How Finance Is Shaping the Economies of China, Japan, and Korea

Yung Chul Park, Hugh Patrick

• Publisher: Columbia University Press
• Year: 2013
• ISBN:
  9780231536462
• Topic: Economics
• Subtopic: Development Economics
• Index: Economics

This volume connects the evolving modern financial systems of China, Japan, and Korea to the development and growth of their economies through the first decade of the twenty-first century. It also identifies the commonalities among all three systems while accounting for their social, political, and institutional differences.

Essays consider the reforms of the Chinese economy since 1978, the underwhelming performance of the Japanese economy since about 1990, and the growth of the Korean economy over the past three decades. These economies engaged in rapid catch-up growth processes and share similar economic structures. Yet while domestic forces have driven each country's financial trajectory, international short-term financial flows have presented opportunities and challenges for them all. The nature and role of the financial system in generating real economic growth, though nuanced and complex, is integral to these countries. The result is a fascinating spectrum of experiences with powerful takeaways.

CHAPTER ONE

An Introductory Overview

HUGH PATRICK

THE ECONOMIC and financial systems of Japan, Korea, and China represent outstanding examples of very successful catch-up economic development and growth, major financial development, and gradual financial liberalization of initially highly repressed financial systems in an increasingly open global financial system. These are major achievements both for their citizens and for the world.

This book provides an analysis of that financial development process and how it has intertwined with the process of real economic growth in complex and nuanced, as well as obvious, ways.

The central theme is what role the financial system has played. That is, in what ways, and to what degree, has finance mattered? Each country is at a different stage of economic and financial development and has its own historical context. Nonetheless, the answers for each country have important similarities, as well as significant differences.

Three general implications for financial development can be derived from the experiences of these three countries:

First, financial development improves a country’s resource allocation, but financial liberalization and increased financial intermediation do not necessarily result in a highly efficient allocation of financial resources, as the cases of Japan and Korea highlight.

Second, financial repression in the early stages of economic catch-up may not necessarily be negative, and may even be positive, as the Chinese case demonstrates.

Third, financial liberalization requires the development of good, prudential, market-supportive regulatory systems and their effective implementation. Financial regulatory failures or forbearance worsen economic performance, as shown on occasions in the Korean case and in Japan’s lost decade of the 1990s. No regulatory model is perfect, nor is regulatory implementation. We cannot end boom-bust cycles, but potentially we can mitigate them.

The next three chapters provide definitive contributions to the literature on the modern history of the financial development of China, Japan, and Korea. The literature on Japan’s postwar economic and financial development is extensive, so that chapter 3 by Edward Lincoln begins in 1990, when Japan had a well-developed financial system in which the bursting of major stock market and real estate bubbles heralded the end of the postwar era. Yung Chul Park’s chapter 4 on Korea begins in 1980, as the country began to grapple with liberalization of a highly repressed financial system. It appropriately emphasizes the importance of the 1997–1998 Asian crisis and the reforms that directly ensued, and the effects of the 2007–2009 global financial crisis. Since the financial-system literature on China is limited, chapter 2 by Yiping Huang and his coauthors begins in 1978, when the reform process was launched, and provides considerable detail. In principle the cutoff date for these financial histories is 2010.

In the final and most explicitly policy-oriented chapter (chapter 5), Yong-Hwa Seok and Hyun Song Shin stress that financial globalization is prone to propagate and especially to amplify the boom-bust cycles, notably through the explosive growth of cross-country, short-term capital flows. They analyze Korea as an important case and consider the effects on European banks and their interactions with American financial institutions in the 2007–2009 financial crisis. Importantly, the authors address the global need for macro-prudential regulations and appropriate policy measures.

The basic purpose of this chapter is to provide comparisons of the similarities and differences among China, Japan, and Korea, both in their domestic dimensions and in their responses to the changing international economic and financial environment. The next section presents the context of the country studies, with particular attention to the 2007–2009 global financial crisis, which is an important part of the international context. Subsequent sections make explicit comparisons of the three countries regarding their economic development and growth, financial development, financial repression and liberalization, financial globalization, and the effectiveness and efficiency of fiscal development. The chapter concludes with a broad evaluation of the role of finance.

Demirgüc-Kunt and Levine (2008) provide a comprehensive survey of the general financial development literature, which also is discussed in the chapter by Huang and his coauthors (chapter 2). Voghouei et al. (2011) review the determinants of financial development; Kose et al. (2009) provide a perspective of the macroeconomic effects of financial globalization. Each of the country chapters provides relevant references to the literature on its financial and economic development.

Context

The broadest context for these country studies has been the unprecedented, good, sustained increases over the postwar period in global output, trade, and finance. This context is one of ongoing, dynamic change in long-run economic and political trends, increasing capital- and financial-market globalization, cyclical movements (booms and busts) in finance and economics, and shocks of varying degrees of severity. Three major groups of participants have been involved.

The first group is the economically advanced, high-income countries of the United States and Europe, which Japan joined in the 1980s. The second is economies that have developed rapidly over a sustained period and have now achieved quite high levels of per capita income. They are epitomized by the four Asian Tigers, led by Korea and Taiwan, Hong Kong, and Singapore. Third are the emerging countries that are rapidly growing from very low initial bases, epitomized by China.

The US-led, market-based, economic and financial world order has constantly evolved since its emergence from the depredations of World War II. In the 1980s the rise of Japan to being the world’s second largest economy forced both it and the West to adjust and accommodate. This was significantly eased by Japan’s close security and political alliance with the United States. By 2010 China, now the world’s second largest economy but still with low per capita income, was clearly a major global power in political and security, as well as economic, dimensions. The absolute and relative rise of China is a qualitatively different challenge to all parties from that presented by Japan. Korea, a staunch ally of the United States, because of its smaller size, was an accepter of, rather than a challenger to, the world order. It has come to play an important role as a middle power. Korea has important bilateral economic relations with both Japan and China, albeit in different ways.

Japan has not dealt very well with success. Korea has been better (though Park is less positive about Korea’s performance than I am), and China still has a long way to go. During the period covered, the three countries have had to deal with two major shocks: the Asian financial crisis of 1997–1998, which began in Thailand, and the global financial crisis of 2007–2009, which began in the United States.

An extensive literature is available on the Asian financial crisis, and each of the country chapters addresses its impact; sufficient time has passed to have a good perspective. The financial impact was different in each country, though in each case export growth declined and gross domestic product (GDP) growth slowed. The Asian financial crisis had a profound effect on Korea’s financial system and its economy. Its banks faced a double-mismatch problem: they had borrowed short term in foreign currency, exchanged the funds into domestic currency, and lent long term to Korean companies. In 1998 Korea’s GDP contracted by 6.9 percent, an almost 12-percentage-point swing from 4.7 percent growth the previous year. Korea had to seek an International Monetary Fund (IMF) bailout. The IMF required it to carry out a wide range of major financial and other economic reforms.

China had insulated itself from the direct financial effects of the Asian crisis with foreign capital controls, as well as domestic controls over its government-owned banks and other financial institutions. Nonetheless, its growth slowed significantly, from 10 percent in 1996 to 7.6 percent in 1999, before accelerating again.

Japan was an international portfolio creditor and lender. Its banks, like those elsewhere, engaged in a flight to safety, reducing foreign lending. However, Japan was going through its own financial crisis for domestic reasons, and the direct effects of the Asian crisis were limited. Nonetheless, its domestic financial crisis choked a nascent recovery, sending Japan into a recession in 1998 with a GDP decline of 2.0 percent.

The global financial crisis of 2007–2009 profoundly affected banks and other financial institutions in the United States, the epicenter of the crisis, and in Europe. The direct financial impacts on Asia in general, and in Japan and China in particular, were much less severe. But, again, Korea was hard hit, though considerably less so than in 1997–1998. Even though Japan is a huge creditor nation, its banks had not invested heavily in US subprime or other securitized instruments, so their losses were modest and manageable. China’s capital controls and domestic policies continued to effectively insulate its financial system from the global crisis, but it had to engage in massive macroeconomic stimulus. However, Korean banks were yet again caught in a double mismatch, depending excessively on foreign short-term loans to finance Korean company investment projects, as is well discussed in Park’s chapter 4 on Korea and emphasized in chapter 5 by Seok and Shin.

The global financial crisis produced the Great Recession, which reached its bottom in 2009. The recession’s impact was different in each country, as were the responses. The external shock in real terms was in the sharp drop in exports. Japan’s exports slipped precipitously—from 8.7 percent growth in 2007 to a 24.2 percent contraction in 2009. As a consequence, GDP dropped 5.5 percent in 2009, its most severe decline in the postwar period. China’s export shock was also very large, from 19.8 percent growth in 2007 to a 10.3 percent contraction in 2009. China’s GDP growth slowed from a peak of 14.2 percent in 2007 to 9.2 percent in 2009, and then rose to 10.4 percent in 2010. Korea had to deal with both the direct effects of its financial system’s double mismatch and a significant drop in exports, from 12.6 percent growth in 2007 to a 1.2 percent contraction in 2009. Korea’s GDP growth dropped from 5.1 percent in 2007 to 0.3 percent in 2009, a decline about the same as China’s and a bit less than Japan’s. All three countries pursued macroeconomic stimulative policies, and as exports strongly expanded in 2010, their economies bounced back.

The 2007–2009 Global Financial Crisis

The global financial crisis of 2007–2009 has caused a rethinking of development strategies in general and the role of finance in particular. What began as an American financial crisis in summer 2007 became global with the dramatic collapse and bankruptcy of Lehman Brothers on September 15, 2008—an event termed by many in Asia and elsewhere as the “Lehman Shock.” The immediate financial crisis was deemed under control by mid-2009, when the global real economy was reaching the bottom of a trough from which recovery has been slow. Difficulties have persisted into 2012 as the original crisis has morphed into a European debt crisis, with widespread trepidation about the future of the euro.

The fundamental causes of the crisis are all too familiar, but the scale was so much larger because of the nature (complexity) of globalized short-term financial markets. As with the Great Depression of the 1930s, there will never be an agreed, comprehensive, objective understanding of the crisis and its implications. Nonetheless the broad outlines are clear. Two Journal of Economic Literature articles are particularly useful: Andrew W. Lo’s (2012) review of 21 books and Gary Gorton and Andrew Metrick’s (2012) review of 16 documents.

The financial crisis began in the United States in August 2007, when problems in subprime housing mortgage markets spilled into short-term wholesale financial and money markets, affecting bank transactions with each other as counterparties. Although the trigger was losses in the imploding subprime mortgage market, it became a major crisis because of vulnerabilities that had accumulated in the overall financial system over a decade or more of institutional and financial innovation and development.

A shadow banking system had developed outside the regulated banking system. It involved mortgage originators, broker dealers, and investment banks participating in short-term money markets, especially markets for commercial paper and repurchase agreements (repos) between financial institutions. In addition to major US banks, European banks...

Table of contents

• Cover 
• Title Page
• Copyright
• Contents 
• Preface
• Acknowledgments
• 1. An Introductory Overview
• 2. Financial Reform in China: Progress and Challenges
• 3. Japan: Ongoing Financial Deregulation, Structural Change, and Performance, 1990–2010
• 4. Financial Development and Liberalization in Korea: 1980–2011
• 5. Banking, Capital Flows, and Financial Cycles: Common Threads in the 2007–2009 Crises
• Index