Agenda for International Cooperation on Mobilizing Development Assistance for North KoreaHyoungsoo Zang and Young-Gon Park
The economic integration of the two Koreas will inevitably induce an additional fiscal burden for South Korea. The relentless trend of the severe economic conditions in North Korea, since 1990 - including the shortages of food, raw materials, and foreign exchange - is likely to continue in the short to medium-term, at the very least. South Koreas economy has also recently been challenged by its own financial crisis and, as a consequence, the weight of the burden has become relatively heavier.

The motivation of this study comes from the fact that South Korea, unfortunately, does not have enough financial resources to support rehabilitation of the North Korean economy. It is obvious that North Korea needs substantial amount of foreign funding for the rehabilitation and reconstruction of its economy, and it is also obvious that South Korea is not rich enough to cover all of the expenses. Thus, the financing needs stemming from Korean economic integration should be satisfied by foreign financing on a much larger scale than in the German unification case. In this regard, there is a need for creating a framework for initiating multilateral international cooperation.

Once North Korea joins the international financial institutions (IFIs), it will be able to receive financial assistance on concessional terms as well as various technical assistance from the IFIs. Helping North Korea to join these international financial institutions would be the first step in laying the foundation for a practical framework for international cooperation. However, the process of North Korea gaining membership in the key IFIs needs some time in order to clear all the hurdles. Therefore, it is equally important to discuss what other modes of support are available to North Korea in the context of its current non-member status.

This study puts forward two conceivable proposals in this regard. One is the creation of the Interim North Korea Development Assistance Group (INKDAG) through which financial, as well as technical assistance to North Korea will be channeled and a multilateral policy dialogue with North Korea will be maintained. Participants of the group could comprise major donor governments, major IFIs, UNDP, Non-Governmental Organizations (NGOs), and international aid agencies. In the early stages of its operation, South Korea would need to take a central role in one way or another. As North Koreas involvement in the international community deepens, and finally, as major IFIs are allowed by major stakeholders to participate more intensely in the Group, INKDAG could incrementally transform itself into a formal Consultative Group (CG) led by the World Bank with Banks financial allocations.

The benefits of INKDAG are the following. First, assistance through multilateral mechanism is less susceptible to political concerns than bilateral channels, for both donor and recipient countries. Second, a collective approach of coordinating resource mobilization is cost-effective and also compensates for the recipient country's lack of diplomatic capacities to reach out to many donors. Third, from the donors point of view, a multilateral policy dialogue mechanism is better suited for preventing aid duplication and for assuring transparency of the economic assistance provided. Fourth, but not the last, development assistance needs a more sophisticated policy coordinating mechanism among donors than humanitarian aid does.

The mechanism need not involve substantial financial assistance from major IFIs so that it would be able to evade the domestic legal problem of a major stakeholder. This is also needed for the swift provision of needed financial and technical assistance to North Korea. Even though all hurdles inhibiting North Koreas admission to international financial institutions are cleared, actual disbursement of substantial financial assistance would take some more time. The mechanism could act as an interim assistance mechanism during the transition period.

The second proposal concerns North Koreas external debt problem. Without the initiation of debt relief talks on rescheduling or reductions, North Korea is, for all intents and purposes, out of the international financial market. Because of North Koreas default history, without collateral or guarantees international financial community does not normally provide new loans until North Koreas debt overhang problem should be cleared. Practically, without initiating debt relief talks on rescheduling or reductions, North Korea will be out of the international financial market, not receiving any commercial bank loans, and so the burden of official donors will be heavier. It is time to think about bailing-in of the international private sector creditors to North Korea, let alone Paris Club official creditors participation in the debt relief negotiation process.

Furthermore, even with North Korea still not having been introduced into the international financial community, utilizing non-governmental organizations (NGOs) in dealing with North Koreas commercial debt overhang, could be of some practical use. The following proposal could be considered as a complement to straightforward debt relief.

Nowadays, there are increasingly many cases in which economic assistance funded by donor governments, but delivered through NGOs. Greater participation by NGOs in aid operations would be more acceptable to North Korea than would explicit provisions by the donor governments. An interesting example of the utilization of NGOs in the course of clearing the insolvent debts of heavily indebted countries through debt-for-equity swaps need to be examined.

A debt-for-equity swap is a deal converting debtor country's foreign debt into foreign equity in domestic asset. Lets assume that a country defaults on a payment to its external debt with a face value of one dollar. Due to the default, the market price of the debt would drop to 10 cents in the secondary market. Then, the debt relief required for clearing all the debts of the country would cost only 10 cents. Now, suppose that a donor country makes a contribution of 10 cents, buys the debt in the secondary market and gives it to an NGO. The NGO goes to the debtor country and swaps the (foreign exchange denominated) debt for local currency, with some degree of discount being applied (e.g. equivalent of 5 cents). With the local currency, the NGO conducts projects to meet its own objectives. The idea of swapping debt for some kind of domestic asset that provides a guarantee that the NGO will be able to protect the debtor country's natural resources may be termed debt-for-environment or debt-for-nature. If the objective of the NGO is the provision of development assistance, then we may call the scheme debt-for-development or debt-for-aid.

The donor community does not lose too much since the debt is already in default and 10 cents is the prevailing price on the secondary market. The debtor country ends up by clearing its debt of one dollar by paying only 5 cents in local currencies and also receiving either environmental or developmental assistance. The debtor country's central bank, however, ends up with domestic monetary liabilities or domestic debt. We think that North Korea may very well be interested. The task would be made more feasible under a multilateral coordination mechanism, such as INKDAG, in which policy dialogue among major donors as well as with the recipient country is well coordinated.

An important task is that South Korea should consider taking the lead in organizing an international coordination mechanism comprised of major donor governments, major international financial institutions, UNDP, NGOs, and international aid agencies, to develop a framework for international cooperation on the Korean peninsula. Under the umbrella of the mechanism, it is time to consider the possible debt negotiation process of Paris Club official creditors. Debt-for-equity swaps, especially through utilizing NGOs, would be a good starting point. On the other hand, the international community will recognize the economic benefits of an increasingly stable and secure Korean peninsula as the North-South dialogue progresses, and be ready to make due contributions. It should be noted, however, that North Korea needs to request on its own the international community of any conceivable support.

Transformation of the Economic System in the Central and Eastern European Countries and its Implications for the North Korean Economy
Yeo-Cheon Jeong

In the early 1990s, every Central and Eastern European country (CEECs) which belonged to the former Eastern Bloc started transforming from a socialist planned economy to a capitalist market economy. This was made possible by the preceding revolutionary political changes in CEECs in the process of which old socialist ideology was discarded. As every CEEC pursued the same goal - establishment of a market economy - the basic directions of economic transformation consisted of the same elements: liberalization of economic activities, macroeconomic stabilization, privatization of state enterprises, and introduction of a market infrastructure. However, the strategies and concrete policy measures applied differed from country to country, reflecting each individual country's political and economic situation.

Although evolution of CEECs' economies under central planning had been tightly interwined due to structural and systemic factors, and the basic direction of economic reform was the same in every country, the outcomes of 10 years of economic transformation in CEECs during the 1990s show a considerable discrepancy among regions and countries of Central and Eastern Europe. On the whole, it could be said that Central European countries such as Hungary, Poland and the Czech Republic show better achievements in market institutionalization and macroeconomic performance than countries of the former Soviet Union.

Differences in policy measures and initial conditions are regarded as two key factors which caused discrepancies in the outcomes of economic transformation among CEECs. Yet, as policy measures applied in CEECs reflected their initial conditions, the initial condition is the most fundamental factor which affected processes and outcomes of economic transformation in CEECs. Taking the experiences of Asian socialist countries such as China and Vietnam into account, the influence of initial conditions on the processes and outcomes of economic transformation becomes more clear.
Defects inherent to the socialist planned economic system and the structural dependency on imported energy resources are two basic obstacles hampering North Korea's economic growth. Therefore, it seems inevitable for North Korea to reform its economy sooner or later, if it could be normalized and grow. In any case, the direction of economic reform in North Korea will be bound to introduce market elements into its planned economy. However, prospect for the regime's stability will play a decisive role in choosing concrete reform measures in North Korea.

The structure of the North Korean economy is heavily distorted. First of all, disproportionate emphasis is placed on heavy industry, and the price structure is more seriously distorted than in CEECs at the beginning of 1990s. Taking these structural distortions into account, an overall economic transformation a la CEECs will definitely lead the North Korean economy into a chaotic situation. On the other hand, North Korea's agricultural sector is more tightly planned and organized, and accounts for a much smaller share of the national economy than in China. Therefore, the Chinese reform strategy of the early 1980s which promoted light industry by using unemployed and chief human resources in the agricultural sector doesn't seem to fully fit North Korea.

Economic reform in North Korea is expected to begin with restructuring heavy industry and promoting light industry, especially in export-oriented sectors. In order to meet these goals, the North Korean government could allow individual state-owned enterprises in heavy industry more initiative in their activities. As a further step, black market activities in the service sector and light industry which are known to have been flourishing in North Korea since the mid-1990s, could be officially allowed. If these reform measures prove to be unharmful to the regime's stability, the North Korean government could take bolder measures in liberalizing economic activities and correcting macroeconomic disequilibrium than have been taken in China since the late 1970s.

As long as reunification through gradual system convergence between the two Koreas remains a basic principle of North Korean policy, the South Korean government's economic policy toward North Korea should focus on marketizing and restructuring the North Korean economy. Measures such as direct investment in North Korea in the field of export-oriented light indusry and multi-party cooperation projects among South and North Korea and China, Russia or Japan to modernize North Korea's industrial facilities are advisable.

Non-Technical SummaryThe Korean government has liberalized its foreign exchange market in early April 1999. The foreign exchange law has been simplified considerably: it transformed from a positive list system―no transactions allowed, apart from certain explicit exceptions―to a negative list system―all transactions allowed, with a few exceptional cases. As a sequel, the second stage of the liberalization is scheduled for January 1, 2001. Both liberalization actions aim at removing unnecessary regulations for transactions related to foreign exchange, either directly or indirectly, as well as at increasing depth and liquidity of the market.

The purpose of this study can be put simply into the following questions: What are the special features in Korea's won/dollar foreign exchange market distinguished from foreign exchange markets of other major currencies? Does foreign exchange liberalization increase the trading volume and enhance market efficiency of the foreign exchange market? We believe that the answers for these questions may be able to provide useful policy guide for the relevant parties.
Participants in the won/dollar foreign exchange market (interbank market) are composed of the central bank, authorized foreign exchange banks (dealers) and two foreign exchange brokers. As of November 2000, there are 73 foreign exchange banks, consisting of 21 domestic banks, 50 foreign bank branches and two development banks. Any financial institution that wants to engage itself in foreign exchange transactions should get permission from the government. They should meet minimum requirements of capital, manpower, and facilities.

Currently, two commercial foreign exchange brokers are competing in interbank transactions, the Korea Financial Telecommunications & Clearing Institute (KFTC) and Korea Money Broker Corporation (KMBC). The commercial foreign exchange broker system was introduced to Korea in January 1999. KMBC, a private organization, was allowed to establish a brokerage firm; KFTC, the public foreign exchange broker that enjoyed a monopolistic position in interbank trading, has became a commercial company. These two brokers play an important role in the market. Of all interbank transactions, 96.9% of spot exchange, 63.8% of forward exchange and 93.7% of swap exchange are conducted through both brokers. These numbers are very different from those of other major currencies of which less than 50% of foreign exchange transactions are executed via brokers. Why is brokered interdealer trading a dominant feature in Korea? Simply put, it could be due to the very small size of the foreign exchange market in Korea. Dealers, not wanting to transact directly with other dealers, avoid revealing any trading-related information since the exchange market amounts to only $3 billion or over a day and less than ten banks handle the share of the order flow.

We investigate whether the liberalization measures have induced the market into a more efficient way based on spirits of two very different existing theories: market microstructure theory and market efficiency hypothesis. To test the first one, we use empirical relations between the exchange rate and the trading volume. We see how the market disseminates and reacts to various shocks including private information shocks before and after the liberalization. If the foreign exchange market becomes more efficient after the liberalization, private information shocks should be short-lived or non-existent. We construct the private information shocks as where the exchange rate and the trading volume move at higher than normal revels, respectively. We implement and interpret the shocks within the framework of noisy trading model by Blume, Easley, and O'Hara (1994). The model postulates that information is diffused and incorporated into exchange rate through the trading of informed investors. The uninformed traders infer a new piece of information via the trading volume.
Therefore, the trading process diffuses information as the new piece of information arrives, resulting in a price movement on higher than normal volume. We also take look into how volume shocks and price change shocks affect both the conditional mean and volatility of a variable before and after the liberalization.

We apply the semi-nonparametric (SNP) nonlinear impulse response analysis proposed by Gallant, Rossi and Tauchen (1993) to see how various shocks including the private information shocks affect the variables. The reason we choose the SNP as an empirical tool is that the SNP family of conditional densities is large enough to encompass almost any conditional density, which will minimize the possibility of wrong interpretation of the liberalization measures on account of a specification error. The SNP technique uses Hermite polynomial expansion to directly approximate conditional density. The leading term of the expansion is an ARCH/GARCH. The higher-order terms in the expansion have coefficients which are functions of the conditioning data. In this manner, the polynomial expansion allows for shape deviations from normality and conditional heterogeneity of unknown form. Nonlinear impulse response functions, summarized in Gallant, Rossi and Tauchen (1994), are the extension of the impulse response function of linear VAR to the nonlinear case. In the nonlinear model, the dynamic properties can be elicited by perturbing the vector of conditioning arguments in the conditional density.

Our empirical findings based on nonlinear impulse response functions are as follows. First, large price and volume movements of private information generate persistent responses before and after the liberalization even if the degree of persistence after the liberalization is much smaller than the degree before the liberalization. The results lead us to conclude that the market becomes relatively more efficient after the liberalization, under the framework often going by the name of noisy trading model. That is to say, informed traders may earn much more at the expense of less informed or noisy traders, but the first can enjoy high profits for relatively short duration after the liberalization. Second, the public information shocks do not affect the volatility of the exchange rate in the short run, but the effects do not dampen for a long term in both periods. The same is true for volatility, even though the result is barely statistically significant. Third, the volume shocks or disparate belief shocks are major sources of price deviation from the average exchange rate and persistence in the volatility before and after the liberalization. Therefore, the trading volume itself generates 'excessive volatility' in the market.

We also investigate how the foreign exchange market has changed after the liberalization through the relationship between the offshore NDF (Non-Deliverable Forward) exchange rate and the domestic spot exchange rate. First, we examine the changes in ex-post profit of NDF rates during the sample period. We find the ex-post profit of NDF rate to be very small before the crisis and negative during the crisis period. However, recently the ex-post profit is fluctuating, showing both positive and negative values. It is believed that this comes from the liberalization measure such that domestic banks were allowed to participate in the offshore market since April 1999. Second, we show the status of market liquidity between the three periods―before, during and after the crisis―and find that the liberalization has increased the market liquidity. To examine the liquidity condition, the difference between bid-price and ask-price is analyzed, since there is no available data on the trade volume of the NDF transaction. Due to the liberalization, the liquidity in the forward exchange market is expected to increase as more participants enter. The liquidity increased as the bid/ask difference has reduced about four times between period 1 and period 3. We find that the forward premium puzzle exists in the domestic foreign exchange market. We also find that the influence of crisis still exists in the foreign exchange market. We also obtain empirical results that the offshore NDF exchange rate is not an unbiased indicator. However, the existence of time-varying risk premium explains the bias in the foreign exchange market of Korea. To find the existence of time-varying risk premium, the ARCH-in-mean model is used. ARCH models capture some important aspects of the risk premium in a foreign exchange market. First, the ARCH model is convenient specification for heteroskedasticity, which is an empirical characteristic of exchange rates. Second, most exchange rate changes exhibit leptokurtosis, and the conditional distribution of the Maximum Likelihood procedure of the ARCH model also shows fat-tailed behavior. Lastly, the ARCH-in-mean model is a suitable econometrical model, such that the time-varying risk premium enters into the regression for the conditional mean.

In addition, forward exchange bias clearly appears in the domestic foreign exchange market, indicated by the fact that it did not have a forward premium bias as seen in the main exchange rates in the free-floating exchange rate system. Thus, while most forward exchange rates are known to have a downward bias, an upward bias is observed domestically. This upward bias is thought to be caused by the system collapse following the shock of the financial crisis. Moreover, the upward bias shows that in Korea the interest rate equilibrium condition is satisfied at least in direction. To make an analogy, the government's interest rate stabilization efforts after the crisis greatly helped the exchange rate's downward stabilization. Bias in the domestic foreign exchange market can be explained by checking for existence of a risk premium or peso problem. This means that the domestic foreign exchange market can be understood as the risk premiums of forward exchange buyers and sellers or the expected excess profits (or losses) from expectations of a regime shift.
Based on our empirical finding, we suggest policy implications for exchange and monetary policy. First, the possibility of excessive volatility caused by noise or bandwagon holds a policy implication for the exchange rate system in Korea. Our results show that the degree of excessive volatility in the market grows weaker after the liberalization or adoption of a flexible exchange rate system. It seems to be very contradictory to the general consensus that the exchange rate would be more volatile under a flexible exchange rate system than a fixed one. The clues on the seeming contradiction can be reconciled with the fact that the absolute magnitude of the estimated conditional volatility decreases by more than ten times. As the volatility of the exchange rate decreases, the risk premium become smaller and the incentive for noise traders to participate in foreign exchange transactions shrinks. If the government's policy objective lies in minimizing the exchange rate volatility, one possible candidate for exchange rate system would be multilateral arrangements in the sense of discouraging noisy traders from participating in the market.

Second, indirect intervention of the traditional interest rate policy may not be as much effective as the traditional theory expected. This is due to the risk premium in the determination of exchange rates. The traditional interest rate policy on exchange rate states that increasing domestic interest rates induce more capital inflows and in turn the domestic exchange rates appreciate. However, this would happen only if interest rates and foreign exchange risk premiums were orthogonal. In other words, the exchange rate depreciates rather than appreciates in the case that the increasing interest rate influences the risk premium as a sign of weak economic conditions. According to empirical analysis, the changes of exchange rates depend on the interest rate differential as well as the risk premium. Since the forward rate and realized expected spot rate are correlated positively, as the interest rate differential increases, capital outflows occur and the domestic currency depreciates. As the time-varying risk premium is deemed as an important factor in the foreign exchange market, it is better to understand the effect of risk components in determination of the exchange markets.

Development of the domestic bond market is also another important economic objective for the Korean economy. An efficient and active bond market provides not only effective benchmark rates in the foreign exchange transactions, but also alternative financial assets to diversify the risk. This results in a deeper and more efficient foreign exchange market. In conclusion, the development of foreign exchange market requires a more efficient domestic financial market in general.

When East Asian countries came under speculative attacks in 1997, some of these countries were not able to defend themselves and subsequently had to seek the IMF financial assistance and accept its stabilization programs. These crisis-hit countries were criticized for not having restructured their financial, corporate, and public sectors along the lines suggested by the Washington consensus. This failure was singled out as the main cause of the crisis and understandably, these crisis-hit countries were subject to heavy doses of structural reforms. The East Asian crisis became contagious, even threatening the stability of major international financial centers. The severity and contagiousness of the East Asian crisis underscored the importance of and renewed interests in reforming the international financial system.

Numerous proposals have been put forward. The G-7 led reform, however, has concentrated its efforts on reforming the financial and corporate sectors of developing economies, while by and large ignoring the problems of the supply side of international finance.

As was in the Mexican crisis of 1994-95, the appetite for radical reform of the international financial system has receded considerably in the wake of global recovery. The ongoing debate on the future direction of the international financial reform in fact suggests that most of the problems that beset the international financial system are likely to remain unchanged. This pessimistic outlook arouses deep concern in developing countries that they will remain vulnerable to future financial crises even if they faithfully carry out the kinds of reform recommended by the IMF and the World Bank. Given this reality, developing countries may have to develop a defense mechanism of their own by instituting a system of capital control and adopting an exchange rate system that lies somewhere between the two corner solutions.

The 1997 financial crisis in Korea has had a substantial impact on the economy and the society as a whole. Korea's overseas direct investment is no exception. Korea's direct investment abroad, which surged in general from the late 1980s to 1996, has fallen dramatically after the financial crisis. Accordingly, a large number of companies have cancelled or delayed their overseas direct investment plans in the face of a wide range of problems, including liquidity. The financial crisis has prompted the need to reassess Korea's past overall economic development strategy; evaluating the accomplishments achieved through the overseas direct investment by Korean multinationals is now more important than ever.

Since the financial crisis which erupted at the end of 1997, the debates over the effects of overseas direct investment have focused on the soundness of overseas investment rather than its effects on the domestic industry or trade. This paper analyzes the performance of overseas subsidiaries holding outstanding invested amounts of more than $10 million based on the financial statements of overseas subsidiaries in 1997 and 1998, before and after the financial crisis. This study shows the poor business performance of Korea's direct investments abroad. Korean subsidiaries exhibit extreme instability due to capital depletion caused by continuous losses and high debt ratios in 1997 and 1998. Added to this are net losses resulting in profit indexes indicating low earning rates.

Such problems in foreign subsidiaries are identified as aggravation of profitability, instability and high dependency on the parent company. This inferiority results from the deteriorated management practice of entering overseas markets for quantitative expansion without sufficient evaluation of business profitability. However, limiting advance into foreign markets on the basis of low business performance is not only unrealistic but also undesirable. Rather, the role of redirecting direct investment abroad toward more profit-based decision making procedures must be left up to the market participants such as creditors and shareholders. In order for market participants to perform their role, openness and easy access to management details must be guaranteed.

This paper provides a theoretical framework to explain why governments seek restrictions on IPR protection and allow R&D subsidies through multilateral trade agreements such as the TRIPS Agreement and the Agreement on Subsidies and Countervailing Measures. After 7 years of discussion, the Uruguay Round extends GATT's trade-liberalizing philosophy to worldwide use of subsidies as a secondary means to intervene in international trade.

Through the Agreement on Subsidies and Countervailing Measures the WTO tries to preserve one of basic principles of GATT's philosophy: Fair Competition. The principle of Fair Competition is of particular importance in understanding the WTO. To harness GATT's trade liberalizing philosophy, the WTO as a successor of GATT takes this principle as objectives that are pursued through the enforcement and implementation of other principles, for instance the non-discrimination and reciprocity. As an example of the fair competition principle, the WTO prohibited any type of export subsidies through the Agreement on Subsidies and Countervailing Measures, but allowed R&D subsidies. The allowance of R&D subsidies by the WTO is a puzzle because it is well known that R&D subsidization forms the prisoners' dilemma when governments are active to set R&D policy.

In order to find any reasonable logic to explain this puzzle, we focus on the interaction between strategic trade policy tools: R&D subsidization and IPR protection. Indeed, at an international level IPR protection has been a major focus of negotiations along with R&D subsidies. The WTO also requires member countries to strongly enforce patent protection through the TRIPS Agreement. In our analysis, it turns out that it is globally optimal to perfectly disseminate knowledge without IPR protection and to subsidize inventive firms by solving a problem that the weak IPR protection damages firms' incentive to invest in R&D activities. However, current trade agreements do not match with our global optimum. We show that exporting countries may benefit at the expense of importers from a trade agreement to demand stronger enforcement on IPR protection because exporting countries experience the prisoner's dilemma problem when both countries free ride on the rival firm's R&D outcome. Therefore we conclude that it is possible to understand the TRIPS Agreement as an inefficient victory of the interests of northern exporting countries over those of southern importing countries.

After joining into OECD, Korea voluntarily adopted IMF programs and additional liberalization measurements, and thereby, the Korean financial and capital markets have been liberalized to a great extent. OECD examines the implement conditions on liberalization which the new member country promised to undertake, after two years later the new member country entered OECD. In February 1999, OECD hosted CIME/CMIT joint meeting, in order to examine the implement condition of the two major commitments that Korea made at the time of its entry. The OECD member countries including United States, Japan, France and the U.K. evaluated highly the Korean efforts to challenge to liberalization, given that Korea was troubled in financial crisis.

However, OECD urged to Korea that the allowance of non-residents' security issuance denominated in foreign currency and the abolishment of overseas' deposit limit of residents should be introduced. For example, domestic security issuance denominated in foreign currency by non-residents was originally scheduled to allow in January 1997. However, this plan was delayed due to the financial crisis and finally implemented in April, 1999 by foreign exchange transaction act. Additionally, the overseas savings limit of the residents was expected to be removed in the late 1998. However, its implementation was postponed until the late 2000. Also, the cross-border-trade in the financial service, as well as asset management service was urged to be liberalized, which is not scheduled yet.

Under the domestic and international market condition, the financial liberalization gives a good opportunity of making available of low-interest capital and improvement of management skill and competition. Yet, it also has a possibility of making the Korean macroeconomic condition unstable by falling into excessive international competition and overly inflow of overseas capital.

Therefore, appropriate efforts should be made in order to promote competition in the financial industry, to operate well-functioning market conditions, and finally to have institutional risk management measurements including early warning system in case of unexpected capital outflow.

Due to industrialization that had put priorities to manufacturing at the expense of services, the service sector in Korea was grossly underdeveloped up to the early 1990s. Numerous sector specific regulations and restrictions on FDI prevented competition and impeded the offering of higher value services. In 1990, the labor productivity of the Korean service subsectors was much lower than that of the advanced countries. The labor productivity of 'distribution services, etc.', in particular, was less than one-fifth that of the U.S. in 1990.

Since the mid-1990s, the Uruguay Round negotiations and the OECD accession enabled the Korean government to gradually open its service sector to foreign suppliers. As a result, distribution services, business services, entertainment and recreational services and other personal services, in particular, have been almost completely liberalized.
The financial crisis of 1997 also gave momentum to the elimination of horizontal and sector-specific market access restrictions in the service sectors beyond the commitments made in the WTO and the OECD. The Korean government has accelerated its liberalization schedules for transportation services, financial services and telecommunication services since 1998. As of July 2000, the degree of liberalization of the Korean service sector is comparable to that of the developed countries, with almost all the service subsectors open, with the exception of a few areas sensitive to national security, culture, and political stability.

Thanks to the accelerated liberalization, Korea's trade in services increased rapidly in the 1990s. Trade in services, by the three modes of supply (cross-border supply, consumption abroad and movement of natural persons), except commercial presence, increased from $22.8 billion in 1991 to $49 billion in 1998. More significant increase in trade in services occurred through commercial presence. FDI inflows in services increased from $1.6 billion in 1982-90 to $6.3 billion in 1998-99. In particular, FDI in distribution services and transportation services increased remarkably in 1996-97. FDI in financial services and other services experienced a sharp increase after the financial crisis.

The liberalization of services is presumed to bring productivity gains in the service sector and also in the manufacturing sector which use liberalized services as inputs. By examining the changes in productivity of the service subsectors in 1970-97, we find that liberalization may have positively contributed to the productivity of the liberalized service subsectors. 'transport and communications', which was partially liberalized in the 1990s, showed a gain in total factor productivity growth in the late 1990s, from 2.2 percent in 1990-95 to 4.12 percent in 1995-97. The total factor productivity in 'distribution, etc.', which was almost completely liberalized in 1996, also improved in the late 1990s, from 0.41 percent in 1990-95 to 0.02 percent in 1995-97. Whereas, 'finance, etc.', which had been nearly closed until the late 1990s, showed negative total factor productivity growth rates throughout the periods studied.

The hypothesis that liberalization in services may increase the productivity of the manufacturing subsectors which use liberalized services as inputs is also tested by comparing the growth rates of productivity by manufacturing subsectors and the input coefficients of services to those manufacturing subsectors. However, it seems to be difficult to extract any consistent pattern, possibly due to the relatively small input coefficients of services in the manufacturing subsectors.
Considering the positive impacts of the liberalization of trade in services on domestic economy, it is in the interest of the Korean economy to continue the liberalization process and refrain from retreating. As entry barriers have been widely removed, most remaining obstacles are the internal barriers faced by both foreign and domestic suppliers. These barriers are more difficult to remove because they are part operating practices, part regulation and part cultural.

In particular, the ambiguous tax laws as well as cumbersome regulations are regarded as the most serious impediment to foreign investors. This implies that deregulation should focus not only on reducing the number of regulations but also on enhancing its transparent enforcement. In the process of deregulation, the government should also be attentive to reducing excessive regulations for fulfilling their objectives.

Another important area which has not been adequately addressed is labor market inflexibility. The limitations on layoffs may discourage foreign service suppliers from establishing local subsidiaries, which otherwise can create employment. Establishing an adequate social safety net and effective retraining programs is thus needed not only because it enhances labor market flexibility but also because it enables the government to liberalize mode 4---temporary entry of service providers.

Dr. Jong-Il Kim, a professor of economics at the Dongguk University, earned his Ph.D. at Stanford University. He specializes in productivity and economic growth. Address: Department of Economics, Dongguk University, Pil-Dong, Jung-Gu, Seoul 100-715, Korea: (Tel) 82-2-2260-3274; (Fax) 82-2-2260-3684; (E-mail) jongil@dgu.ac.kr
Dr. June-Dong Kim, a research fellow at the Korea Institute for International Economic Policy (KIEP), earned his Ph.D. in Economics at the University of Chicago. He specializes in international trade policy and direct investment. Address: 300-4 Yomgok-Dong, Seocho-Gu, Seoul 137-747, Korea; (Tel) 82-2-3460-1129; (Fax) 82-2-3460-1077; (E-mail) jdkim@kiep.go.kr

For over three years, the East Asian crisis countries, other than Malaysia, have dutifully followed the IMF structural programs to make their corporate and financial sectors more transparent, efficient and resilient to financial market instability. The reform processes in these countries are far from over, yet there is already a growing concern that they will remain vulnerable to future financial crises even with faithful execution of reforms. The domestic economic reforms alone may not safeguard them against future crises, so long as the reform of the international financial system is deferred or pushed forward without due consideration of the institutional and structural characteristics of the emerging market economies.

The reform led by the G-7 countries has been losing steam and from the viewpoint of emerging market economies does not adequately address the supply side problems. In particular, the small and medium-sized open economies in East Asia, on their own, may not be able to fend off rapidly globalized and virtualized speculative attacks. For these reasons, there has been increasing support in East Asia for developing a regional mechanism of defense in the form of financial cooperative arrangements. This support has culminated in the Chiang Mai Initiative of ASEAN+3 to create currency swap arrangements among thirteen countries in East Asia. The initiative is widely perceived as a major step toward strengthening financial cooperation among East Asian countries.

Details of the swap arrangements among the ASEAN+3 countries will need further elaboration; however, at this stage it is too early to tell whether they will be able to successfully negotiate the creation of such arrangements, given the different interests of different countries in the region. As was the case of the Asian Monetary Fund proposed by Japan when the crisis touched off in July 1997, the idea of a regional monetary fund or regional lender of last resort still faces strong opposition by the United States, European countries and, of course, the International Monetary Fund (IMF) for a number of reasons. Many western scholars dismiss the contention that an East Asian regional fund may have a comparative advantage in diagnosing regional economic problems and prescribing appropriate solutions on the basis that it will increase competition in the market for ideas. A more serious argument is that East Asians are not ready or capable of creating and managing an effective regional monetary fund. Compared to European countries, East Asia lacks the tradition of integrationist thinking and the web of interlocking agreements that encourages monetary and financial cooperation.
Nevertheless, regional financial arrangement could be structured and executed so as to be complementary to the role of the IMF. For example, a regional financial arrangement could provide additional resources to the IMF while joining forces to work on matters related to the prevention and management of financial crises. Furthermore, the East Asian countries' joint efforts to monitor economic and financial market developments in the region will support the IMF's global surveillance activities. In this regard, an East Asian regional financial arrangement, along with a regional surveillance process, can be explored while avoiding institutional duplication and reducing operational costs as well.

Beyond the Chiang Mai Initiative, the Asian Arrangements to Borrow (AAB) would build a strong foundation for committed financial cooperation in East Asia. The AAB shall be activated as the first line of defense for a country faced with a temporary shortage of foreign exchanges before officially requesting emergency loans from the IMF. The AAB would not require the establishment of a formal institution. The AAB would be based on the credit arrangements among participants, as in the case of the credit mechanism under the European Monetary System (EMS). However, the AAB should be distinguished from the facilities to maintain the par value system among participating countries under the regional monetary system.

To avoid or mitigate the moral hazard problem embodied in the automatic lending system of the AAB, it would be desirable to link the limit of borrowing assigned to each participant with its credit commitments. In addition, a penalty rate should be applied to borrowing countries. The AAB could become the next initiative by developing the network of bilateral swap arrangements, currently discussed under the Chiang Mai Initiative, into a truly multilateral scheme. If carefully designed and implemented, the AAB may serve as a milestone for closer and deeper financial cooperation in East Asia.
As the East Asian countries become more regionally integrated, the next agenda for the regional financial cooperation would be to search for a means to stabilize exchange rates among regional currencies. An even higher level of concerted cooperation would be required to establish appropriate monetary arrangements at the national as well as regional dimensions. As seen in the ERM crisis of 1992-93, however, even this EMS institutional framework would not be sufficient to ward off speculative attacks. An Asian currency unit or a single currency could be further explored over a longer term, if regional political consensus emerges along with deeper regional economic integration.

East Asia has a long way to go before formalizing and putting into effect the Chiang Mai Initiative, and launching further cooperative initiatives. In this respect, China and Japan should be able to provide leadership in leveling out the differences among the East Asian countries that are likely to surface during the negotiation process.

A total of 14 agriculture-related rules in OECD consist of 11 Decisions and 3 Recommendations, out of which South Korea only joined the rule of official inspection of tractors in December, 1995.

In March 30th, 1999, the OECD announced a final report examining Korean agricultural policy. Actually, it has been publishing each member's report on agricultural policy in order to evaluate whether their agricultural policy are consistent with agricultural reform principals of OECD. This report recommended that Korean agricultural policies should encourage direct income payment system, pursue environment-friendly agricultural policy, expand open market, promote sustainable agricultural development, improve infrastructure, continue to restructure agricultural industry, and enhance transparency in implementing regulatory reform policies. Furthermore, it recommended that transparent, targeted, tailored, flexible, equitable application of standards in practice will excessively contribute to attain OECD members' goals in agricultural sector and overall economy.

In making a decision whether to accept or reserve certain rules, those rules that are viewed to benefit domestic agriculture come first. In doing this, it is important to collect the opinions from institutions or experts with accumulated professional knowledge and experience regarding to the rules. In addition, a member country should listen to voices from various fields through a public hearing.

On the other hand, it is not quite easy to evaluate the implementation of other recommendations that are not rules because those recommendations are not specifically designed to suggest totally new measures or to scrap existing ones. Rather, they require overall improvement in agricultural structure and comprehensive agricultural policies to facilitate trade of agricultural products. However, as shown in the OECD report on Korean agriculture, OECD evaluated that Korean agricultural policies are being improved. Nevertheless, we should continue our efforts to reform agricultural policies in due consideration of hereafter agricultural situations.

Ministers outlined a set of Shared Goals. There was a broad consensus that OECD Member governments should provide on appropriate framework to ensure that the agro-food sector: is responsive to market signals; is efficient, sustainable, viable and innovative, so as to provide opportunities to improve standards of living for producers; is further integrated into the multilateral trading system; provides consumers with access to adequate and reliable supplies of food, which meets their concerns, in particular with regard to safety and quality; contributes to the sustainable management of natural resources and the quality of the environment; contributes to the socio-economic development of rural areas; contributes to food security at the national and global levels.

In line with those policy goals of OECD, we should improve our competitiveness in agricultural industry to cope with changes of international situation by successfully carrying out "Rural Development Plan and Agricultural Reform Policy", which has been implemented as a basic moto of agricultural administration toward 21th century. Especially, we must go ahead with reforms under operation such as reforming cooperative associations, innovating distribution systems and restructuring agricultural production systems.

Moreover, we should accelerate the expansion the direct payment system promoted in OECD members in supporting agriculture, while reducing the support market price and stimulate agricultural policy reform in an attempt to reorganise more easily.

In addition, Korea should make efforts to achieve the improvement of overall agricultural policies such as reducing trade-distortive policies, narrowing government assistance(the assistance with agricultural inputs), recommending environment-friendly agricultural policies, facilitating regulatory reforms, developing agricultural village, and restructuring agricultural industry.With regard to Korea's accession to OECD rules, we should take a forward-looking stance based on our agricultural outlook, rather than just being content with status quo of current agricultural situation.