Theory Evidence From The Korean Experience Economics Essay
Ever since the Schumpeterian theory emphasized the function of fiscal systems, peculiarly fiscal mediators, in heightening economic growing, Schumpeter ‘s penetration has been the topic of assorted theoretical and empirical researches. Some economic experts such as Robinson ( 1956 ) argue that fiscal development passively follows economic growing. In 1969, Goldsmith successfully documented a positive correlativity between the fiscal superstructure of an economic system and its economic growing. Goldsmith ( 1969 ) noted that fiscal systems ameliorate economic public presentation by easing the migration of financess to the most productive high-return undertakings. However, Goldsmith was unable set up the way of causality with assurance, which induced many theoretical and empirical probes.
Some theoretical theoretical accounts focused on the unidirectional causality from fiscal development to economic growing by stressing the function of fiscal agreements in bettering the effects of information, enforcement, and dealing costs ( Levine ( 1991 ) , King and Levine ( 1993b ) , Bencivenga and Smith ( 1991 ) ) . Other theoretical accounts considered bidirectional causality between finance and growing ( Greenwood and Jovanovic ( 1990 ) ) . Each of these theoretical accounts presented empirical grounds back uping their penetrations.
This paper presents a reappraisal of the different strands of ideas on the finance-growth link. The paper focuses on Korea sing its singular economic public presentation since the sixtiess. The Korean experience is a suited survey instance of the finance-growth relationship as its highest economic growing rates coincide with a series of fiscal reforms. This paper is structured as follows. Section I is a reappraisal of literature and empirical findings. Section II focuses on the Korean instance, including a sum-up of a set of theoretical and empirical documents.
Section I: Reappraisals of Literature and Empirical Findingss
Reappraisal of Literature
The connexion between fiscal development and economic growing has been the topic of intense theoretical and empirical research. The statement is whether there is a causality relation between fiscal construction and economic growing or non, and if such a connexion exists, what is its way?
The supply-leading hypothesis
As labelled by Patrick ( 1966 ) , the supply-leading phenomenon refers to the creative activity of fiscal establishments and the supply of their fiscal services before the demand for them. The supply-leading hypothesis implies a causal relation from fiscal development to economic growing, i.e. the creative activity of fiscal establishments and the betterment of fiscal agreements enhances economic growing. Numerous theoretical and empirical documents support this statement.
Schumpeter ( 1911 ) argues that services provided by fiscal mediators, including bring forthing antique ante information about possible investing chances, measuring undertakings and monitoring directors, easing trade and bettering hazard direction, and mobilizing and pooling nest eggs are indispensable for technological invention and economic development.
Supporting the function of fiscal mediators in supplying information about possible investing, Boyd and Prescott ( 1986 ) show that fiscal mediators arise endogenously within an environment where the investing chances of agents are private information. The services of fiscal mediators in such an environment might cut down of costs related to geting and treating information and hence lead to a better resource allotment. By conserving on costs of information acquisition, fiscal mediators ameliorate the ex-ante rating of investings chances.
King and Levine ( 1993b ) argue that the presence of fiscal mediators eases the designation of the most promising productivity-enhancing activities, which enhances the rate of technological invention.
In add-on to supplying information, fiscal agreement, i.e. liquid equity markets, debt contracts, and mediators, may better corporate administration and accelerate growing. Levine ( 2004 ) explains the importance of corporate administration in understanding economic growing and its effects on nest eggs and allotment determinations. Aghion, Dewatripont, and Rey ( 1999 ) show that debt contract cut down managerial slack and fix the rate at which directors implement new engineerings. Therefore, the usage of debt instruments is linked to growing. Boyd and Smith ( 1992 ) add that the development of fiscal intermediation reduces involvement rates derived functions and recognition rationing, and thereby promotes efficient investing and growing.
Fiscal constructions besides facilitate trading, fudging and pooling of hazard. Financial intermediation allows persons to keep diversified portfolios of hazardous undertakings, which facilitates the reallocation of nest eggs to high risk-return undertakings. Harmonizing to King and Levine ( 1933b ) , fiscal mediators and securities markets authorize enterprisers who are seeking to accomplish additions from profitable market niches to diversify the hazard related to advanced but unsure activities. Hence, fiscal systems contribute in speed uping technological alterations and economic growing.
Refering liquidness hazard, Bencivenga and Smith ( 1991 ) show that, by supplying liquidness, competitory fiscal mediators permit hazard averse rescuers to keep bank sedimentations instead than liquid but unproductive assets. The financess obtained by fiscal mediators are so allocated for investing in productive capital. Hence, Bankss affect resource allotments with positive deductions on growing.
Fiscal systems have outstanding function in mobilising and pooling nest eggs. Harmonizing to Levine ( 2004 ) , fiscal systems that mobilize nest eggs and put them in diversified portfolios improve the allotment of financess for hazardous undertakings and thereby lend in economic growing.
The demand-following hypothesis
As defined by Patrick ( 1966 ) , the demand-following phenomenon refers to the creative activity of modern fiscal establishments, their fiscal assets and liabilities, and related fiscal services in response to the demand of these services by investors and rescuers in the economic system. The demand-following hypothesis implies a causal relationship from economic growing to fiscal development, i.e. the fiscal sector responds passively to the demand of the turning economic system.
As stated by Robinson ( 1952, p.86 ) , “ there is a general inclination for the supply of finance to travel with the demand for it. ” Harmonizing to Robinson, finance passively responds to the demand for it. As the economic system grows, the finance construction is developed consequently.
Gurley and Shaw ( 1967 ) support this hypothesis and province that fiscal development depends on conditions of demand for and supply for fiscal assets, which are conditional to the existent economic growing. Harmonizing to Gurley and Shaw ( 1967 ) , differences in fiscal systems are explained by differences in income and wealth and finance accretion depends on both the degrees of end product and the end product growing rates. Financial development comes as a effect to economic growing.
Bidirectional causality
Another strand of idea in the finance-growth link stresses the bidirectional connexion between fiscal development and economic growing. Greenwood and Jovanovic ( 1990 ) develop a theoretical account to show the inextricably nexus between finance and growing. In the theoretical account, economic growing Fosters investing in organisational capital, while fiscal construction allows for a more efficient resources allotment. Therefore, there is bidirectional causality between finance and growing.
Patrick ( 1966 ) argues that, in the existent universe, the supply-leading and demand-following hypotheses are more likely to interact. Fiscal construction may bring on existent capital formation at the beginning of the growing procedure. As economic system grows, the supply-leading phenomenon diminishes and the demand-following fiscal response dominates.
Review of Empirical Findingss
Jung ( 1986 ) investigates the international grounds on the causal relationship between fiscal development and economic growing utilizing one-year informations on 56 states, of which 19 are industrial states. Jung finds that there is some grounds bespeaking that the low development states have a supply-leading causality instead than a demand-following causality. In this sense, the importance of fiscal development for the growing of developing states is through empirical observation verified.
King and Levine ( 1993a ) behavior a cross-country time-series analysis utilizing a set of 119 developed and developing states over the period 1960 to1989. Their findings suggest the being of the contemporary relationship between fiscal development and growing indexs, and the degree of fiscal development is a good index of subsequent economic growing. King and Levine ( 1993a ) conclude that Schumpeter was right about the importance of finance to economic development.
Neusser and Kugler ( 1998 ) test the Schumpeterian finance-growth link, utilizing a sample of 12 OECD states over the period 1970 to 1991. They fail to reject the void hypothesis of no Granger causality from fiscal construction to fabricating merely for USA, Japan, and Germany. However, the causal nexus seems to be through empirical observation weak for most of the smaller states.
Calderon and Liu ( 2003 ) examine the way of causality between finance and growing utilizing a set of 109 industrial and developing states, with informations crossing the 1960-1994 period. Their consequences suggest that there is a causal way from fiscal development to growing. Furthermore, their grounds supports the being of bidirectional causality for the sample of developing states, with supply-leading lending more than demand-following causality.
Aghion, Howitt, and Foulkes ( 2005 ) develop and prove a Schumpeterian theoretical account of cross-country convergence with fiscal restraints utilizing 71 states over the period 1960-1995. The trial is estimated utilizing growth-regression with an interaction term between fiscal development and the initial degree of end product. Their theoretical account shows that all states above a degree of fiscal development converge in growing rate.
Section II: The Korean Experience
The Korean economic system has achieved singular growing since the early sixtiess. Graph 1 retraces the one-year GDP growing over the period 1960 to 2011.
Graph 1: The one-year GDP growing rate
Beginning: World DataBank: The World Bank
As shown in the graph above, Korea had an impressive economic public presentation from the 1960 ‘s to the late 1980 ‘s. Cho ( 1989 ) related this rapid economic growing to the authorities ‘s aggressive development scheme in 1962. The Korean authorities implemented five-year economic development programs through a figure of financial and fiscal reforms. These programs were characterized by a strong governmental intercession in the fiscal system as the authorities controlled involvement rates, owned all major commercial and specialised Bankss, and monitored the bulk of mediators ‘ recognition allotment.
This subdivision reviews the chief literature of finance-growth link concentrating on the Korean experience. The intent is to measure whether the fiscal sector development contributed in the growing of the Korean economic system. The first portion summarizes the development of the Korean fiscal system. The 2nd portion reviews the relation between fiscal development and economic growing in Korea.
The Financial System Evolution
Choe and Moosa ( 1999 ) see five sub-periods to retrace the development of fiscal system in Korea. The 1960s were characterized by the ordinance of the fiscal system. The authorities implemented an aggressive economic development scheme on which it has an extended control. The fiscal system was controlled by the authorities to pull off financess allotment to the high precedence sectors of the economic system. On the other manus, the Korea Stock Exchange merely operated with low-returns investings and merely a few companies were listed until the late 1960 where a series of steps were taken to further dynamic and just capital markets.
During the 1970s, the banking sector declined bit by bit to go forth topographic point for developed capital markets. Harmonizing to Cho ( 1989 ) , a figure of houses which had heavy loans from domestic and foreign Bankss went insolvents due to the high bank involvement rate. This called for an exigency step to lower involvement rates. The authorities implemented a low involvement rate policy while keeping control over recognition allotment to maintain up with the alteration in the industrial development scheme toward the publicity of heavy chemical industry. As involvement rates increased, the banking sector growing decelerated. However, a big figure of non-banking fiscal establishments were created and grew quickly over this period.
The 1980 ‘s were marked by a gradual fiscal liberalisation. Harmonizing to Choe and Moosa ( 1999 ) , the 1970s oil daze exposed the failing of the Korean economic system. The authorities focal point on heavy industries had positive impact on the industry growing but it caused a loss of fight of domestic industries in the international market ( Cho ( 1988 ) ) . The authorities was constrained to cut down it intercession and follow a more market-oriented attack. Under the fiscal liberalisation plan, commercial Bankss were privatized during 1981 and 1983. In 1982, the authorities eliminated the usage of discriminatory loaning rates and allowed fiscal establishments to make up one’s mind their ain rates within a given fury in 1984. In 1993, the authorities implemented the Three-Stage Blueprint of Financial Reform that included the deregulating of involvement rate, policy loans reforms, and capital histories liberalisation.
The Financial Structure and Economic Growth: The Korean Experience
From 1966 to 1999, Korea recorded a rapid mean growing rate of 7.5 % per annum. Cho ( 1989 ) tie in this economic public presentation to the authorities ‘s development scheme adopted in the early sixtiess. As explained above, this scheme aimed to advance industrial exports via the control of fiscal constructions such as the authorities ownership of commercial Bankss and the control of interest-rates. Choe and Moosa ( 1999 ) argue that Korea ‘s experience is a counterexample to the conventional wisdom that authorities intercession in fiscal systems confines economic growing ( McKinnon, 1973 ) .
The intent of this paper is to reexamine the available literature on the relation between fiscal development and economic growing sing the instance of Korea. A figure of empirical researches were done to analyze whether the fiscal development that Korea experienced over the old ages is a important account to the rapid economic growing of the state.
Choe and Moosa ( 1999 ) analyze through empirical observation the relationship between economic growing and fiscal system utilizing one-year informations over the period 1970 to 1992 collected from assorted issues of Flow of Funds in Korea ( The Bank of Korea, 1993b ) . Choe and Moosas set two void hypotheses to analyze the causality between the growing variable and the fiscal variable:
H0,1: fiscal development does non do economic growing ;
H0,2: economic growing does non do fiscal development.
The appraisal of the coefficient is obtained by arrested development and the void hypotheses are tested on the footing of F statistics calculated from the amounts of residuary squares. Harmonizing to the writers, the trial reject the void hypothesis H0,1, i.e. there is statistical grounds that fiscal development leads to economic growing. The consequences besides support causality from the growing variable to the fiscal variable. Harmonizing to Choe and Moosa, this causality is the consequence of the positive influence of the GDP growing on the families sector ‘s demand for fiscal plus and the concern sector ‘s demand for loans.
Another facet being examined is the comparative importance of fiscal mediators and capital markets with regard to their part in the economic growing. The consequences show that fiscal mediators are more influential than capital markets.
Choe and Moosa ( 1999 ) sum up their empirical findings into two decisions: foremost, there exists causality from fiscal development to economic development ; 2nd, fiscal mediators have a more powerful influence on the economic growing than capital markets.
Another empirical trial is conducted by Arestis, Luintel, D. and Luintel, B. ( 2005 ) utilizing a sample of six states: Greece, India, Korea, the Philippines, South Africa, and Taiwan. The information is one-year and covers the period 1966-1999 for Korea. The variables used are the GDP, existent gross fixed Investment, Bank Lending, and Market Capitalization. The information is collected from Global Financial Data, Inc. and Standard and Poor ‘s Emerging Markets Database ( 2002 ) . Harmonizing to the clip series findings, fiscal construction seems to be important for the panel of sample states including Korea.
Liu and Hsu ( 2006 ) assess the function of fiscal development in economic growing utilizing a sample of three Asiatic states: Taiwan, Korea, and Japan. The pick of the three states is based on their fiscal liberalisation experience. The intent of Liu and Hsu ‘s trial is to research the consequence of the fiscal development of the economic growing of the three counties utilizing quarterly informations over the period 1981-2001.
The trial is based on the standard neoclassical one-sector sum production in which fiscal development is considered as input. The bank-based fiscal steps are M2GDP, Private Credit, and Commercial-Central bank. For the market-based, the steps are Market Capitalization, Turnover, and Stock Return. The appraisal method is the generalised method of minutes ( GMM ) which will rectify the endogeneity job of the variables.
The empirical findings of the trial show a important consequence of the finance-aggregate on economic growing in Taiwan, which become undistinguished or negative in Korea and Japan. The Market Capitalisation estimated coefficient is significantly positive for Korea and Taiwan. However, the estimated coefficient of Turnover is undistinguished or negative for these two states. That is, Korea ‘s experience is inconsistent with Levine and Zervos ( 1998 ) . Furthermore, estimated coefficients of Stock Return are undistinguished for Korea. The consequences presented by Liu and Hsu constitute the exclusion of all the empirical documents presented in this Section.
More late, Yang and Yi ( 2008 ) test the causal relationship between fiscal development and economic growing utilizing one-year informations for Korea covering the period 1971-2002, which recorded the most of import economic growing and fiscal reforms. Data is extracted from the Bank of Korea database. Financial development variable considered is the ratio of the amount of loans and price reductions of all fiscal establishments and trading values of securities to nominal GDP. Yang and Yi conduct the trial following the superexogeneity methodological analysis.
The empirical findings provide grounds of a causality relation from fiscal development to economic growing, while it rejects the hypothesis that growing causes fiscal development in the instance of Korea. Yang and Yi describe their empirical trial the “ foremost serious empirical grounds ” that finance causes growing. Yang and Yi ( 2008 ) conclude that there exists a unidirectional causal relationship from fiscal construction to economic growing.
Decision
The intent of this paper is to reexamine the theoretical and empirical literature on the relationship between fiscal development and economic growing. Different strands of ideas argue about the nature of this relationship, whether or non there is causality, and the way of this causality if bing. Schumpeter ( 1912 ) presents his theory of economic development in which he emphasizes the function of fiscal construction in fosterage and heightening economic growing. A group of economic expert agree with this theory and develop legion theoretical accounts to back up it. Other economic expert, nevertheless, seem to pretermit the importance of fiscal construction and see it as a inactive effect of the existent growing.
To settle the statement, legion empirical trials are conducted to measure the existent finance-growth link. Early empirical grounds suggests that there exists a relationship between fiscal construction and economic growing, although it is hard to measure with assurance the way of this relation ( Goldsmith, 1969 ) . More recent trials find grounds of a unidirectional causality from finance to growing, while others support bidirectional causality between the two variables.
This paper presents a set of empirical and theoretical documents that focus on the Korean instance. Korea has recorded a rapid economic growing since the 1960s. This growing coincides with the fiscal reforms implemented by the Korean authorities in order to back up the economic system. The inquiry remains whether these reforms contributed in the impressive economic public presentation. It is necessary to observe that the aggressive development scheme was characterized by the heavy intercession of the authorities. McKinnon ( 1973 ) argues this kind of intercession merely slows the growing procedure, while Cho ( 1989 ) believe that the Korean growing is chiefly due to the authorities intercessions.
Trials of the finance-growth link for the instance of Korea came with consequences back uping the importance of finance in growing. Most of the empirical trials suggest that the fiscal reform that Korea experienced since the early sixtiess have significantly contributed in its rapid economic growing. Hence, Korea is another instance back uping the supply-leading hypothesis. However, one must near these consequences with healthy agnosticism as the findings depend on the methodological analysis used. As stated by Neusser and Kugler ( 1998 ) , most empirical trials are conducted utilizing growth-regression methodological analysis which has been criticized as it might be biased.
