followed. Lee, a native Taiwanese promoted by Chiang and educated in
Japan and U.S. later, was a liberal and pro-market reformer. Lee soon became the
target of attack from members from other conservative KMT factions, who were also
interested in struggling for the next presidency. During Lee’s early years of ruling, he
had struggled hard for power with Yu Kuo-hwa, who represented the old KMT
factions supported by Chiang’s family. After alliance with other pro-reform
supporters within KMT, Lee’s power was gradually consolidated and finally elected as
the president in 1990. After Lee’s inauguration, he released political prisoners such as
Huang Hsin-chieh who was jailed for his involvement in anti-KMT movements. Lee
further initiated the constitutional amendments and dissolved the duties of old national
assemblymen, who remained in positions since they were elected after they retreated
with Chiang Kai-shek from mainland China. Lee further established the first direct
elections at the parliamentary level, including the election of National Assemblymen
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59
and the Legislature members. In the Legislature elections of 1992, KMT lost almost
one third of its seats, among the 161 seats, DPP secured 50 seats, and the election
result was manipulated by Lee to get rid of his Executive Minister, Hau Peitsun, who
was recruited from old-KMT faction by Lee under his political calculation (Chang,
2000, p.24-50).
The development of faction politics during Lee’s era was strikingly different
from his predecessors in three ways. First, Lee did not prohibit vertical or horizontal
connections among the factions. In fact, Lee even went to visit leaders of different
faction s for regaining their supports after Lee had split with old KMT factions (Chen,
1995, p.235). And there were at least nine sub-groups established in the Legislative
Yuan during 1988-1992 (ibid, p.230). With the opening of elections at the
parliamentary level, local factions further integrated their resources to compete for the
newly released big shares brought by the national elections. Second, the local factions
that had monopolized regional economics merged with each other and became national
business conglomerates, which arbitraged heavily from engaging in real estate,
construction, and financial-related businesses. The 15 newly established commercial
banks in 1991 and numerous bill and securities companies established later were
representatives of the newly formed conglomerates groups. Third, the enormous
interests gained by participating local and national politicians usually involved violent
incidents and crimes that were characterized as “black gold” in Taiwan. The
coexistence of politics, money, and crimes was the most potent issue
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60
in Taiwan’s political ecology. It was fiercely attacked by the DPP during the late
years of Lee’s term.
Lee’s policy of privatizing state-owed enterprises in 1990s further nourished
those newly established and faction-backed conglomerates. There are two models
designed for privatization: either through transferring state-owned shares in one time,
or through brokers dealing with shares in many times. In either case, conglomerates
are the largest beneficiaries. For instance, the Core Pacific Group dominated eight out
of thirty stock dealing cases for the privatization, with the total stocks released
amounting to 128 billion NT dollars (Chang, 1999, p.44). The privatizing of KMT-
owned enterprises was another tactic Lee adopted to secure his political support. In
1991, among the ten largest conglomerates in Taiwan, eight of them were associated
with KMT-owned enterprises (Chu, 1994, p.138). A new institution was soon
separated from KMT, and run independently (asset management committee) for
seeking the private co-operation of KMT-owned enterprises since 1993. Soon, the
KMT-owned enterprises became the most favorite enterprises to cooperate with. Huge
funds may be injected to the conglomerates’ investments and business or
conglomerates may get the profitable shares of KMT-owned enterprises in favorable
prices (Chang, 1999). Though the initiation of the financial liberalization since 1990
was led by Lee’s pro-market reforms coupled with the results of political power
struggle, however, the growth of interests groups was developed by a combination of
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the capitalists and factions, and the boundaries of business and politics had become
even blurrier.
2.5 CONCLUSION FROM THE PREVIOUS SECTION
The decentralized style of development in Taiwan originated from faction
politics in the very beginning. Nationalized enterprises and tight control of Chiang’s
dominant one-party system limited the chances of developing large business
conglomerates early on. With the increase of the economic rents and accumulation of
factions, anti-KMT sentiments were growing, and ultimately Chiang Ching-kuo
decided to get rid of the corrupt factions. Under the resistance from the factions,
Chiang’s policies failed. However, he accidentally opened the door for democratic
transition. The decentralized development fixrther propelled the formation of a number
of interest groups from different factions. Business conglomerates were formed to
exploit the new markets that the new democracy had just brought. In the early 90s, the
emergences of new banks, financial and security companies and the privatizations of
state-run enterprises typified the fast growth of decentralized and competing interest
groups among the markets. The government under Lee was no longer able to control
the private sectors as his authoritarian predecessors did; instead the government began
to seek political alliance with her liberalizing policies for gaining support. The
increase of interest groups further weakened the government’s ability to control the
financial market, and as a result, the speed of financial liberalization was more gradual
in the 1990s.
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62
CHAPTER THREE
DOMESTIC POLICIES OF FINANCIAL LIBERALIZATION IN SOUTH
KOREA AND TAIWAN IN THE 1980-1990s
3.1 INTRODUCTION
This chapter provides a qualitative analysis of the differing domestic
liberalization policies adopted by South Korea and Taiwan, comparing and contrasting
the sequence and pace of financial liberalization and identifying consequences of these
on financial market development. This chapter presents empirical evidence detailing
the effects of domestic policies on competition.
This study finds that domestic policies of financial liberalization were
complicated by various motives from political calculations, leaders’ personalities,
hegemonic policies, and market pressure. Domestic structures played equally
important roles in formulating policies of financial liberalization. The sequence and
pace of financial liberalization had direct impacts on corporate borrowing behaviors;
Korean corporations tend to borrow more from the external and debt markets, while
Taiwanese corporations tend to borrow from the equity market.
In this chapter, the domestic policies of financial liberalization in South Korea
and Taiwan are compared and contrasted. It may be a good beginning for one to
explore the similarities and differences between the two cases by taking the snapshots
on the economic and financial markets after the recent crisis. The basic economic
indicators and characteristics are summarized in Table 1. The population and GDP of
Korea are about two times that of Taiwan. The PPP GDPs per capita are $12,200 in
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63
Korea and $15,370 in Taiwan at the end of 1997. However, the domestic structures of
their financial markets are very different between the two countries. The equity
capitalization of Taiwan is about six times that of Korea’s, and the debt market
capitalization of Korea is about four times as big; the total external debt of Korea is
about five times that of Taiwan, and the non-performing loans of Korean is about four
times as big. These figures suggest that the domestic structures of financial markets
are different between the two countries: Korean corporations borrow more from
external and debt markets, while the equity market is more important to the Taiwanese
corporations. Why are the domestic structures of financial markets so different
between the two countries? To investigate such questions, this research begins with
examining the domestic and external backgrounds of their financial liberalization.
Table 1. Economic and financial indicators of Korea and Taiwan in 1997
Korea Taiwan
Population 46 million 22 million
PPP GDP per capita $12,390 $15,370
Exports (% of GDP) $140 billion (33%) $122 billion (46%)
Foreign currency reserves $8.9 billion $ 84 billion
Annual savings rate 37% 25%
Equity capitalization $55 billion $326 billion
Debt market capitalization $174 billion $ 40 billion
Total external debt $151 billion $30 billion
Non-performing Loans 25-30% 7%
Source: excerpted from Casserley, Gibb, & the Financial Institutions Team (1999).
Since the 1980s, Taiwan and Korea have initiated a series of measures on the
liberalization of financial sectors such as lifting bank interests rate ceilings, lowering
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compulsory reserve requirements, lowering the entry barriers of the financial sector,
reducing government interference in credit allocation decisions, privatizing
commercial banks, and deregulating the non-bank financial institutions. The states
also actively developed their equity markets, and opened the entry of foreign
institutions or individual to participate in the equity markets. Deregulation of financial
sectors was also pressured by many interests-groups, which argued for the need of
efficiency in privatization within the trends of globalization. All the agents,
internationally and domestically, believed that financial liberalization would increase
capital mobility and contribute to more efficient capital allocations and hence larger
economic growth in the long run.
Externally, with the collapse of the Soviet Union and the end of Cold War in
the early 1990s, the East Asian policies of the United States had shifted toward a
stance of resistance to the trade protectionism and neo-mercantilism of their East
Asian allies. The United States emerged as the main advocator of globalization, and
was increasingly less inclined to view East Asian countries as important military allies
but more inclined to treat them as competitors and mercantilist states. Economic
issues such as the establishment of an international framework to accelerate
international trades and capital flows had outweighed security concerns. On the other
hand, the export-oriented momentum cannot be sustained without further expansion of
overseas markets for many newly industrialized countries (NICs). Thus there were
also demands for more rapid trade and financial liberalization in the emerging
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65
economies. Partly with the threats of U.S. unilateral retaliations, liberalization
measures were implemented via talks such as APEC, GATT/Uruguay Round, and
WTO, etc. In short, since the early 1990s, the pressure from both hegemonic policies
and domestic demands has forced the “developmental states” in Eastern Asia to
formulate their agenda to promote faster trade and financial liberalization.
In the following sections, the research will be an investigation on how
processes of liberalization on interest rates, exchange rate, capital flows and
deregulation of domestic financial institutions developed in two countries. But before
that, the study will be a literature review on the theoretical debates on the issue of
financial sequencing and pace of financial reform. After that, I will attempt to evaluate
the usefulness of such theories in the cases of South Korea and Taiwan. The object of
analysis is to identify the similarities and differences in their respective processes of
financial liberalization in the two countries, which can help explain their different
outcomes of domestic development.
3.2 THE SEQUENCE OF FINANCIAL LIBERALIZATION
Financial liberalization refers to the progressive allocation of resources
according to market forces rather than personal relationships or government direction.
This study will focus on the processes of liberalizations on interest rates, exchange
rate, capital flows and deregulation of domestic financial institutions. The aims of
liberalization policies are to strengthen competitiveness of the financial sector and to
increase economic growths. However, there are two commonly advocated options for
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transforming a repressed financial sector toward a more open and liberalized structure.
One of the options is to proceed with gradual liberalization according to the optimally
designed schedules for restructuring corporate and financial sectors, and the other
option is to adopt a broader and simultaneously more radical big-bang reform known
as shock therapy.
A gradual approach usually involves a wait-and-see attitude toward the
outcome of the previous reforms before taking the next step; the big-bang approach, on
the other hand, usually involves reforming a number of areas simultaneously. Sachs
has advocated the use of the decisive and rapid approach in the transition of Eastern
European economies4. His arguments for a swift and dramatic leap consider reform as
a seamless web, and that the gigantic bureaucracies who remain in place and the sheer
scale of adjustments needed will militate against a gradual approach. Winiecke argues
for rapid liberalization so that international financial markets can signal warnings
earlier and policy makers can react faster than in a system where government
intervention is only gradually reduced5 . Johnson (1999) emphasized that an
assessment of the costs of financial repression and the capacity to respond to the risks
of liberalizing financial markets can determine what will be feasible or desirable in
terms of the speed of the reforms, and in particular he listed a number of reasons why
it may be desirable to undertake a more rapid liberalization of capital account along
4 Discussions in the article “Eastern Europe’s Economies: What Is To B e Done?”, The Economist,
January. 13 1990.
5 Discussions in the article “So Much for Interventionist Utopias”, Asian W all Street Journal, 10, March
1998
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with reform of the domestic financial system. First, the circumvention of controls and
the existence of foreign exchange curb markets would complicate the interpretation of
underlying economic realities and obscure the interrelationship between domestic and
external financial conditions. Second, supporting policies to liberalize domestic
interest rates that help to create an environment conducive to competitive and efficient
domestic financial system could reinforce the effects of liberalization of capital
account. Third, capital account liberalization in the context of appropriate
macroeconomic policies contributes to a return of capital flight and supports the
balance of payments during the period of domestic financial liberalization. In
addition, rapid financial liberalizations have been used as the catalyst in broad
economic reforms and as a way of overcoming inertia in certain parts of the economy.
For instance, it is usually easier politically to start a reform in the financial sector
rather than the labor market. Speed also reflects quick and visible evidence that the
authorities are moving ahead with reforms and proves the willingness of the
governments to subject themselves to market-oriented disciplines. Nevertheless, as
Johnson (1999) warned, there are risks and costs for liberalization of the capital
account resulting from an inappropriate sequencing of reforms. The continued reliance
on credit controls or high non-interest-bearing reserve requirements for monetary
control purposes, or a failure to address inefficiencies in the domestic financial system,
could lead to wide gaps between deposit and lending rates and encourage borrowing
abroad rather then domestically and thus create excessive external debt burden.
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Indeed, the surges in capital inflows have become a problem for most Eastern and
Southeast Asian countries. The foundation of financial liberalization lies in
establishing adequate institutional capacities for regulation and risk management
before subjecting the domestic economy to potentially volatile forces of open markets.
And it is quite likely that such institutions could not be learned and established in the
short-run, therefore, the feasibility of faster reforms may not be too optimistic, and it
may be exacerbated by inadequate sequences of financial liberalization.
Do sequences really matter? In the early 1970s, Shaw (1973) suggested that
financial reforms should better be conducted all at once, but witnessing the serious
consequences after the rapid financial reforms adopted in Latin America in the late
1970s, the sequences of financial reforms began to assume more importance. New
literatures based on gradual assumptions began to focus on the order of liberalization,
i.e. between the macroeconomic fundamental and the capital account liberalization.
Edwards (1985), and McKinnon (1991) proposed that capital account should be the
last step to be liberalized. McKinnon (1991) pointed out the order in which fiscal,
monetary, and foreign exchange policies are sequenced is critical to the consequences
of financial liberalizations and governments cannot, and perhaps should not, undertake
all liberalizing measures simultaneously, instead, there is an optimal order of economic
liberalization, which may vary for different liberalizing economies depending on their
initial conditions.
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Table 2. The sequences of financial liberalization
Domestic External
1st Step 3r d Step
Real Sector
*Set up market-oriented
price signal in domestic
financial sectors.
* Remove preference
loans, and implicit or
explicit taxes subsidies
* Privatize state-owned
financial institutions.
* Remove high tariffs as
entry barriers.
*Open market and
liberalize trades.
* Liberalize current
account
Financial Sector
2n d Step 4th Step
* Deregulate domestic
financial institutions.
* Abandon interest rate
controls
^Develop domestic capital
and money markets
*Open Market for foreign
participants.
* Relax controls on capital
mobility.
* Liberalize capital
account
Data Source: summarized from McKinnon (1991)
According to McKinnon, and as the study has summarized in Table 2, the
preferred order is: first, domestic real sector reform (i.e. controlling inflation,
removing of subsidies on selected industries, privatization, etc.); second, domestic
financial sector reform (i.e. removing interest rate ceiling, improving banking system,
developing capital and money market, etc.); third, external real sector (i.e. removal of
trade barriers, trade account convertibility, etc.); and finally, external financial sector
(i.e., removal of capital controls, free capital mobility, etc.). In short, domestic
financial sector liberalization must precede capital account liberalization to ensure
efficient intermediation of capital inflows.
Cole(1999) reviewed the changes in macroeconomic and financial policy
regimes in Indonesia since her decontrolling capital account in 1970 and illustrated, in
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practical cases, policies do not normally evolve in a consistent, unidirectional manner
according to an ideal sequential logic. He argued that the theoretical propositions
about or empirical searches for optimal sequences for macroeconomic policy reforms
will likely prove to be unrewarding. External forces (i.e. the change of oil prices, the
U.S. policies, etc.) and political processes would cause individual countries conduct
different sequences of financial reforms. Harwood (1999) pointed out that financial
sector reform everywhere is a political process influenced by personalities and power
plays, not just economic theories and objectives. For example, in the 1980s, the
Japanese Ministry of Finance tried to stall financial liberalization to retain its control
over particular policy areas and to prevent other ministries from gaining new powers.
Claudio Gonzalez-Vega (1999) noted financial sector development does not merely
occur because of government actions, and there is not just a top-down process but also
is often driven by market pressures for change.
The development process is complicated and not always straightforward and
logic; it is not purely economic, but mixed with various motives from political
calculations, leaders’ personalities, hegemonic policies, and market pressure. Given
these parameters, the discussions on the sequences and methods to control the process
of financial sector development seems to be unrealistic. However, the objectives of
this research are to identify the similar or dissimilar sequential processes in Korea and
Taiwan since the 1980s, and the study tries to compare and contrast the possible results
of the sequences that may be applied to explaining the formation of corporate
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71
borrowing behaviors either in the debt or the equity markets. To do this, please first
refer to Appendix A in which I have summarized chronologically by country the
processes of liberalization on interest rate, exchange rate, deregulation of financial
institutions, and capital flows. In the following analysis, I have synthesized the
characteristics of their developments according to Appendix A and only present the
most important findings related to explaining their similar or dissimilar developments
are presented.
The most striking characteristic between the Korean and Taiwanese models lies
in the sequence of their financial market deregulation. In the Korean model, four state-
owned banks were privatized between 1981-19936 , and with the revised Banking Act
in 1982, the entry barriers to establishing new non-bank financial institutions were
lifted. Twelve short-term financing companies, fifty-eight mutual savings and finance
companies, and one investment trust company were setup between 1982-1983 (Chung,
2000). However, the interest rate was tightly controlled during the 1980s, and the
interest rate liberalization was very selective. The short-term lending rates (i.e. the CP
discount rates) were first deregulated in 1990-1991, then the longer-term lending rates
in 1993, and the deposit rates were later liberalized from the long-term to short-term
sequence during 1993-1997. In contrast to the Korean case, the interest rate control of
Taiwan was totally phased out as early as 1989, though most of the banks were state-
6 There were Hanil Bank in 1981, Korea First Bank and Bank o f Seoul and Trust Company in 1982, and
Chohung Bank in 1983.
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72
owned. The amended Banking Act in Taiwan initiated financial market deregulation
since 1989, and suddenly 16 new commercial banks were established by 1991. The
privatization of state-own banks was not be conducted until 1998. The characteristics
of financial markets may reflect the consequences of the different sequences between
deregulation and interest rate decontrol. The early-deregulated financial market made
the Korean financial system significantly fragmented. This was because of the strict
separation of business lines; the existence of specialized lending institutions, and the
practice of chaebols to establish their own financial institution to ensure funding for
growth. Therefore, retail banking development was highly repressed and almost
dominated by nationwide banks. The nationwide banks were under considerable
government influence, directly through the complete or partial ownership and
indirectly by approval of key executive appointments and lending instructions. The
priorities of the banking business were set on supporting chaebol expansion and
development but not for profits, and policy loans and preferential credits were not
phased out until 1997. In 1997, eight dominant nationwide banks controlled 72
percent of total market asset and 75 percent of total loans. On the other end,
Taiwanese financial institutions and retail banking markets were revitalized by market
competition generated by the participation of newly established commercial banks
since 1991 and that had forced several state-owned banks begin privatization in 1998.
In the Taiwanese case, the rate of total market assets shares of state-owned banks
dropped from 63.98% in 1990 to 54.91% in 1997, the market shares of total deposits
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dropped from 55.67% in 1990 to 44.88% in 1997, and the market shares of total loans
dropped from 65% in 1990 to 58.75% in 1997. The 16 new banks owned about 19%
of market assets and 20% of loans market, and 21% of deposit market in 1997 since
they set up their operations from scratch in the early 1990s. In 1997, 55% of total
market revenue was from the retail banking (i.e., the consumer lending, deposits, retail
stock broking, private banking, and retail asset management, etc.)(Casserley et al,
1999, p.235). The success of small and medium-sized businesses and the competitive
build-up in the early 1990s provided corporate and retail customers with an
unprecedented degree of choice, and also fostered the growth of a robust retail-banking
sector.
The motivations to liberalize the capital flows in the late 1980s were also
different between the two countries. Attracting more foreign direct investment for the
Korean chaebols was the original motive to liberalize the capital account. Since 1984,
the introduction of a negative system for FDI greatly increased opportunities for
foreign investors. In 1989, the list of non-permissible businesses for FDIs was greatly
reduced that all but 10 of 522 categories of manufacturing activity were open to FDIs.
However, the liberalization of foreign capital in securities markets since the late 1980s
apparently attracted even much more funds for portfolio investments than the FDIs.
According to Table 3, since 1990, the inward portfolio investment in Korea had
exceeded the inward direct investment, and in 1997, the inward portfolio investment
was about $12 billion U.S. dollars, but the inward direct investment was only about $2
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74
billion U.S. dollars. On the other end, the motivation for the capital flow liberalization
in Taiwanese case was initiated by the concern of relieving the pressure of currency
appreciation generated by the huge trade surplus accumulated in the late 1980s. In
1987, the government initiated the liberalization of capital outflow rather than inflow.
Table 3 shows that the outward direct investment in Taiwan increased significantly
since 1988. The equity market for foreign investors was gradually liberalized since
1991, and please note that contrasted with the Korean case, the increase of inward
portfolio investment in Taiwan was smaller in scale and the flows were rather stable.
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Table 3. Inward and outward capital flows in Korea and Taiwan, 1980-1996
Korea Taiwan
Inward
direct
investment
Inward
portfolio
investment
Outward
investment
Inward
direct
investment
Inw ard
portfolio
investment
Outward
direct
investment
1980 96 46 - 161 45 42
1981 105 104 - 151 85 60
1982 69 15 127 104 145 32
1983 69 188 126 149 41 19
1984 110 333 37 201 50 72
1985 234 982 34 340 46 79
1986 435 301 110 327 75 65
1987 601 -113 183 715 9 705
1988 871 -461 151 959 541 4121
1989 758 29 305 1604 65 6950
1990 715 899 820 1300 69 5249
1991 1116 3155 1357 1271 786 2054
1992 551 5761 1048 879 1149 1967
1993 516 11022 1056 917 2399 2611
1994 758 7276 2075 1375 2902 2640
1995 1240 8915 3120 1559 2729 2983
1996 1953 12092 3934 1864 3256 3843
Millions of U.S. dollars
Source: excerpted from Chen, & Ku, 2000.
The other interesting feature in the Taiwanese case is that most of the
liberalizations (i.e., interest rates, exchanges rates, capital flows, and financial
deregulations) were implemented intensively between 1987-1992. Several reasons
account for such swift government action. First, the political climate became more
open with the lifting of the martial law in 1987. The death of President Chiang in
early 1988 also stimulated energetic movements for both political and economic
liberalizations. Second, the accumulated foreign reserve gave rise too much
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speculative capital in domestic stock and real estate markets since 1987. Third, the
currency appreciation pressure and the hiking wages in labor market made
manufacturing firms relocate their plants overseas, i.e. the Southeastern Asian or
China. However, after President Lee strengthened his leadership in 1992, the
liberalization measures were mild and gradual, and this tendency is different from the
Korean case. In the Korean case, the exchange rates, interest rates and capital flows
were intensively liberalized between 1989-1992, but the speed was quite gradual and
mild compared with the Taiwanese case, and more rapid liberalization was taken
during 1993-1997 due to President Kim’s globalization policies.
Table 4 summarizes the contrasting features between Korean and Taiwanese
financial liberalization during 1980-1997. Overall, in the Korean model, the financial
reforms were more gradual between 1980-1990, but more rapid after 1991 whereasin
the Taiwanese model, the financial reforms were more rapid between 1987-1992, but
more gradual after 1992. The patterns of pace and sequence in two countries,
however, are developed according to their domestic structures.
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Table 4. Contrasting characteristics of financial liberalization between Korea
and Taiwan, 1980-1990s
Financial
Deregulation
Interest
Rate
Exchange
Rate
Capital
Flow
Rapid and
Intensive
Reforms
Period In early 1980 1990-1997 1990 1989 1993-1997
Korea
Inactive retail
banking and
national-wide
banks
dominated 75%
o f loans in 1997
Lending rates
liberalized first,
and deposit rates
followed.
Lending rates
deregulation
began with short
term and deposit
rates deregulation
began with long
term
Abolished soft-
pegged system
and adopted
managed
floating policies
Originally,
aiming at
attracting FDI.
The external
debt and
inward
portfolio
investments
increased
sharply after
1993
Implementation
o f the Kim
Young sun’s
globalization
plans.
Period In early 1990 1985-1989 1990 1987 1987-1992
Taiwan
Active retail
banking and
state-owned
banks
dominated
58.75% o f loans
in 1997
Banks were
allowed to set
loan and deposit
rates
independently.
Banks were
allowed to set
FX rates and
adopted
managed
floating policies
Originally
aiming at
encouraging
capital
outflows to
ease currency
appreciation
due to
accumulated
foreign
reserve.
Inward
portfolio
investment
increased
m ildly after
1992
Tackling with
the speculative
investments in
stock and real
estate markets
Reallocating
labor-intensive
manufacturing
toward
Southeastern
Asia.
Improving
investment
environments
for hi-tech
industries.
The impacts of the sequences and paces of financial liberalizations on capital
inflows and outflows are summarized in Table 3 and the consequences are related to
their domestic policies of financial liberalization, and the consequences have direct
impacts on their corporate borrowings behaviors. As I have shown in Table 4, the
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more rapid speed and intensity of financial reforms in Taiwan occurred during 1987-
1992, and after deregulation of the banking sector, the corporate borrowings from
banks or non-banks loans had increased from 85.74% in 1991 to 97.42% in 1993 as
Table 5 illustrated. And after 1993, the Taiwanese firms began borrowing from the
securities markets again, the percentage of the corporate direct financing increased
from the 2% of 1993 to 38% in 1997. However, there was no clear evidence on the
impact of the Korean reform in 1993-1997 according to Table 5. However, as Cho
pointed out (p.175, 2001), the financial liberalizations had differential impact by group
and firm size. With the opening of capital market, domestic firms could borrow more
n
easily from abroad, but it was mainly the five largest chaebols which could borrow
easily by their established reputation in the international market, and smaller chaebols
(the sixth to the thirtieth largest) and other corporate firms mainly borrowed through
the intermediation of banks or merchant banks. During 1993-94, the five largest
chaebols increased their borrowing from abroad by issuing long-term convertible
bonds and while the five largest chaebols increased their reliance on the international
capital market, domestic financial institutions tried to fill the vacuum by seeking
smaller chaebols, and it was by being largely financed in the short term through
corporate borrowing in the domestic banks that had deteriorated the financial
structures of the smaller chaebols and caused them to be insolvent in the 1997 crisis.
7 They are Hyundai, Samsung, Daewoo, Lucky-Goldstar, and Sunkyung
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Table 5. Sources of Finance in South Korea and Taiwan, 1990-1997
South Korea Taiwan
Indirect
Financing
Direct
Financing
Indirect
Financing
Direct
Financing
1990 38.4 42.4 87.7 12.23
1991 41.8 37.9 85.74 14.26
1992 36.3 41.4 94.28 5.72
1993 31.4 52.9 97.42 2.58
1994 44.5 38.1 85.62 14.38
1995 31.8 48.1 89.93 10.07
1996 29.1 47.2 81.21 18.79
1997 37.9 37.1 61.93 38.07
Unit: In percentage
Note: Indirect financing includes band and non-bank loans. Direct financing includes commercial
paper, corporate bonds, stocks, etc..
Data Source: Korea, Bank o f Korea, Monthly Bulletin, various issues; Taiwan, Central Bank o f China,
Financial Data Report, 2001
3.3 CONCLUSION
The domestic policies of financial liberalization in South Korea and Taiwan
were not consistent with the theoretical sequence of orders, but the development
processes are complicated and not always straightforward and logical. It is not purely
economic, but mixed with various motives from the political calculations, leaders’
personalities, hegemonic policies, and market pressure. As Table 4 illustrated, the
patterns and processes of financial liberalizations between two countries are dissimilar,
and the consequences of liberalizations are also different. The retail banking sector
was active and state-dominated banks owned less than 60% of the total shares of loans
in the Taiwanese model before the Asian financial crisis, but in the Korean case, the
retail banking sector was inactive and national-wide banks dominated almost two third
of loan lending. The most striking characteristic between the Korean and Taiwanese
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models lies in the sequences of their financial market deregulation. The various
degrees of competition in financial sectors are closely related to their sequences of
policy implementations. The early-deregulated financial market made the Korean
financial system significantly fragmented, while the recent deregulation of Taiwanese
financial sectors has created a robust competitive retail banking market. Overall, in
the Korean model, the financial reform was more gradual between 1980-1990, but
more rapid after 1991, and in Taiwanese model, the financial reform was more rapid
between 1987-1992, but more gradual after 1992. The impacts of the sequences and
paces of financial liberalizations also have direct impacts on their corporate
borrowings behaviors that Korean corporations tend to borrow more from external and
debt markets, while the Taiwanese corporations tend to borrow from the equity
market.
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81
CHAPTER FOUR
TIME-VARYING ESTIMATES ON THE OPENNESS OF FINANCIAL
LIBERALIZATION IN SOUTH KOREA AND TAIWAN IN THE 1990s
4.1 INTRODUCTION
Building on the descriptive analyses of Chapters Two and Three, Chapter Four
establishes a quantitative model for assessing the effects of domestic policy differences
on transitions of financial liberalization, identifying a gradual growth pattern in
Taiwan versus a dramatically fluctuating pattern in South Korea. It is very difficult to
quantify the degree of financial openness; the most frequent approach is to examine
interest rate differentials. This work applies the Kalman filter technique to plot time-
varying estimates on the openness of financial liberalization in South Korea and
Taiwan.
Several studies have been conducted on estimating how the capital account
liberalized in Korea and Taiwan during the 1980s (Reisen, & Yeches, 1993; Chinn, &
Frankel 1994; Jwa 1994; Chinn and Maloney, 1996). Reisen and Yeches(1993)
reported a low degree of capital mobility for both Korea and Taiwan, and no trend
towards more financial openness. Chinn (1996) pointed out that there were structural
breaks in the interest rate behaviors after early 1989 for both Korean and Taiwanese
market. Are the capital accounts in the two counties more integrated to the
international financial market in the 1990s? In this chapter, the study will try to
investigate the time-varying estimates on the openness of financial liberalization in the
90s for both South Korea and Taiwan.
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Interest rate differentials are the most commonly used indicators to estimate the
openness of financial liberalizations among different countries. The reduction of
covered interest parity differential has often been used as the indicator of capital
account liberalization.8 However, for several developing countries, forward exchange
market is either extremely thin or non-existent, rendering covered interest parity tests
irrelevant and making it difficult to judge the economic impact of capital account and
financial sector liberalization (Chinn, 1996). For instance, it was not until 1996 that
the Taiwanese forward exchange market was fully liberalized for all purposes of
transactions, though the market had existed since Feb. 1979.9 Therefore, it is more
pragmatic to adopt uncovered interests rates as my measures of interest rate
differentials during 1990s for the two countries.
4.2 MODELING THE OPENNESS OF THE CAPITAL ACCOUNT
The economies of most developing countries are semi-opened, and domestic
interest rates are assumed to be decided between the open market rates and extremely
closed market rates. Edwards, and Khan (1985) first outlined the approach of
measuring the openness of capital account by examining the relative influence of
foreign and domestic interest rates. Following this concept, Haque and Montiel (1990)
8 When CIP holds, similar assets should yield similar returns across countries with the corrections o f
expected risks o f currency fluctuations. See Chinn and Frankel (1994) for the test o f several Pacific
Basin countries.
9 The forward markets were extremely restricted by CBC before 1991, and after 1991 the market was
open for the import and export agents only, after 1994, the transportation and insurance agents were
allowed to participate the market, and after 1996, all the restrictions were abolished and the market was
open for any agent who had the need o f forward exchange transactions. For more detailed processes o f
forward exchange liberalization o f Taiwan, please refer to Jung-Chen Lee (p.73-p.77, 1999).
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extended the model and derived the measurements of openness by estimating
equations from the money demand equations. The approach assumes the domestic
nominal market-clearing interest rate (if) to be the weighted average of the uncovered
interest parity rate ( if *), and the domestic market-clearing interest rate that would be
observed if the private capital account were completely closed (Rc ):
R = y/R* + (l-y/)Rc (K y/£ 1 (1)
¥ is considered as the estimator of the openness of capital account. If the value of y/ is
close to one, it assumes that domestic nominal market-clearing interest rate ( if) is
fluctuated according to the international rate of interest, thus the economy is to be seen
as highly integrated with the world economy; if the value of y/ is close to zero, it
assumes that domestic nominal market-clearing interest rate (if) is not related to
international market, and thus to be considered as mostly closed capital account.
In this study, uncovered interest parity rate (if* ) is defined as:
R * ^ R W + E(e) (2)
if"’is the interest rate of the international market, and the E(e) is the expected change
rate of currency value. That is, if the uncovered interest holds, there is no difference
for a person to hold assets between the domestic and foreign markets,1 0 and the study
assumes that the rational expectations hypothesis holds in my model.
1 0 As Reisen and Yeches(1993) noted, though most empirical studies indicated the assumption o f
covered interest rates was valid, but the uncovered interest parity did not hold in most industrialized
countries[Frankel(1989)], however, Reisen and Yeches interpreted the findings alternatively. They
argued the findings might reflect the fact that the industrialized markets were in favor o f the existence o f
an exchange risk premium, thus the rational expectations hypothesis might still hold.
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Next, a regular equation of money demand function similar to the one in the
Reisen and Yeches(1993) is assumed:
ln(MD /P) = a o +o iR +a 2 ln(Y/P) +cr 3 ln(M/P) a 0 <0, a 2 >0, a 3 >0 (3)
P is the domestic price level, M °/P is the real money demand, Y/P is the real output,
and (M/P) _/ denotes the real money supplied in previous unit of time, assuming the
equilibrium in the money market [MD /P - MP/P = M/P], All the variables are in the
form of natural logarithms, except for the domestic nominal market-clearing interest
rate, R. The sign of the coefficients assumes the relationships of supply and demand
theories in the money market.
The domestic market-clearing interest rate (R) can be obtained from the
equilibrium condition of equation (3):
R = -(a ,/a ,) - (a 2 /a ,) ln(Y/P) - (a / a 3) ln(M/P) + ( l / a , )ln(M/P) (4)
According to the balance of payment equations, money supply can be defined as:
M = Res.i + DC + CA + KA (5)
where Res is the reserve for foreign exchange in domestic currency, DC is the
domestic credit, CA and KA are the current and capital accounts respectively. In the
new version of IMF format1 1 , the private capital movements are included separately in
1 1 In 1993, IMF published its 5th version o f the balance o f payment manual that included most o f private
capital flows (i.e. the direct investments, securities and portfolio investment, bonds, derivative financial
producs, etc.) in the financial account, while capital account only included capital transfer and other
non-productive or non-financial asset transactions (i.e. patterns, trademarks, etc.)
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the financial account. The money supply, which would correspond to the hypothetical
situation with a closed private capital account, can be obtained by setting the financial
account into zero:
M ° = M -F A (6)
M c is the money supply in a hypothetical closed capital account, and FA is the portion
of private capital movements. According to the equation (3), M c is also satisfied by
the money-market equilibrium condition with ln(M °IF^lniAflP). Therefore, the
hypothetical interest rate in closed capital account can be derived from the equation
(4), if we substitute money supply, M with M c:
Rc = -(a o /a , ) - {a 2 /a , ) ln(Y/P) -(a/a,) ln{M/P) _/ + (1 /a , )ln(Af/P) (7)
So far, the exogenous parameter, Rc, in equation (1) can be calculated from
equation (7), and to rearrange the equation (1), we obtain:
(R- Rc) = y/(R *-Rc) 0 < iff < I ( 8 )
Equation (8) can be estimated directly to determine the important parameter iff as an
index of financial openness.
4.3 DATA AND METHODOLOGY
The remaining problem in estimating equation (8) is to decide the domestic
nominal market-clearing interest rate (if). The financial markets were quite repressed
until the late 80s for both Taiwan and Korea. In Korea, the comprehensive interest
rate deregulation was introduced in 1988 but it was canceled after two months, and
interest rate liberalization was resumed later in 1991. In Taiwan, since 1980, the CBC
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86
had adopted a series of measures to remove controls over interest rates but a more
comprehensive measure was taken until July 1989 when the Banking Law of Taiwan
was revised which allowed domestic banks to decide their own rates of interest.
Therefore, in previous studies (Edwards and Khan, 1985; Haque and Montiel, 1990;
Reisen and Yeches, 1993; Chinn and Maloney, 1996) curb market rates1 2 usually were
considered as possible proxy of market-clearing interest rates, and to account for
different asset quality, some of the studies included a constant markup to the
1 3
uncovered interest rate parity. However, in 1990s, both two countries had liberalized
their interest rates, and series of interest rates are observable and available, therefore,
in this study, money market rates are used instead of curb market rates for the proxy of
market-clearing interest rates in these two countries. Interbank money market interest
rates (weighted average) are collected quarterly from 1980 to 2000 for Taiwan, and the
data is offered by the Interbank Money Center and published in the financial statistics
monthly by the CBC. The money market rates are collected quarterly from 1985 to
2000 for Korea, and the data is published in the IFS volumes.
The purpose of this section is to estimate the openness indicator, ip. In order to
directly measure it, the first step is to obtain the information about the parameters in
equation (3). I performed an Ordinary Least Squares (OLS) estimation of the money
demand function, using quarterly data for the period 1987:2 to 2000:2, in the case of
1 2 Except curb market rates, in Reisen and Y eches(1993), interbank call loan rates was also tested for
Taiwanese case, and in Chinn and Maloney (1996), corporate bond rate and overnight call money rate
were tested for Korean case, and 90 day banker’s acceptance rate were tested.
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87
Taiwan, 1990:2 to 1999:1, in the case of Korea.1 4 Chinn and Maloney (1996) reported
that the structure breaks were detected in the late 1988 and early 1989 in the Korean
case, and late 1989 in the Taiwanese case. Reisen and Yeches(1993), using the
interbank loan interest rate for the Taiwanese case, had reported a seemingly structural
break in 1987. According to this research, the break for Taiwan is closer to Reisen and
Yeches’s findings, and the break for Korea is in its early 1990. The estimates
produced the following results1 5:
Taiwan (1987:2-2000:2):
ln(M°/P)t = 0.830444 - 0.019181R, + 0.210295ln(Y/P)t + 0.733818ln(M/P),
(3.30161)*** (-5.75338)*** (2.71546)*** (9.56390)***
Adjusted R-squared = 0.967604 Durbin's h = -3.60118
Korea (1990:2 -1999:1 ):
ln(M°/P)(= -3.23228 -0.010662R, + 0.508572/w(F/P), + 0.51\9m n(M /P)t .h
(-2.39069)** (-2.06804)** (3.43837)*** (6.15088)***
Adjusted R-squared = .866079 Durbin's h = 1.39236
In Taiwan’s case, the Durbin’s h value suggests the existence of serial autocorrelation
in the money demand equation. To deal with serial autocorrelation, the study uses the
Cochrane-Orcutt procedure to correct the estimates:
1 3 For more discussons on the markup o f curb market over foreign interest rates, please refer to Reisen
and Yeches (1993).
1 4 The data o f Taiwan are collected from CBC publications, and IFS for Korean data.
1 5 The inclusions o f different time frames are tested between 1980 and 2000, the significant o f
parameters cannot be found before 1987 in Taiwanese case, and before 1990 and after 1999, in Korean
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Taiwan ( 1987:2-2000:2):
IniM0/F)t = 0.675078 - 0.016919R, + 0.138346/«(F/P), +0 M 5648ln(M/P)t
(4.32695)*** (-7.95241)*** (2.8282 4)*** (16.1294)***
Adjusted R-squared = 0.971991 DW = 1.91822
RHO= -0.517327 (-4.10647)***
In both cases, R t stands for the domestic money market rates, Yt is the local currency
GDP, P,is domestic CPI, and M t is M lb denoted in local currency in the Taiwanese
case, and M l denoted in local currency in the Korean case. In both cases, the interest
rate, output, and lagged money parameters are correctly signed and significant. The
corrected regression coefficient R-squared shows a good fit. This research also tests
for homoskedasticity, using the LR test for heteroscedasticity1 6 , and cannot reject the
homoskedasticity hypothesis in both cases. To avoid the cases of spurious regression,
the study also performs the Dickey-Fuller augmented test for unit root and Engle-
Granger test for cointegration. The results show that the residuals of both equations
1 7
can accept the hypotheses of cointegration at the 0.05 significant levels. To insure
the parameters in the money demand functions are constant during the observation
period in both countries, Chow tests are adopted for the detection of instability. First,
1993:4 and 1994:1 are set as the criteria to separate observations into two sub-sample
data for the Taiwanese and Korean cases respectively, and the money demand equation
case. The value in the parentheses is the t-statistic, and ‘***’ and “**’ denote a <1%, a <5%,
respectively.
1 6 The LM heteroscedasticity test statistic is 0.188103 in Korean case, and 0.000317799 in Taiwanese
case.
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89
of Taiwan has also been corrected with Cochrane-Orcutt procedures. F-tests are used
to detect the stability of regression coefficients over the subsamples of the data. In
neither case, the hypothesis of parameter stability can be rejected:
Taiwan (1987:2 - 2000:2 ) F (l,49)= 1.251327 Upper tail area: 0.29511
Korea (1990:2 - 1999:1) F(2, 32) = 1.84230 Upper tail area: 0.149
The estimates of the equation (3), money demand functions in the two countries,
reported above allowed us to derive the hypothetical closed economy interest rate, R°,
as equation (7). M ° can be calculated by subtracting M with financial account,
including foreign direct investment, portfolio investment, other-short-term capital, etc.,
measured in local currencies. The uncovered interest rates, R*, can also be measured
from equation (2). Here, the study assumes London interbank offer rates (LIBOR) on
U.S. dollar for three-month deposit as the proxy of the interest rates in the world
market, Rw. Expected changes of currencies were measured by the actual rate of
changes of the respective currencies in the corresponding periods.1 8 So far, we are
able to estimate equation (8) with the derived values of the hypothetical closed
economy interest rate, R c, obtained by the procedures of two-stage least-squares
method (2SLS) or instrumental variables (IV) methods. The estimates produced the
following results:
1 7 The Engle-Granger test statistic is -7.272919 in Taiwanese case, and -4.652268 in Korean case.
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90
Taiwan (1987:2-2000:2)
(R -R c) t = 0.661109 (R*-Rc)t
(9.00173)***
Adjusted R-squared = 0.604771 Durbin-Watson = 0.719340
Korea (1990:2: - 1999:1)
(R -R c), = 0.651339 (R*-Rc) t
(11.0032)***
Adjusted R-squared = .928487 Durbin-Watson = 1.07932
It is important that equation (8) satisfies tests for autocorrelation,
heteroscedasticity and normality of residuals based on the assumption of constant
parameters before we can build our indicator by the Kalman filter technique. In both
cases, the equations pass the tests of heteroscedasticity and normality of residuals, but
autocorrelation are detected in the series. The problems are corrected and I obtain the
following estimates1 9 :
Taiwan (1987:3-2000:2)
(R -R c)t= 0.780333 (R*-Rc),
(13.5539)***
RH01= 0.689888 (6.28367)***
1 8 This assumption may be justified by the heavily “managed “ floating exchange rates in two countries
during late 80s and 90s.
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91
Adjusted R-squared = 0.773720 Durbin-Watson = 1.90107
Korea (1990:3: - 1999:1)
(R -R c), =0.769223 (R*-Rc ),
(12.3299)***
RH01= 0.636671 (3.61400)***
Adjusted R-squared = 0.893347 Durbin-Watson = 1.71179
These results suggest that according to the openness indicator, yi, both
countries’ capital accounts seem to be highly integrated with the international financial
market. So far, the study has obtained the static regression coefficient that tries to
proximate the degree of capital mobility, but the coefficients themselves do not reflect
the dynamics of evolution over time. Thus, in the next section, the study measures the
time-varying estimates of the coefficients. In the following analysis, the study will
explore on how to obtain the time-varying estimates of the indicators of financial
openness by applying the Kalman filter technique.
4.4 TIME-VARYING ESTIMATES: KALMAN FILTER APPROACH
The estimates of the index of financial openness y/ have been presented as a
constant for a given period in the previous section. The objectives of analysis are to
capture the dynamic evolutions of financial liberalization by applying the Kalman
filter technique and to detect any particular patterns that may distinguish the financial
developments of the two countries.
1 9 To correct the serial autocorrelation in equation (8), 1 adjust the equations by adding the residuals in
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92
To avoid estimating the time-varying parameters arbitrarily, the Kalman filter
approach offers a useful method to investigate structural change in parameters or to
construct forecasts based on the historical data. The Kalman filter method is an
updating method that bases the regression estimates for each time period on last
period’s estimates plus the data for the current time period. In short, it bases estimates
only on data up to and including the current period. The term Kalman filter refers to
the estimation method commonly used to estimate state-space models. There are two
equations in the state-space models: the transition equation, which describes the
evolution of a set of state variables, and the measurement equation, which describes
how the data actually observed are generated from the state variables. For example,
using the notation in Harvey (1981), the Kalman filter model for our analysis can be
expressed as:
(R -R c)t = \j/t(R*-Rc)t + E t (measurement equation) (9)
y/t-T*i//t.i + rj t (transition equation) (10)
i / j o ~ N(y/o, O 2 P0 ) (initial condition) (11)
T and Pq are the matrixes assumed to be known and given according to our definitions
of initial condition. The discussions on the technical operations can be found in
the previous lag as dependent variables, and the first observation in each equation is dropped to avoid
the missing values.
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Hamilton (p. 372-p.408, 1994), and Harvey (p. 100-p.l67, 1989). The statistical
techniques are based on the applications discussed in Reisen and Yeches (1993),
Browne and McNelis (1990), and Doan, Litterman, and Sim (1984). The Kalman
procedure was transformed with p (RHOl) respectively for the two countries, and the
study allows the value of p to vary along with the other parameters in equations (9),
and (10). The estimations obtained in equation (8) are the starting points for the
Kalman filter iterative process. This study multiplies the variance-covariance matrix
by 0.001, and 0.0001. T tests are applied to be sure if the variation of the estimated
values of y/t by the Kalman filter were significant. All values resulted in the estimates
do not violate the theoretical priori assumptions for if/f To evaluate the results of time-
varying estimates in terms of the intervening power of states, two assumptions are
made for simplicity of analysis. First, the strong intervening policies of states would
be reflected in the forms of shocks in the pattern of the time-varying estimates.
Second, if the state adopted market-confirming policies, the curve of the time-varying
estimates would be smooth or gradual; otherwise, the curve is shown with dramatic or
fluctuating shocks. Figures 2 and 3 chart the time-varying parameters for the index of
financial openness in Taiwan and Korea, respectively. Figure 4 compares the results
between Korea and Taiwan.
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94
Figure 2. The index of financial openness, Taiwan 1987:3- 2000:2
aiwan AR1 sigmF*0.0001
0.80
0.78
0.76
0.74
0.72
0.70
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Figure 3. The index of financial openness, South Korea 1990:3- 1999:1
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95
Korea ARl sigma ^ O .OOOl
0.750
0,725
0.700
0.675
0.650
0.625
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
Figure 4. The openness of financial liberalization by comparison
aiwan A R l sigm a= *0.0001 K orea A R l sigm a=*0.Q001
0.800
0.775
0.750
0.725
0.700
0.675
0.650
0.625
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
4.5 FINDINGS
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Reisen and Yeches (1993) reported 0.353 and 0.594 as their estimates of the
financial openness during the 1980s for Taiwan and Korea respectively. Though
following their similar frameworks of analysis, this study replaces the curb market
rates with the money market rates as the estimates of domestic market-clearing interest
rates for both countries and this can be justified with the increasing bank loans and
liberalization of equity markets in the two countries which weakened the functions of
curb markets as the main source for firms’ funding. According to the data in my
previous section, the estimates of the financial openness are 0.780333 for the
Taiwanese case and 0.769223 for the Korean one, and these results show that the
financial sectors of two countries are more liberalized than they were in 1980s, and the
degree of openness of Taiwan is higher than that of Korea in 1990s. According to
Figures 2 and 3, there are the trends of the growing financial openness since the early
1990s for two countries. Next, according to the comparisons of the time-varying
analysis, as in the figure 4 shows, different patterns of financial liberalization between
two countries are detected. The dramatic shocks are found to be more frequent in the
case of Korea than in the case of Taiwan. In the case of Taiwan, a pattern of dramatic
shocks is detected between 1987-1990, but disappeared after 1990, however, the
pattern of dramatic shocks continued to exist in the Korean case. As the figures
shown, in the case of Korea, the dramatic shocks were found in 1990 - 1992, 1993 -
1994, and 1997- 1998. What qualitative characteristics can explain for the different
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97
patterns detected between the two countries? Under what contexts do the causes for
these dramatic shocks fade away in the case of Taiwan?
In the Taiwanese case, the control over the foreign exchange market was
dramatically liberalized in July of the 1987. Since then, the foreign exchanges
required by the current account transactions can be freely bought and sold in the
markets with CBC approvals. Firms and individuals are allowed to transfer 5 million
U.S. dollars to overseas and 50 thousand U.S. dollars from overseas to their domestic
accounts. The exchange rates were also dramatically depreciated between the periods
of 1987 and 1990, from the rate of 27 NT dollars per US dollar in 1987 to the rate of
40 NT dollars per US dollar in the end of 1990. Accidentally, the indexes of the stock
market were also highlighted with historical peaks and collapses. The index was 2,978
at the end of 1987, and it almost quadrupled in September of 1998, reaching 8,831
points. After the announcement of levying security-earning taxes by the Ministry of
Finance, the index dropped to 5,716 points. Afterwards, the Ministry of Finance
modified their announcements and lowered the security-earning taxes, and then the
market reacted heatedly with over 10,000 points in June of 1989. The historical peak
of the stock index was created in February of the 1990 with 12,682 points, about 6
times the index at the end of 1987, and the historical collapse was followed in October
of the 1990, from 12,882 points in February to 2,485 points in October. Less than 10
months, the index dropped 10,197 points. On the political sides, the martial laws
implemented for almost 40 years were lifted in 1987, and between 1987 and 1990
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98
there were dramatic changes toward liberalization on the developments of politics and
societies. In short, the dramatic shocks were consistent with the economic and political
characteristics of Taiwan between 1987 and 1990.
In the Korean case, in response to the domestic and external pressures for
liberalization, a four-stage interest rate deregulation plan was announced in 1991
(Kong, 2000, p.161). Between 1990 and 1991, most short-term lending rates of banks
and non-bank financial Institutions were deregulated, and interest rates on money and
capital market instrument, i.e. issue rates on corporate bonds with maturities of over
two years, were liberalized. Market was opened for top foreign investors subjected to
approval and foreign investors allowed to invest directly in Korean stocks subjected to
ceilings. However, progress on liberalization took another step backward in late
1990s, when the Finance Ministry ordered short-term finance companies to cut their
interest rates. These short-term finance companies were far more market-oriented than
state-manipulated banks, however, the authority tried to shut down these short-term
finance companies. In 1991, these firms were encouraged to become either banks or
securities companies (Clifford, 1998, p.312). Afterwards, the measures to deregulate
various interest rates have been taken and a four-stage interest rate deregulation plan
was announced in 1991. The inconsistent policies to liberalize the financial sector
showed the authority’s ambivalence over market-oriented deregulation. The second
phase of dramatic fluctuation in 1993 is consistent with the liberalizing measures
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promoted by Kim Young Sam’s segyehwcf or globalization policies. To continue the
previous liberalizing measures, and to bolster Korea’s chances of joining the OECD, a
five-year plan of accelerated financial liberalization was announced in July 1993 with
schedules for the completion of deregulation in key areas of the financial system
including interest rates, deposits, policy loans, and external capital account (Kong,
2000). The first phase of liberalization in 1993 deregulated interest rates on all loans,
banks and non-banks, of more than two years; and except for policy loans, and the
interest rates on all long-term deposits were also liberalized. And it was estimated that
foreigners owned up to 9.8% of market capitalization in the Korean market (Harvey, &
Roper, 1999). The third surge of the financial openness is consistent with the
emergent IMF reform plans with conditionalities for rescuing financial crisis in the late
1997 and the following structural reforms adopted by Kim Dae Jung. Indeed, we can
observe the quick effects of the IMF rescue packages to speed up the processes of
financial liberalization and industrial restructuring. In 1998, the IMF program, with
its measures for capital account liberalization, included the ful liberalizing of money
market instruments issued by financial and non-financial institutions, deepening
treasury bill market by issuing treasury bills of more than one trillion won, lifting
restrictions on borrowing up to U.S. $ 2 million for venture companies, and reviewing
the removal of restrictions on corporate borrowing of 1 -3 year maturities for large and
2 0 Kim Young Sam’s government announced on March 1995, that it had decided to keep, not translate,
the Korean word segyehwa in its romanized form, as the official name for its globalization drive, and for
Koreans, segyehwa does not merely mean “economic liberalization”, but it embraces political, cultural,
and social open-mindedness.( p.2, Kim, 2000)
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9 1 - »
small-medium enterprises, etc. The requests of the bold implementation of capital
account liberalization can be found in the 6th Letter of Intent that called for the opening
of all capital markets, including opening the short-term capital market to foreigners.
Following the steps of IMF, the Kim Dae Jung administration liberalized the capital
account even ahead of the schedule stipulated by the IMF. A new Foreign Exchange
Transaction Act was enacted and implemented in April 1999, and this law liberalized
corporate overseas borrowing, and established a futures market. The financial
derivatives market and the Korea Futures Exchange was inaugurated also in April
1999 (Jwa, 2001, p.226). In short, the effect of the radical liberalization since 1999 is
reflected in the results of empirical tests which seemed to indicate a structural break
after the second quarter of 1999, and therefore, the significant of the parameters could
not be found after the second quarter of 1999 in Korean case.
So far, the study has presented related empirical evidence for the dramatic
shocks. In addition to looking at the financial policies adopted by the states that may
explain the shocks manifested in the patterns, the study also investigates qualitative
characteristics that may reveal the clues to the puzzle that the dramatic shocks
disappeared and the Taiwanese pattern of time-varying estimates became more gradual
and smooth in the 1990s. According to the analyses of liberalization policies and
developmental politics in Taiwan, the study finds that most of the policies of financial
liberalization have been completed between 1987-1992, and due to the decentralized
2 1 MOFE press releases at www.mofe.go.kr
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style of developmental politics, the interests have been diffused rather than
concentrated. The 16 newly established commercial banks in 1992 and the
deregulation of short-term bill and securities companies afterwards indicate that the
Taiwanese financial markets had been very competitive since 1992, and the
government also willing to adopt the market-conforming policies. Therefore, it is the
Taiwanese case but not the Korean that a more smooth and gradual pattern was
detected in 1990s.
Given similar pressures of U.S. policies and market conditions, this research
argues that the different patterns of financial liberalizations detected between South
Korea and Taiwan may suggest that the results of different patterns are due to their
domestic diversity. Bearing the pattern detected from the two cases in mind, the
following chapter will continue to investigate the relationship between financial
liberalization and economic growth.
CHAPTER FIVE
TIME-VARYING ESTIMATORS OF FINANCIAL LIBERALIZATION AND
ECONOMIC GROWTH IN SOUTH KOREA AND TAIWAN IN THE 1990s
5.1 INTRODUCTION
This chapter evaluates the influence of domestic policies on the relationship of
economic growth and financial liberalization in emerging markets. Applying
qualitative characteristics to interpret the quantitative findings of chapter four, this
chapter finds that the gradual pattern of financial transition in Taiwan is consistent
with a gradual pattern of economic growth, whereas the fluctuating pattern of
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transition in South Korea is consistent with a fluctuating pattern of growth. These
linkages between patterns of financial transition and economic growth suggest that the
impacts of capital mobility on economic growth were more dramatic in South Korea
than Taiwan.
Financial liberalization has been taken as an important measure to sustain
economic growths for many developing countries, especially the policies of
liberalization of capital account to attract more foreign direct investments (FDI), and
the liberalization of equity markets to help corporations raise more funds from foreign
investors. But most developing countries have also been worried about the side effects
caused by financial liberalization. For instance, rapid financial liberalization may
erode their autonomies of monetary policies and increase the difficulties maintaining
their consistency of economic reforms. In addition, without the appropriate structural
adjustments, a country may exploit substantial capital inflows. However, rapid
financial liberalization may highlight the problems of weak financial institutions,
credit over-expansion, and corruption. In this chapter, the study attempts to verify the
impacts of capital account liberalization on economic growths by applying the time-
varying estimators and the objective of this exercise is to validate the following
propositions:
Proposition I\ The effects of financial liberalization on economic growth in Korea and
Taiwan during 1990s were positive.
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Proposition II: The effects of financial liberalization on economic growths are
differentiated by their particular domestic structures in Korean and Taiwan during the
1990s.
5.2 DID FINANCIAL LIBERALIZATION INCREASE ECONOMIC GROWTH
IN THE 1990S?
Though a lot of researches have been conducted on the relation between
financial development and economic growth, but few have analyzed the time-varying
effects of financial liberalization on economic growth, and very few of them have
noticed how individual domestic structures differentiate the effects of such
relationships. Recent studies have put much effort on proving the positive or negative
effects of financial liberalization on economic growths in emerging markets. Rodrik
(1998) finds no correlation between capital account liberalization and economic
growth and criticizes the assumption that opening an economy to financial capital
flows has favorable effects. Bakaert, Harvey and Lundblad(2001) conducted the
impact of financial liberalization on the economic growth, using a GMM instrumental
panel estimator with overlapping data over 95 countries beginning in the year 1980
and they showed that the liberalization of equity market, on average, led to a one
percent increase in annual real economic growth over a five-year period. They also
concluded that the liberalization effect is not spuriously accounted for by macro-
economic reforms and does not reflect a business cycle effect. Sebastian Edwards
(2001) investigates the effects of capital mobility on economic growth by allowing the
data set to have intermediate situations and two different periods in time. Edwards
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suggests an open capital account positively affects growth only after a country has
achieved a certain degree of economic development, and supports the thesis that there
is an optimal sequencing for capital account liberalization. He concluded “while for
financially sophisticated countries an open capital account is a boon, at very low levels
of local financial development a more open capital account may have a negative
effects on performance. In that sense, then, emerging markets are essentially
“different” from advanced nations” (2001, p. 16). Arteta, Eichengreen, and Wyposz
(2001) conducted similar exercises but argued that the effects of sequencing reforms
are period specific, and in the presence of macroeconomic imbalances, capital account
liberalization is likely to hurt economic growth. In sum, the researches suggest the
effects of capital account liberalization may not have a general effect on economic
growth in the emerging markets, and based on these findings, the study attempts, first,
to verify the effects of capital account by applying the time-varying estimators for
South Korea and Taiwan in the 1990s, and second, to incorporate the diversity of
domestic structure to interpret the effects of liberalization on economic growth
according to the qualitative difference surveyed in the previous chapters.
Recent researches on economic development have emphasized the effect of
convergence by including the initial level of productive factors. Barro (1997) showed
that if one holds constant initial levels of human capital and other determinants of the
steady state level of per capital GDP, poorer countries do grow faster per capita than
wealthy ones. Sachs and Warner (1995) suggested that respect for private property
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rights and open international trade were important policies for long-term economic
growth. Campos and Nugent (1999) reported that the institutions of governance, such
as the executive, the bureaucracy, the rule of laws, the processes of policymaking and
civil societies have significant impacts on the economic developments. These results
suggest that by implementing adequate economic policies, poor countries can become
part of the “convergence club”(Bakaert, Harvey and Lundblad, 2001).
Policies of financial liberalizations influence economic growths; therefore, the
states have the incentives to formulate adequate policies to liberalize their economies.
According to a number of economic theories, financial liberalization has the following
effects. First, by the progressive allocation of capital according to market forces rather
than personal relationships or government direction, financial liberalization may
produce more efficient allocation of resources. Second, by improved risk sharing,
financial liberalization may lower the cost of capital on enticing additional investment.
However, liberalization also leads investments to riskier and higher expected return
project (Obstfeld, 1994), and it may also lead to lower precautionary savings and
reduced growth (Devereux and Smith, 1994). In general, the aim of capital account
liberalization is to strengthen the competitiveness of the financial sector and thus
increase economic growth.
5.3 MODELING THE TIME-VARYING EFFECTS OF LIBERALIZATION ON
ECONOMIC GROWTH
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The method of this study combines the traditional economic growth model with
convergence effect by applying the time-varying index of financial liberalization that
generated in Chapter Four. The general regression model is specified as:
A yt = ao + a iln (y )t + a 2 ’X t + a 3 Libt + s t (12)
The time-series analysis of equation (12) includes quarterly data in 1990:2-1999:4 for
the Taiwanese case and 1991:2-l999:1 for the Korean case.2 2 The dependent variable
is the real economic growth rate, A y t . The first explanatory variable is real GDP in
the natural logarithm form. Structural factors are included in the second explanatory
variable. The Kalman-filter index of liberalization of capital account that the study
has generated in previous chapter is the third explanatory variable.
Before the empirical econometric model of equation (12) is evaluated, it may
offer some useful clues to our analysis by plotting out the relationship between the
Kalman-filter index of liberalization and real GDP. Figures 5 and 6 compare the trends
of real GDP and the index of liberalization on capital account for the Taiwanese and
Korean cases respectively. Similar to the pattern in the growth of Taiwanese financial
openness in Figure 4, the pattern of real GDP in Figure 5 also grew gradually. Similar
2 2 The sources o f data are form central bank o f China in the Taiwanese case and central bank o f Korea
and IFS in the Korean case. .
2 3 The matrix o f structural factors may include the level o f education, life expectancy, fertility rate, rule-
of-law index, investment, exports, etc (see Barro, 1997). However, for the simplicity o f our analysis, I
reduce the structural factors to include loans and investment, and export only. Other factors 1 assume
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to the fluctuating pattern in the growth of Korean financial openness in Figure 4, the
pattern of Korean real GDP grew with a zigzag pattern. By adjusting the real GDP
with few lags, I observe similar trends between the Kalman filter index and economic
growth.
Figure 5. GDP and the time-varying index of liberalization adjusted with lags,
Taiwan
0.8 0 -
0. 78 -
0 .7 6 (-
0 .7 4
0 .7 2 -
0 .7 0
Figure 6. GDP and the time-varying index of liberalization adjusted with lags,
Korea
they are constant in 90s, and the constant tenn in equation (12) may account for the effects not included
in the second explanatory variables.
1 0 . 0 0 -
9 . 7 5 -
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19 9 0 19 9 5 2 0 0 0
To verify the proposition that the effects of financial liberalization on the
economic growths in Korea and Taiwan during 1990s were positive, the sign of the
independent variable Libt is expected be positive. The negative sign of the variable,
ln(y)t is expected if there is a convergence effect that lower GDP in previous period
will generate higher economic growth rate later. Structural factors such as loans and
investment and the amount of exported goods are expected to be positive to economic
growth, and the positive constant term may represent the effects of other productive
factors neglected in my equation.
5.4 EMPIRICAL RESULTS AND THE FINDINGS
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The empirical evaluations of the econometric model, equation (12), generated
the following results24:
Taiwan (1990:2-1999:4)
Ayt = 1.2416- 0.2376 GDP,.2 + 0.1037 Export ,.3 + 0.0089 Loans, + 0.7645 Libt.j
(4.54)*** (-4.11)*** (3.58)*** (2.07)** (2.16)**
RHOl = 0.4926 (3.16)***
Adjusted R-squared = 0.778921 Durbin-Watson= 1.82915
Korea (1991:2-1999:1)
Ayt = 6.1677- 1.005 GDP,.S + 0.4228 Export ,.2 - 0.2679 Loans ^ +1.3793 Lib,.3
(5.76)*** (-7.19)*** (5.16)*** (-2.48)** (2.50)**
Adjusted R-squared = 0.667193 Durbin-Watson= 1.83367
The empirical results verily Proposition I. The positive relationships between the
index of financial liberalization and economic growth are confirmed in both countries
in the 1990s. For both countries, the negative signs on the parameters of variable,
GDPt, also confirm the convergence effect that lower GDPs in previous periods will
generate higher economic growth rates in later periods and vice versa. The increase of
exports will raise the rate of economic growth in both cases. One of the interesting
findings from the empirical study is that the sign of the parameter of the variable,
2 4 The variable GDP and Export have been transformed into natural logarithmn forms, and the variable
Loans are the change rates o f total loans and domestic investments. The parentheses is the t-statistic,
and ‘***’ and ‘**’ denote a <1%, a < 5% , respectively. The parameters have been corrected if serial
autocorrelation detected. Diagnostic tests such as LM test for heteroscedasticity and Engle-Granger test
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Loans in the Korean case is negative while the sign is positive in the Taiwanese case.
This fact implies that the increase in loan and investment rates did not raise economic
growth rate in the Korean case. In other words, there were excessive borrowings and
inefficient investments in the Korean case, and this finding may indirectly support
Proposition II.
Theoretically, the increase of financial liberalization should increase the
mobility of capital and thus resources will be located more efficiently. The effect of
financial liberalization can be seen as the effect of capital mobility, i.e., the impact of
capital inflows or outflows. Though my empirical results show the impacts of
financial liberalization are positive to the rates of economic growths, but this does not
mean developing countries should liberalize the capital account as fast as they can.
Dramatic capital inflows or outflows may increase financial instability, i.e.,
hyperinflation, capital flight etc. For instance, Kaminsky and Reinhart (1996) found
that out of the 26 banking crises they study, 18 are preceded by financial sector
liberalization within a five year interval and financial liberalization accurately signals
71 percent of all balance of payments crises and 67 percent of all banking crises.
Chang and Velasco (1998) reported that financial liberalization is strongly correlated
with a fall in bank liquidity and the financial liberalization in Asia increased the
possibility of a financial crash through its effect on international illiquidity.
Demirguc-Kent and Detragizche (1998) found that banking crises are more likely to
for unit root and cointegration are conducted to ensure the estimators are efficient and consistent, and
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occur in liberalized financial systems with weak institutions where there is little
respect for the rule of law, poor contract enforcement, and a high level of corruption.
Therefore, domestic structures will influence the results of financial liberalization and
the effects of economic growth. According to qualitative analyses from previous
chapters, domestic structures differentiate the pattern of financial liberalization
between South Korea and Taiwan in the 1990s. To verify the thesis that domestic
structures have also differentiated the effects of economic growths between Korea and
Taiwan in 90s, this study shows the following arguments.
First, the effects of capital mobility on the rates of economic growth in 1990s
between the two countries are different. According to the empirical results, the
increase of every 0.1 on the scale in the openness index tends to increase
approximately 0.3% of economic growth rate per year in the Taiwanese case, and
approximately 0.55% of economic growth rate per year in the Korean case and vice
versa. This implies that the impacts of capital mobility in the Korean case on
economic growths are more unstable than that of the Taiwanese case and this
observation is consistent with the fact that the pattern of financial liberalization of
Taiwan is more gradual than that of Korea due to their different domestic structures.
the occasion o f spurious regression is avoided.
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Second, there is the evidence showing a tendency of rapid increase of foreign
capital and excessive borrowings in Korea. Figure 7 shows the trends of total foreign
debt and portfolio and other investments increased in Korea from 1990 to 1997.
Figure 7. Korean foreign debts and portfolio investments during 1990-97
forign debt!
12500C
10000C
75000
50000
1990 1991 1992 1994 1996 1997 1993 1995
25000
20000
15000
10000
5000
1990 1991 1992 1994 1997 1993 1995 1996
Data Source: World Debt Tables and Global Development Finance: Country Tables, World Bank
(several issues).
The dramatic increase of foreign debt and portfolio investments can be
observed between 1993-4, and this peak is consistent with the dramatic increase of the
index of openness in Figure 4. The amount of Korean foreign debts in 1997 had at
least tripled from the amount of 1990’s, and the amount of portfolio investment
fluctuated widely. These figure and data suggest that there are excessive borrowings
after the 1993 Korean Segyehwa plans and the negative sign found on the parameters
of Loanst in the Korean case supports the assumption that these loans and
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investments are non-productive. This finding is also consistent with the fact that
during 1990s the Korean chaebols sought to diversify their business investments by
taking advantage of a relaxed market entry system. These business conglomerates
were power-seeking rather than profit-seeking, they expanded their business though
their financial statements turned poor (Lee, 2000, p. 120). The best example is
Samsung’s entry into the auto manufacturing industry. Samsung was the second
largest conglomerate in terms of sales, next to Hyundai in 1993, but a crucial
motivation for the entry into the auto manufacturing industry lay in her chairman’s
ambition to become the largest chaebol in Korea and after Samsung’s auto business
launch, the debt ration of Samsung group deteriorated as high as 371 per cent (ibid,
p.121).
5.5 CONCLUSION
Though there is evidence pointing to the convergence of economic growth of
South Korea and Taiwan by liberalizing their the capital accounts in 1990s, the
evidence shows that the effects of capital mobility of Korea on the rates of economic
growths are more dramatic than those of Taiwan, and this finding is consistent with the
trend in the increasing amount of total foreign debts and portfolio investments in
Korea. The evidence is also consistent with the qualitative characteristics of domestic
developments of Korean that the state had directed domestic resources and foreign
investments to favor chaebols and the chaebols borrowed excessively in short-term
debts markets and made a lot of non-producing loans. The evidence further suggests
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that the impacts of capital mobility in the Korean case on economic growths are more
dramastic than that of those of the Taiwanese case and this observation is consistent
with the fact that the pattern of financial liberalization in Taiwan is more gradual than
that of Korea due to the market-conforming policies adopted by Taiwan. In any sense,
all the evidences validate the proposition that the effects of financial liberalization on
economics growths are differentiated within their domestic structures.
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CHAPTER SIX
DOMESTIC FACTORS AND THE RECENT ASIAN FINANCIAL CRISIS
6.1 INTRODUCTION
This chapter surveys common causes in the recent Asian financial crisis,
demonstrating that excessive corporate borrowing behaviors bear a crucial relationship
to the crisis. The chapter concludes that diversity in domestic structure development
greatly influenced these borrowing behaviors. In South Korea, excessive borrowing
developed via the foreign and short-term debts made by chaebols under the
government’s explicit guarantees. In Taiwan, excessive borrowing increased via newly
liberalized banks and bill and securities companies, liberalized as a result of
contemporaneous political power struggles.
It was frequently cited that the inadequate international financial infrastructure
had been an important cause of the recent financial crises. The Asian financial crises in
late 1997 have made many people believe that the increasing mobility of capital has
significantly increased the international financial instability and has been harmful to
the domestic economies. In emerging markets where more fund was requested for
further expansions or where domestic financial sectors were repressed and credits were
rationed to preferential industries, foreign borrowings were easy-and-quick sources to
resort to and the influx of too much hot money was blamed as the main source for
recent financial crisis. However, the nature of domestic factors may be as important as,
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or even more important than international capital mobility in making these economies
highly vulnerable to the attack of a financial crisis. According to empirical data
obtained from the econometric tests in this study, this research demonstrates that
excessive corporate borrowing is one of most the important factors contributing to the
recent Asian financial crisis, but the excessive corporate borrowing behaviors are
directly related to their domestic structures and such behaviors only reflect their
domestic differences between the case of Taiwan and South Korea. The most
important thesis of this study is that domestic factors are the crucial determinants in
the outcome of financial liberalization in the emerging markets, though external forces
such as market and hegemonic policies may exert their own impacts. In this chapter,
the study will utilize similar perspectives to elucidate the cause of recent financial
crisis in South Korea and Taiwan. Taking into account the structural diversity in
policies of financial liberalizations and developmental politics, this chapter has
confirmed the explantory power of domestic factors in recent Asian financial crises in
two countries.
6.2 LITERATURE REVIEW AND DEBATES
Volumes of discussion on the determinants and the explanatory models have
shown the uniqueness of Asia’s economic crises. However, so far, the crises cannot be
completely explained with the so-called first-generation and second-generation models
on currency crises.2 5 The Asian economic crises in late 90s should neither be the
2 5 The first-generation models ( Krugman,1979) predicted crises are aroused as the results o f loose
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simple results of fundamental deterioration by the fiscal deficits as in Latin America in
the early 1980s, nor the outcome of a self-fulfilling foreign financial panic such as in
the ERM crisis in early 1990s and in the Mexico peso crisis in 1995. In general, the
debates over the causes of financial crisis differ between the views of the
fundamentalists, who see the currency overvaluation and current account deficits as the
crucial elements in the formation of self-fulfillment panics and the non-
fundamentalists, who blame the herding behavior of international capital markets.2 7
Recent debates over the determinants of Asia’s economic crises have concentrated on
international finance factors such as large and volatile capital flows and inadequate
28
financial deregulation and supervision. A large body of literature also support the
argument that the weakness of financial sector is not only due to bank runs and panics
by depositors, but is the outcome of excessive lending, distorted incentives, poorly
administered liberalization processes, and weak macroeconomics.2 9 The more recent
“third-generation” models adopt the theory of agency and transaction costs. These
models emphasize how the informational asymmetry of domestic banks leads to
macroeconomics policies such as excessive fiscal policies that are monetized by the international
foreign reserves. The inconsistency o f exchange rate policies will exhaust foreign reserves toward the
currency attack. Second-generation models ( Obstfeld, 1994) analyzed the model o f self-fulfilling
expectations, and the herding behavior by foreign investors expecting currency realignments or
contagion effects are not related to the fundamentals.
2 6 See Corsetti, Pesenti and Roubini (1998)
2 7 See Radelet and Sachs (1998)
2 8 See Chang and Vellasco ( 1998), Kaminsky and Reinhart (1998), Eichengreen ( 2000)
2 9 See Demirguc-Kunt and Detragiache (1998), Tom ell (1999), Coresetti, Pesenti and Roubini (2000)
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excessive lending of domestic firms under the implicit or explicit guarantees of
governments.3 0
All the theories and models, without a doubt, have explained the operations of
economic crises to some extent in certain areas. But among them, which one is more
fitted to explaining the developments of financial turmoil in the cases of South Korea
and Taiwan3 1 ?
According to Krugman(1997, 1998a, 1998b), the Asian economic crises were
mainly related to the burst of a financial bubble. He pointed out the measurement of
factor productivity growth did not grow as much as the investments, and indicated that
the economic growth would be slowed by the low and declining returns on
investments. If the financial bubble hypothesis is correct, then we should observe
similar bubbles especially in the stock and real estate markets in two countries.
However, we can observe similar bubbles in stock and property markets in the
Taiwanese case whereas Korea did not experience a similar bubble in the property
market. Moreover, the bulk of the capital influx into Korea had been used to finance
investments in manufacturing instead of speculation in real estate or finance. Corsetti
et al (1998) pointed out that the imprudent macroeconomic policies such as the fixed
exchange rate peg to the US dollar and lending booms should account for the currency
, r > For more discussions on the models o f agency costs please read Dekle and Kletzer (2001)
jl Although most o f the studies did not classify Taiwan as the victims o f Asian financial crisis in 1997-
98, however, we recognized similar financial disorders during 1998-1999 in Taiwan (i.e. the bankrupts
o f several corporations, excessive borrowings and exponentially grown ratio o f non-performing loans,
the illiquidated financial institutions bailed out by government, high unemployment rate, and the deepest
recession in stock and real-estate markets).
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overvaluation and the current account deficits. Unsound fundamentals combined with
moral hazard problems resulted in the accumulation of foreign debts in the form of
short-term, foreign-currency denominated and unhedged liabilities, which in turn led
to speculative attacks. However, the impacts of unsound fundamentals had been
exaggerated. Researches have shown that the Korean won was slightly undervalued at
the time when the crisis broke out (Chinn, 1998) and at the period of appreciation
during 1990 and 1997 (Radelet and Sachs, 1998). Furthermore, the current account
deficit was very small in Korea during the 1990s, and the private borrowing in the
exported-oriented manufacturing sectors mainly caused these deficits. Obviously, the
case of Korea and Southern Asian, especially Thailand and Indonesia was somewhat
different.
Radelet and Sachs (1998) argued “the crisis was triggered by dramatic swings
in creditor expectations about the behavior of other creditors, thereby creating a self-
fulfilling, though possible individually rational, financial panic” (p.22). They tend to
emphasize, “the international loan markets are prone to self-fulfilling crisis in which
individual creditors may act rationally and yet market outcomes produce sharp, costly
and fundamentally unnecessary panicked reversals in capital flows.” (p.41998)
However, the refusal of foreign creditors to rollover their short-term loans should not
be attributed to the sudden swing in their expectations in the case of Korea. Only $2
billion worth of foreign capital was withdrawn from the securities market of Korea
between the months of August and November in 1997, and this trend of capital drain
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was soon reversed to a net inflow of capital after December 1997. On the other hand,
there were several swings for the Korea’s weakening economy. A lot of large Korean
corporations collapsed in 1997. In January 1997, South Korea’s fourteenth-largest
conglomerate, the Hanbo Business Group, collapsed under a debt burden of more than
$5.9 billion and Hanbo Iron and Steel Company, and Sang-A Pharmaceutical
Company became insolvent. Their loans from Korean financial institutions became
non-performing. In mid-1997, the Ministry of Finance and Economy urged South
Korean companies to speed up their efforts toward restructuring, citing basic
weaknesses in the economy. The second-largest car company and the tenth-largest
conglomerate in Korea, Kia went into bankruptcy in October 1997. In sum, these
events should account for the vulnerable signs of attack in Korea’s currency crisis of
November 1997.
The financial crisis of Taiwan in 1998-1999 was attributed to what
Krugman(1995) had described, the burst of the financial bubble, and what Radelet and
Sachs(1998) had claimed, the financial panics triggered by herding behavior. In the
1990’s, several Taiwanese conglomerates tried to manipulate their subgroups’ stock
prices to get short-term arbitrages, and negotiated illegal loans from domestic banks
via personal links or political pressure, and the collaterals usually were their stocks.
The funds they raised from domestic banks were injected into the stock markets again.
The more they invested in the stock market, the higher their stock prices rose, and the
:2 The scale o f Taiwanese stock market is quiet small, up to Mar. 1999, the number o f listed stocks is
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higher the value of their collateralized stocks which in turn implies that they can
borrow even more from the banks. Therefore, in the early 1990s, a lot of Taiwanese
firms started their high-leverage portfolios in stock markets. It is estimated that over
one fourth of the listed companies in the stock market have collateralized their own
stocks and the total shares of the collateralized stock have exceeded 50% o f their
issued stocks. Ultimately, the stock prices were not sustainable, and the bubble burst
in the late 90s, which made several conglomerates declare their inability to redeem
their debts of the banks. Banks were run by public panic, and these affiliated banks
finally asked for bailouts from the government. Pan Asia Bank lost at least NT$ 70
billion in the case of Ever Fortune Group, and was bailed out by the Central Bank of
China (CBC). Central Finance Bill lost at least NT$ 8 billion in the case of New
Magnitude Group, and was bailed out by the Ministry of Finance. CBC lent at least
NT$ 9 billion to Taichung Business Bank for the scandal of Kuangsan Group. Other
Taiwanese conglomerates involved in the financial crisis were Hai-Shan Group, Victor
Taichung Machinery, Feng An Metel Company, Tun-Lung Metal Company, Chinese
Automobile Corporation, and Tuntex Group.
6.3 DOMESTIC FACTORS: THE CRUCIAL ELEMENTS
Krugman(1999) stressed banking problems as the main cause for explaining
the crises. He pointed out that the deficient regulation of banking sectors such as the
lack of transparency and the presence of various implicit governmental guarantees, led
451, and the total market value is 310 billions U.S. dollars. Therefore, to manipulate stock prices is
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122
Asian banking and financial sector to the plight of over-indebtedness and of
excessively high levels of non-performing loans. He criticized that the corrupt
industrial policies have given rise to the moral hazard and the subsequent lending
booms. Follow this track; increasing attention in the analysis has been paid to the role
of domestic factors and the processes of financial liberalization.
Wade (1998a,b and c) pointed out the removal in the early 1990s of the
traditional institutional structure of govemment-bank-firms collaboration and of
restrictions in the capital accounts as the crucial elements in the crises. The rapid
liberalization of capital account has contributed to the excessive borrowing behaviors
of domestic firms. In this section, I try to empirically test the possible factors that
accounted for the 1997 financial crisis in order to validate his hypothesis that the
excessive borrowing behavior is significant to the degree of financial crisis. The
empirical methodology is similar to the approach of Sachs, Tomell, and Velasco
• it
(1996). Panel data regression techniques are applied to analyze our data . Crisis
indicator is calculated by the ratio of the nominal exchange depreciation rate divided
by the rate of depleting foreign reserves. A large positive crisis indicator implies rapid
exchange rate depreciation and rapid depletion in foreign reserves. Explanatory
variables include current account deficits, GDP growth rate, investment, saving, stock
index, fiscal deficit, inflation, short-term debt, nominal exchange rate, real exchange
rate, interest rate, etc. For the detailed econometric operations, please refer to
possible.
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123
Appendix B. According to the econometric results, excessive borrowings account for
the largest explanatory power among other significant variables such as interest rate,
M2/FX ratio, and pegged exchanged rate in the model. In sum, the domestic factor of
corporate excessive borrowing behaviors has crucial explanatory power in the recent
Asian financial countries across the emerging markets.
The evidence of increasing corporate borrowings can be easily recognized from
Table 6 and Table 7. The funds were generally borrowed from bank loans, corporate
bonds, and commercial paper. In Korea, between 1991 and 1999, the borrowings
through bank loans and corporate bonds doubled respectively, and the issuing of
commercial paper increased by almost four times. In Taiwan, between 1990 and 2000,
the bank loans grew almost three times; the commercial paper grew almost four times.
Table 8 and 9 illustrate the deteriorating corporate finance from the loans made by
eight bankrupt Korean Chaebols in 1997, and loans made by the ten deepest in-debt
conglomerates of Taiwan in 2000. The common features of developments reveal
similar rent-seeking behaviors among govemment-firm-bank interaction in the
processes of financial liberalization. In Korea, the borrowings were developed via
foreign and short-term debts made by chaebols under the government’s explicit
guarantees; and in Taiwan, the borrowings were increased via newly liberalized banks
and bill and securities companies under the implicit promises of the ruling party for
gaining political supports during the process of financial liberalization.
The annually data include eight Asian countries, including Korea, Indonesia, Malaysia, Philippine,
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124
Table 6. Sources of funds for corporate borrowings, South Korea, 1911-1996
Commercial paper Corporate bonds Bank loans
1991 21.6 43.5 113
1992 25.5 50.1 132.9
1993 36.1 59.5 152
1994 44.4 72.2 187.1
1995 61 87.5 218.8
1996 80.8 111.4 254.6
Unit: trillion won
Note: Outstanding sources
Data Source: Bank of Korea, Monthly Bulletin, various issues
Table 7. Sources of funds for corporate borrowings, Taiwan, 1990-2000
Commercial
paper
Corporate
bonds
Bank Loans
1990 11.37 0.4 49.86
1991 8.49 0.07 61.26
1992 11.82 0.04 77.04
1993 6.90 0.03 89.78
1994 7.34 0.02 104.66
1995 24.90 1.76 114.24
1996 31.24 10.18 118.67
1997 45.62 14.59 133.42
1998 59.95 18.05 140.79
1999 74.53 15.16 147.01
2000 49.12 10.11 154.44
Unit: billion N.T. dollar
Note: Outstanding sources
Data Source: Monthly statistics o f finance, MOF, Taiwan, 2001
Singapore, Thailand, China, and Taiwan from 1990 to 1997.
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125
Table 8. Loans made by eight bankrupted Korean Chaebols in 1997
Loans by
Bank
Loans by Non
bank
Total Loans
Hanbo 4627 968 5595
Sammi 811 36 847
Jinro 1340 895 2235
Daenong 699 603 1302
Kia 4440 5035 9475
Haitai 1310 1971 3281
Newcore 938 377 1315
Halla 3036 3440 6476
Total 30526
Unit: billion won
Data Source: Press releases o f Financial Supervisory Commission, Korea
Table 9. Loans made by the ten worst in-debt conglomerates, Taiwan, 2000
Group Total Debt The largest creditor
Hualou
90
Chung Hsing, International, China Bill Finance
Corporations
Core Pacific
80
First Commercial, Hua Nan, Chang Hwa
commercial banks
Tuntex
67
First Commercial Bank
Tiawan Pineapple
38.2
Chung Shing Bank
Hung Kuo
33.5
United World Chinese Commercial Bank
Chin Fon
32
Chung Hsing Bill Fiance Corporation
Ever Fortune
26
United World Chinese Commercial Bank
Asia World International
20
Chiao Tung Bank
Hone Shee
20
China Trust Commercial Bank
Chung Shing Textile
16.3
Chang Hwa commercial banks
Total 423
Unit: billion NT dollar
Data Source: Open Weekly, vol.], June 20, 2001, Taipei, Taiwan
6.4 CONCLUSION
The Asian financial crises in late 1997 have made many people believe that
increasing mobility of capital has significantly increased domestic financial fragility
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and has been harmful to the domestic economies in emerging markets. However, the
nature of domestic factors themselves may be as important as, or even more important
than international capital mobility in making these economies highly vulnerable to the
attack of a financial crisis. The empirical econometric tests from this research have
confirmed that excessive corporate borrowing is one of the important factors
contributing to the recent Asian financial crises, and the causes of excessive corporate
borrowing behaviors are subject to the development of their domestic structures and
thus the behaviors will be different from one country to another. In South Korea, the
excessive borrowings were developed via foreign and short-term debts made by
chaebols under the government’s explicit guarantees; in Taiwan, the excessive
borrowings were increased via newly liberalized banks and bill and securities
companies under the implicit promises of the ruling party for gaining political support
during the process of financial liberalization. These findings are consistent with the
thesis of this research that domestic factors are the crucial determinants in the outcome
of financial liberalization in emerging markets, though external forces such as market
and hegemonic policies may exert their own impacts. In sum, I argue that the rent-
seeking behaviors which prevailed in the processes of financial liberalization in South
Korea and Taiwan cannot be distinguished without examining their developments of
domestic structures, and that the qualitative differences are very difficult to recognize
if only the quantitative cross-countries researches alone are conducted.
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127
CHAPTER SEVEN
CONCLUSION
7.1 INTRODUCTION
It needs to be reemphasized that there was, and is, no single pattern of financial
liberalization. The various institutional arrangements of emerging markets will
differentiate the governances’ different performances in the ascending economic
openness. The core idea of this research is that domestic diversity has impacted
transitions of financial liberalization more than international factors. In exploring
domestic diversity, this research highlights variance in Taiwan and South Korea’s
timing, pace and sequence of liberalization policies as well as the roots of
centralized/decentralized government-bank-firm relationships.
This work identifies differing patterns of liberalization by comparing South
Korea and Taiwan during the 1990s, assuming that they have shared similar pressures
of increasing capital mobility and imperative U.S. policies. The analytical
contribution of this research is to recognize that the transition of financial
liberalization was market-oriented in Taiwan but state-intervened in South Korea.
This study has interpreted these unique patterns using comparative historical analyses
and empirical econometric analyses, constructing a comprehensive analytical
framework to understand the political economy of financial liberalization on both
international and domestic levels.
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1 2 8
Incorporating both qualitative and quantitative methods, this research analyzed
internal structures by examining developmental politics and the pace and sequence of
domestic financial policy implementation. The results indicate three major
conclusions. First, South Korea and Taiwan experienced different patterns of
transition during the 1990s; South Korea’s powerful state intervened in financial
markets while Taiwan’s influential political factions constrained government
intervention. Secondly, this work pinpointed these transitions’ effects on patterns of
economic growth, suggesting that the effect of South Korea’s liberalization on
economic growth was more influential than Taiwan’s. Third, different patterns of
corporate borrowing were detected; this work argues that these variances led to
differing reactions to crisis.
7.2 LESSONS LEARNED AND POLICY IMPLICATIONS
The comparison of South Korean and Taiwanese financial liberalization during
the 1990s highlights several important lessons. First, it underscores the familiar and
recurring theme of competition. The evidence put forth in this research suggests that
the market-oriented transition in the Taiwanese case involves the simultaneous
operational forces of competition from all financial, industrial and political sectors.
These competitive circumstances are particularly difficult to establish since most of the
common features of late development have been associated with concentrated
economic structures. For example, the early privatization of the banking sector in
Mexico contributed to bank-dominated financial sectors, while in Korea the close
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129
govemment-bank-firai relationship contributed to chaebol-concentrated industrial
sectors. A concentrated economic structure seems to be crisis-prone under the
ascendancy of capital mobility. The experiences of the Mexico peso crisis in 1994-95
and the Korean currency crisis in 1997-98 have shown that oligopolization of banking
or industrial sectors tends to induce the onset of financial crisis.
Second, according to Taiwan’s experience, the sequence of introducing
liberalizing reforms and creating competitive circumstances in the industrial, political
and financial sectors may reveal important policy implications for avoiding crisis. In
Taiwan, prosperous SMEs developed first, then were followed by political
liberalization; the state liberalized the financial sector last. State-dominated banks,
however, were not privatized until competitive financial markets were formed by
deregulation policies.
Next, the performances of financial liberalization in emerging markets involve
more than the mere analysis of sequences of optimal financial policies or the adequacy
of macroeconomic measures. Competitive economic structures, democratic
liberalizations, and adequate prudential regulations and institutions all have
fundamental impacts on the consequences of liberalization. Market-led liberalizations
will not avoid financial crises if competitive industrial, bank and political structures do
not exist simultaneously.
Most importantly, there must be adequate prudential regulation and supervision
to eliminate rent-seeking behaviors, which are very common in emerging markets
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130
following financial liberalization. The increasing amounts of non-performing loans
during the 1990s in both South Korea and Taiwan show that liberalization induced
rent-seeking behaviors between banks and business conglomerates. Although the loan
sources were different, the motivations and results were similar. Thus, market-
oriented policies are not enough for crisis-proof financial liberalization. To avoid
crisis, it is necessary to implement prudential regulation and supervision before
liberalization.
7.3 DISCUSSION AND SUGGESTIONS FOR FUTURE RESEARCH
This study has offered a political economy approach to gaining a better
understanding of financial liberalization in emerging markets. The analytical
framework and methodology have helped explain why, during the 1990s, Taiwan
chose more market-oriented policies of financial transition than did South Korea, and
why South Korea was more affected than Taiwan by the currency crisis of 1997-98.
Based on the findings from this research, several interesting questions may be posited,
offering deeper insights into the politics of finance.
First, how important is the sequence of introducing liberalization to the
creation of competitive circumstances in the financial, industrial, and political sectors?
What are the impacts of different sequences on transitions of financial liberalization
among other emerging markets and developed countries? The findings of this study
suggest that liberalizing in a sequence beginning with industrial sectors, proceeding to
political
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131
sectors and, finally, liberalizing financial sectors produces more competitive
conditions.
Second, does the sequence of deregulation of the financial sector and
privatization of state-dominated banks determine the competitiveness of the domestic
financial sector among other emerging markets? According to this research, the
deregulation of financial sectors coming before the privatization of state-dominated
banks produces more competitive results.
Third, by applying a similar analytical framework and methodology on strong
states such as Japan, Singapore, and Malaysia, will market-led or state-led adjustment
processes be observed? What kind of financial transitions might be seen through
applying similar analyses to Latin American countries such as Argentina, Brazil and
Mexico?
Understanding the politics of finance among emerging markets is a very
challenging endeavor. The difficulties lie in the diverse conditions and circumstances
embedded in each country. To strengthen the findings from these case studies on
South Korea and Taiwan, more research must be conducted in the future. The
analytical framework and methodology adopted in this research may serve as useful
methods to investigate further inquiries, and the results of this study may serve as a
foundation for gaining more insights into the political economy of financial
liberalization in emerging markets.
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APPENDIX A. THE COMPARATIVE POLICIES OF LIBERALIZATION
Liberalization o f Interest Rates
To compare and contrast the different processes of interest rate liberalizations, I
first briefly describe the sequences of financial liberalization by individual countries.
The comparative processes of interest rate liberalization are summarized in Table 1 A.
Table 1A. The comparative processes of interest rate liberalization, 1980-1997
Korea Taiwan
1980
♦Liberalized CD rates. Banks were allowed to freely
determine the rates on negotiable certificates o f
deposit and bank debentures and the discount rate on
short-term bills
1981
*CP market established
1982
♦Abolished credit ceilings, most
preferential interest rates abolished
1984
♦Lifting the upper limit on call rates
♦Lending rates were allowed to
differ within a band
♦Flexible maximum and minimum lending rates
introduced.
1985
♦Commercial banks were allowed to set prime loan
rate, and deposit rates o f foreign currency were
allowed to vary within administered range.
♦Revoked regulation prohibiting maximum deposit
rates from exceeding minimum lending rate
1986
lib e r a liz e d CD rates
1989
♦Interest rates control phased out
1990
1991
♦Most short-term lending rates o f
banks and NBFIs were deregulated
♦Interest rates on money and capital
market instruments were freed
1993
♦Implemented 100-day economic
stimulus package
* Deregulated interest rates on all
loans o f more than two years o f
banks and non-banks, except for
policy loans.
lib e r a liz e d interest rates on all
long-term deposits
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142
Table 1A. (Continued) The comparative processes of interest rate liberalization,
1980-1997
1994
*Policy loan: liberalized interest
rates on policy loans;
* Commercial loans: lending rates
were offered by financial institutions
to reflect credit standing ob
borrower.
^Continued reduction of interest rate
subsidy on policy loans
*Liberalized interest rates on short
term deposits
1996
^Terminated the preferential interest
rate for the manufacturing sector
^Introduced deposits at market
interest rates
1997
*No policy loan, fully implemented
open market operations
Korea:
The commercial paper (CP) market was first established in 1981. In Korea,
CPs are one of the short-term bills accepted by the finance and investment companies
or the merchant banking companies, and they are discounted by individuals or
institutional investors. The discounted rates of CPs can be viewed as the short-term
borrowing rates. The discounted rates of CPs are formally liberalized in 1991, and the
rapid liberalization of CP rates began in 1993. Since 1982, the credit ceilings were
abolished, and the most preferential interest rates were discarded. In 1984, modest
liberalizations of interest rates, such as lifting the upper limit on call rates and allowing
lending rates to differ within a band, was implemented. The comprehensive interest
rate deregulation was outlined in 1988. The liberalization plan liberalized most bank
and non-bank financial institutions lending rates and long-term deposit rates, but the
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143
plan was canceled after two months. However, the short-term borrowing markets were
robust due to the existence of non-bank financial institutions (NBFIs), but the
circumventive interest rate relaxation took another step backward in the late 1990s
when the Finance Ministry ordered short-term finance companies to cut their interest
rates. Anyway, interest rate liberalization was resumed in 1991, and most short-term
lending rates of banks and NBFIs were deregulated, and interest rates on money and
capital market instruments were liberalized. In 1993, a more rapid liberalization was
brought by the implementation of the 100-day economic stimulus package designed by
Kim Young Sam administration. Interest rates on all loans, banks and non-banks, of
more than two years; except for policy loams were deregulated, and interest rates on all
long-term deposits were liberalized. The interest rate was fully liberalized by the
implementation of open market operations, and the policy loans were abolished after
the 1997 financial crisis.
Taiwan:
Since 1980, the Central Bank of China (CBC) adopted a series of measures to
remove controls over interest rates. In November 1980, banks were allowed to freely
determine the interest rates on negotiable certificates of deposit and bank debentures
and the discount rate on short-term bills. The CD rates were also liberalized in 1980.
In 1984, flexible maximum and minimum lending rates were introduced, and
commercial banks could determine their lending rates according to the bands. In 1985,
commercial banks were allowed to set prime loan rates, and deposit rates of foreign
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144
currency were set within administered ranges. The regulation that prohibited
maximum deposit rates from exceeding the minimum lending rate was also revoked.
A more comprehensive measure was taken in July 1989 with the amended Banking
Act. A former article in the law, which stated that the upper and lower limits on all
kinds of loan and deposit interest rates must be either prescribed or ratified by the
Central Bank, was abolished. From then onwards, bank interest rates were totally
liberalized.
Deregulation o f domestic financial institution:
To compare and contrast the different processes of domestic financial
deregulation, I first briefly describe the sequences of financial deregulation by
individual countries. The comparative processes of financial market deregulations are
summarized in Table 2A.
Table 2A. The comparative processes of domestic financial deregulation, 1981-
1998
Korea Taiwan
1981
*4 commercial banks were privatized
1982
*Bank Act were revised
♦Relaxed NBFIs
1983
*12 new short-term credit companies and 57
mutual savings and finance companies were
chartered
1984
*Offshore banking operations began
♦Domestic banks were allowed to
increase three more branches annually
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145
Table 2A. (Continued) The comparative processes of domestic financial
deregulation, 1981-1998
1986
*Opened branch offices o f DM Bs and NBFIs
were deregulated
*Foreign banks were allowed to setup
with authorities approval
1987
*5 new investment and finance companies, 12
new life insurance companies were opened
1989
*Three more banks were established * Amended Bank Laws, new commercial
banks were allowed to open
1992
* 16 new commercial banks were set up
*The short-term bill & securities
companies were deregulated
1997
* 8 dominant nationwide banks’4 account for
72% total assets, and 75% o f total loans.
1998
* State-owned banks began to privatize
Korea:
A program of gradual domestic financial-sector reform began in the early
1980s. During 1981-1983, the government began to privatize her four state-owned
commercial banks3 5 and the Banking Acts were revised in 1982, which liberalized the
entry into the commercial banking sector. The government chartered two joint-venture
commercial banks3 6 with Korean and foreign partners in order to promote competition
in the banking industry and to establish linkages with international financial markets
(Park, & Kim; 1994, p. 151). However, the immediate impetus for financial
deregulation came from a series of financial crises between 1982-1984, which were
blamed on the rigidity and corruption of the financial system in which the formal
j4 Korea Exchange, Kookmin, Hanil, Cho Hung, Commercial, Seoul, Housing & Commercial, Korea
First
j5 Hanil Bank in 1981, Korea First Bank’s and Bank o f Seoul and Trust Company in 1982, and Chohung
Bank in 1983. In addition, The Commercial Bank o f Korea was denationalized in 1972.
'6 Shihan Bank was wholly subscribed by Korean businessmen in Japan, KorAm Bank was with joint
investment by Bank o f America and Daewoo Group. Hana Bank and Boram Bank were founded in
1991.
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sectors had spawned a large informal money market (ibid, p. 148). The government
responded to these situations by lowering the barriers of entry in the NBFI sector. At
the end of 1983, 12 new short-term credit companies and 57 mutual saving and finance
companies were charted. The government widened the business of turf of non-bank
financial institutions and gave investment and finance companies and merchant banks
permission to engage in brokerage business involving a new type of commercial paper
that had a higher face value and longer maturity than the traditional type with a
deregulated interest rate (Bank of Korea, 2000). In 1987-1989, 5 new investment and
finance companies, 12 new life insurance companies were opened. In 1989, three new
commercial banks were established, and 2 short-term finance companies and Korea
Exchange Bank became commercial banks in 1989-1991. However, progress on
financial deregulations took another step backward in late 1990, when the Finance
Ministry ordered short-term finance companies to cut their interest rates. These short
term finance companies were far more market-oriented than the state-manipulated
banks, however, the authority tried to shut down these short-term finance companies.
In 1991, these firms were encouraged to become either banks or securities companies
(Clifford, 1998, p.312). In general, the Korean banking industry was designed to be
very similar to the Japanese model such that several specialized banks focused on
particular segments of the economy, (i.e. the Industrial Bank of Korea, Housing &
Commercial Bank, and several national cooperatives), development institutions (i.e.,
Korea Development Bank, Export-Import Bank of Korea, and Korea Long-Term
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Credit Bank), and nationwide and regional commercial banks (Casserley et al; 1999,
p.323). The characteristics of the Korean financial system were the significant
fragmentations, which were due to the strict separation of business lines; the existence
of specialized lending institutions, and the practice of chaebols to establish their own
financial institutions to ensure funding for growth. Retail banking development was
highly suppressed by regulations capping deposit rates and by limited consumer loan
options (ibid, p.328). The priorities of banking business were set on supporting
chaebol expansion and development but not for the profits, and in 1997, eight
dominant nationwide banks controlled more than 70 percent of commercial banking
assets and loans (ibid, p.323).
Taiwan:
Until 1980, the Taiwanese financial sectors were still highly repressed and
were characterized with her dual financial infrastructures. Informal financial
organizations existed in forms of underground loan/investment companies, mutual
loans among community groups, etc. In 1980s, the informal financial organizations
(curb markets) acted as significant funding sources for corporations. According to
CBC reports, about 30% of total business loans were funded from the informal sources
before 1990. The banking sector was dominated by state-owned commercial banks
and new commercial banks were not allowed to enter the banking industry until the
Banking Laws were revised in 1989. The revised Banking Laws, which came into
effect in July 1989, took a further step toward financial liberalization by allowing new
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148
private commercial banks to participate in the domestic financial sector. In June 1991,
the Ministry of Finance approved the establishment of 15 new private commercial
banks, each with a minimum capital requirement of NTS 10 billion (US$400 million).
In July 1992, the China Trust and Investment Company, the capitalization of which
was increased to exceed NTS 10 billion, was converted into a commercial bank, and
thus until 1992, 16 new commercial banks had been established and began to compete
fiercely. The revised Banking Law also greatly enlarged the scope of operation of
foreign bank branches in Taiwan. It permits foreign bank branches to set up savings
and trust departments through which they can accept savings deposits, extend rnedium-
and long-term loans, and apply for securities underwriting and brokerage licenses. As
of the end of September 1998, there were 46 foreign banks operating 76 branches and
26 representative offices in Taiwan. On the other hand, after 1987, the direct finance
(i.e. from equity market) had become another important source of funds for domestic
business and was as important as debt markets. From 1990 to 1999, the size of direct
finance had grown up from 23.5 billion U.S. dollars to 1.84 trillion U.S. dollars, that is,
during the 10 years the size of direct finance expanded 6 times. During the same
in erval, the size of indirect finance had grown up from 1.88 trillion U.S. dollars to
5.16; trillion U.S. dollars, that is, from 1990 to 1999 the size of indirect finance had
only expanded less than three times. In addition, the 16 private banks set up in 1992
have initiated some ecological changes of the traditional banking market. The
increasing competition from private commercial banks speeded up the process of
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149
privatization of public-owned banks. Up to 1998, the major thirteen state-owned
banks included The Export-Import Bank of Republic of China, Chiao Tung Bank, The
Fanners Bank of China, Central Trust of China, Bank of Taiwan, Taipei Bank, Bank
of Kaohsuing, Land Bank of Taiwan, Taiwan Cooperative Bank, First Commercial
Bank, Hua Nan Commercial Bank, Chang Hwa Bank, and Medium Business Banks37.
The competitive force had forced several state-owned banks to privatize in 1998 and
four state-owned banks have completed their privatization.3 8 Table 3A shows the
decreasing rates of the public-owned banks’ shares on the total assets, deposit and loan
markets during 1990-1998. The rate of total market assets shares dropped from
63.98% in 1990 to 54.91% in 1997, the market shares of total deposits dropped from
55.67% in 1990 to 44.88% in 1997, and the market shares of total loans dropped from
65% in 1990 to 58.75% in 1997. In short, state-owned banks have decreased about
10% of market shares in both saving and loans under the fierce competition of newly
established private commercial banks. The 16 new banks owned 19% of market assets
and 20% of loans market, and 21% of deposit market in 1997 since they built their
operations from scratch in the early 1990s. In addition, the success of small and
medium-sized businesses and the competitive build-up in the early 1990s provided
corporate and retail customers with an unprecedented degree of choice, and thus
increased the robustness of the retail-banking sector. Except for the banking
’7 Medium Business Banks include Taiwan Business Bank, Kaohsiung Business Bank, Enterprise Bank
o f Hualien, and Taitung Business Bank.
j8 The four banks include First Commercial Bank, Hua Nan Commercial Bank, Chang Hwa Bank, and
Taiwan Business Bank.
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150
deregulation in 1991-1992, the deregulations in the short-term bills and securities were
« • T Q
initiated since 1992. The original three state-owned bills finance companies
monopolized the money market before 1992, but after the deregulation, the money
market has been fiercely competitive. They were 21 bill finance companies, and 4
securities finance company by the end of 2000.
Table 3A. State-owned bank’s total shares of asset, deposits and loans in market
during 1990-1998
90’ 91' 92' 93' 94' 95’ 96' 97' 98' 98'*
Shares of
Total Asset
in Market
63,98 63.8 58 56.28 53.91 51.55 57.07 54.91 57.64 34.69
Shares of
Saving/
Deposits in
Market
55.67 57.43 49.97 48 44.91 43.49 47.08 44.88 44.84 27.91
Shares of
Loans in
Market
65.26 66.18 58.79 57 55.96 53.53 58.89 58.75 57.64 36.63
Unit: in percentage
Note: Four privatized banks were deducted from the calculation o f the percentage in 98'*.
Data Source: Important Statistics o f Financial Institutions, Ministry o f Finance, R. O. C
Liberalization o f foreign exchange rates:
To compare and contrast the different processes of the liberalization of foreign
exchange rates, I first briefly describe the sequences of liberalizations by individual
country. The comparative processes of liberalization on exchange rates are
summarized in Table 4A.
j9 The three are International, Chung Hsing, and China Bills Finance Corporation
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151
Table 4A. The comparative processes of exchange rates liberalization, 1978-1997
Korea Taiwan
1978
♦Forward exchange market was created
1979
♦ Effective exchange rate was determined by the
interbank spot averaged rate and allowed to vary
within a narrow band
1980
* Forward exchange market was created ♦ Liberalized the holding o f foreign exchange by
resident
♦Abandoned the upper limit o f FX rate
1983
*Computerized exchange trading system
1988
♦Accepted IMF’s obligations o f
convertibility
1989
♦Foreign exchange controls phased out ♦Introduced new FX trading system, exchange
rates were freely bided among banks
♦Lifted bands o f FX transactions inter-banks
1990
♦Abandoned the multiple-basket pegged
exchange rate system, effective exchange
rate was determined by the interbank spot
averaged rate and were allowed to vary
within a narrow band
♦Banks were allowed to set FX rates in the
markets for usual customer small-amount
transactions
1993
♦Authorities approved purchase by domestic
investors o f futures traded on international
exchanges as a part o f a three stage program to
develop domestic futures and options trading
facilities
1994
♦ Liberalized the holding o f foreign
exchange by resident abroad
♦Moved towards liberalization o f the
won
1997
♦Government abandoned its defense o f
the won and sought a $20 billion loan
form the IMF
♦Korea got a $55 billion bailout package
from IMF
♦Exchange rate was independently
floating
♦Exchange rate was independently floating
Korea:
A forward exchange market was established in 1980, and the interest and
currency swaps and financial futures have been introduced. The emergence of the
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152
current account surplus in 1986 increased the government willingness to deregulate
foreign exchange transactions. In 1990, the government abandoned the multiple-
basket pegged exchange rate system, and effective exchange rate was determined by
the interbank spot averaged rate, and was allowed to vary within a narrow band. The
Korean government acceded to the convertible foreign currency in 1988 as one of the
obligations of her IMF membership. In general, the exchange rate policy of Korea was
managed as floating during 1990-1997, and after that the exchange rate was
independently floating( Hernandez and Montiel, 2001)
Taiwan:
The forward exchange market was created as early as 1978, and the exchange
rate was liberalized as early as 1979 that effective foreign exchange rate was
determined by the interbank spot averaged rate and allowed to vary within a narrow
band. In 1980, the upper limit of foreign exchange rate was abolished. The next phase
of progressive liberalization began in 1989 with the introduction of a new foreign
exchange trading system, and the foreign exchange rates were allowed to be freely
bided among banks. Until 1990, banks were allowed to set foreign exchange rates in
the markets of small-amount transactions for usual customers. In general, similar to
Korea, during 1990-1997, the exchange rate was managed as floating and
independently floating after 1997.
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153
Liberalization o f capital flows:
To compare and contrast the different processes of the liberalization of capital
mobility, I first briefly describe the sequences of liberalizations by individual country.
The comparative processes of liberalization on capital mobility are summarized in
Table 5A.
Table 5A. The comparative liberalization of capital flows, 1980-1998
Korea Taiwan
1980
♦Liberalized foreign investment rules
1982
*MOF announced gradual liberalization in
three stages: the first stage will allow
indirect investment through trust funds
established in Taiwan, the second stage
will allow FDIs, and the third stage will
allow free access to foreign capital
1983
*The International Trust Company Limited
was established
*$41 million were raised from Europe and
Japan for investments in the Taiwan stock
market.
1984
* Introduced a negative system for FDI, and
greatly increased foreign investments
* Korea Fund was launched on NYSE
1986
*Allowed foreign investments firms to
remit capital gains and investment after
one year
*Taipei Fund was launched on the London
Stock Exchange
1987
*Residents were permitted to hold or
export up to U.S. $5 million annually
lib e r a liz e d foreign capital account, and
all foreign exchange controls were lifted
♦Individuals were allowed to import $
50,000 annually
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154
Table 5A. (Continued) The comparative liberalization of capital flows, 1980-1998
1988
*$300 million o f foreign funds was allowed
into Korean Stock market
*Non-limited industries would have foreign
investment limits o f up to 10% o f market
capitalization
*Limited industries would have foreign
investment limits up to 8% o f market
capitalization
*Foreign stockbrokers could open branches
in Taiwan
1989
* All but 10 o f 522 categories o f manufacturing
activity were open to FDIs
* Insurance and Investment trusts opened to
foreign firms.
*The stock-listed companies were allowed
to issue overseas bonds
* Individuals were allowed to imported FX
up to $1 million annually
1991
*Foreigners were allowed to purchase listed
stocks, foreign investor cannot own more than
3% o f a company’s shares and collectively
more than 10%. Latter, the government raised
the limit to 25% for 45 companies that already
had more than 10% ownership by foreigners.
*Market opened to foreign investors
* Individuals were allowed to imported FX
up to $3 million annually
in d ivid u al foreign institution was
restricted to hold 5% o f listed- firm shares,
and total foreign in any listed firms may
not exceed 10%
*First ADR was announced
^Eligible foreign institutional investors
may invest directly in Taiwan securities
1992
*Foreign securities companies could own up to
10 percent o f Korean firms
*Lifted o f foreign ownership restrictions on
Korea Electric Power and Pohang Iron and
Steel
in d ivid u als were allowed to imported FX
up to $5 million annually
1993
*Relaxed total amount o f foreign
investments in stock markets up to $5
billion
*Domestic firms were allowed to imported
FX up to $5 million annually
1994
*Approved ADR listing o f POSCO on NYSE *Domestic firms were allowed to imported
FX up to $10 m illion annually
* Relaxiedtotal amount o f foreign
investments in stock market up to $10
billion
1995
*Of the Korean Stock Exchange had 702 listed
firms, 98 have reached their 12% foreign
ownership limit. Overall, 8.6% o f the total
market capitalization was owned by foreigner
*Govemment raised foreign stock ownership
limit from 12% to 15% and raised the limit for
single investors from 3% to 5%s
* Abolished total amount limits o f foreign
investment in stock market, individual
foreign institution was restricted to hold
7.5% o f listed- firm shares, and total
foreign in any listed firms may not exceed
15%
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155
Table 5A. (Continued) The comparative liberalization of capital flows, 1980-1998
1996
♦Government raised foreign ownership from
15% to 18%
♦The foreign ownership was further relaxed
from 18% to 20%.
♦The ceiling on foreign ownership o f total
market capitalization was raised from 15%
to 25%
1997
♦Government relaxed foreign ownership from
20% to 23%, and planed to 33% in two years.
*The government took steps to give greater
access to foreign banks in domestic
markets
1998
Foreign investment ceiling on Korean
securities was raised to 55%
♦The ceiling on foreign ownership o f total
market capitalization was raised to 50%
Korea:
The deregulation of foreign direct investment was more rapid since 1984 when
the government introduced a negative system for FDI, which had greatly increased
foreign investments. In 1988, the amount of the foreign funds allowed to invest in the
stock market was $300 million dollars, and non-limited industries could have foreign
investment limits of up to 10% of market capitalization, while the limited industries
will have foreign investment limits of up to 8% of market capitalization. Up to 1989,
all but 10 of 522 categories of manufacturing activity were opened to FDIs, and
insurance and investment trusts were opened to foreign firms. In 1991, foreigners
were allowed to purchase listed stocks, and the individual foreign investor could not
own more than 3% of a company’s shares and collectively more than 10% and the
government raised the limit to 25% for those 45 companies which already had more
than 10% ownership by foreigners. Up to 1992, foreign securities companies could
own up to 10 percent of the Korean firms. The liberalization momentum continued to
last, and in parallel with the deregulation of other domestic financial sectors, the 1993
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156
liberalization plans of Kim Young Sun’s administration continued to envisage
progressive liberalization of capital flows. The share of industries that are eligible for
FDI was increased from 81 percent in early 1992 to about 98 percent in 1997. In 1995,
98 firms among the 702 listed firms in Korean stock market, had reached their 12%
foreign ownership limit and overall, 8.6% of the total market capitalization was owned
by foreigners, and the government further raised foreign stock ownership limit from
12% to 15% and raised the limit for single investors from 3% to 5%. The government
continued to raise the limit of foreign ownership from 15% to 18% in 1996, and the
limit was raised to 33% at the end of 1997. However, direct foreign borrowings by
Korean firms through commercial loans were subject to tight restrictions, but as the
capital market was opened up, domestic chaebols could borrow more easily from
abroad, especially the five largest chaebols that had already established their reputation
in the international market (Cho, 2001, p. 175). From 1993-94, the five largest
chaebols began to increase their borrowing from abroad by issuing long-term
convertible bonds and were thereby able to improve the maturity structure of their
debts.
Taiwan:
In 1980, the plan of gradual liberalization was outlined in three stages: the first
stage would allow indirect investment through trust funds established in Taiwan, the
second stage would allow FDIs, and the third stage would allow free access to foreign
capital. However more pressure of liberalization was formed when there was a huge
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157
trade surplus and foreign capital inflow in the mid-1980s, and significant steps toward
the liberalization of capital outflow were taken in July 1987. Residents were permitted
to hold or export up to U.S. $5 million annually, since then, the foreign exchange
controls were gradually lifted. The liberalization of capital inflow via security markets
was then gradually opened up and the stock-listed companies were allowed to issue
overseas bonds and individuals were allowed to imported foreign exchange of up to $1
million dollars annually since 1989. In 1991, individuals were allowed to import
foreign exchange of up to $3 million annually and individual foreign institution were
restricted to hold 5% of listed- firm shares, and total foreign shares in any listed firms
may not exceed 10%. The limit on foreign investment in each individual company was
relaxed gradually since 1993, and until 1995, the government abolished the limits in
total amount of foreign investment in the stock market, but individual foreign
institutions were restricted to hold 7.5% of listed- firm shares, and the total foreign
shares in any listed firms may not exceed 15%. In 1996, the ceiling on foreign
ownership of total market capitalization rose from 15% to 25%, and the ceiling on
foreign ownership of total market capitalization was raised to 50% in 1998. However,
the inward portfolio investment did not grow too rapidly, and it gradually increased
from $ 69 million dollars in 1990 to $ 3.256 billion dollar in 1996. In contrast to the
Korean case, it increased from $899 million in 1990 to $12,092 billion dollars in 1996
(Chen, & Ku, 2000, p. 128).
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158
APPENDIX B. SEARCHING FOR THE CAUSES OF THE 1997 FINANCIAL
CRISIS: THE PANEL DATA ANALYSIS
Methodology and The Data:
The methodology to conduct the empirical test is similar to the approach of
Sachs, Tomell, and Velasco (1996). But panel data regression techniques are adopted
for the purposes of analysis. Cross-country annually data is collected from 1990 to
1997, and eight countries are included4 0. Crisis index is calculated as the index of
mixed effects measured by the nominal exchange rate depreciation and the decreasing
rate of m2/reserves ratio for each year. A large positive crisis index implies deep
exchanger rate depreciation or rapid declining of foreign reserves, and I assume the
larger the index, the higher the level of financial crisis. The model is described as the
following:
Index = a + /3 ’ [X] + e
[X] is the matrix of explanatory variables. The explanatory variables to be evaluated
include current account deficit, growth rate of GDP, investment rate, saving rate, the
stock index, fiscal deficit, inflation rate, short-term debt, nominal exchange rate, real
exchange rate, interest rate, etc. For a detailed description of explanatory variable
evaluated, please refer to Appendix C.
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159
Empirical Results:
Most of the fundamental variables i.e. current account deficit, investment rate,
fiscal deficit, inflation rate, short-term debt, etc are insignificant. However, following
variables show significant results to the crisis index41:
Table 6A. Significant Results to the Crisis Index
Variables Coefficient T-Statistics P-Value Sign Correct?
Interest Rate -3.590936 -1.906604 0.0638* Yes
Real Exchange Rate
Appreciation
-1.490122 0.0082 0.0082 No
Pegged Misalignment 1.053092 3.993701 0.0003*** Yes
M2/FX Ratio 3.13112 2.235381 0.031** Yes
Excessive Borrowings 18.363913 2.595814 0.0131** Yes
4 0 They are Korea, Indonesia, Malaysia, Philippine, Singapore, Thailand, China, and Taiwan
4 1 Fixd effect is applied to the model
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160
APPENDIX C. DESCRIPTIONS OF EVALUATED VARIABLES
Dependent Variable:
Crisis Index is an index of mixed effects measured by the nominal exchange
rate depreciation and the decreasing rate of m2/reserves ratio for each year. A large
positive number implies that there may be high an exchanger rate depreciation or a
rapid decline in foreign reserves. The larger the value, the higher the crisis level.
Independent Variables:
Current Account Balance: BOP definition (% of GDP), a negative number
implies a deficit.
Trade Balance: BOP definition ( % of GDP)
GDP: GDP growth rate
Investment: Investment rates ( % of GDP)
Stock Index: Stock market price indexes,
Stock Index Fall Ratio: The ratio of stock fall in stock market prices indexes,
a negative number implies a fall.
Saving Rate: Saving rates (% of GDP)
Fiscal Balance: Government fiscal balances ( % of GDP)
Inflation Rate: Inflation rate
Nominal Exchange Rate: Nominal exchange rate
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161
Nominal Exchange Depreciation Rate: The rate of nominal exchange rate
depreciation. A negative number implies depreciation.
Real Exchange Rate: Real Exchange Rate. The base figure (100) is the
average for the year 1990. A larger number implies real exchange rate appreciation.
Real Exchange Rate Appreciation: Real Exchange Rate Appreciation. A
positive number implies appreciation.
Pegged Misalignment: Exchange Rate Misalignment. The index measures the
gap between real exchange rate appreciation and nominal exchange rate depreciation.
A larger number implies the government managed the peg improperly.
Private Lending: Bank lending to private sector (% of GDP)
Lending Increase Rate: The increase in rate of lending. A large number
implies a lending boom.
Short-term Debt: Short-term debt, World Bank Data (% of Total)
M2 to FX: M2 to foreign reserve ratio
Interest Rate: Short term interest rate (the call rates inter banks)
Dummy Variable for Excessive Borrowings: equal to 1 if the increase of the
variable, Private Lending, is over 6% annually; otherwise, 0.
Data Source: IFS, various volumes
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Asset Metadata

Creator Chen, Tsaubin (author)

Core Title Political economy of financial liberalization in emerging markets: A comparative study of South Korea and Taiwan in the 1990s

Degree Doctor of Philosophy

Degree Program Political Economy and Public Policy

Publisher University of Southern California (original), University of Southern California. Libraries (digital)

Tag Economics, Finance,OAI-PMH Harvest,political science, international law and relations

Language English

Contributor Digitized by ProQuest (provenance)

Permanent Link (DOI) https://doi.org/10.25549/usctheses-c16-270675

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Legacy Identifier 3093964.pdf

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Document Type Dissertation

Rights Chen, Tsaubin

Type texts

Source University of Southern California (contributing entity), University of Southern California Dissertations and Theses (collection)

Access Conditions The author retains rights to his/her dissertation, thesis or other graduate work according to U.S. copyright law. Electronic access is being provided by the USC Libraries in agreement with the au...

Repository Name University of Southern California Digital Library

Repository Location USC Digital Library, University of Southern California, University Park Campus, Los Angeles, California 90089, USA