Academic journal article Contemporary Economic Policy

Asian Financial Crisis and Korean Trade Dynamics

Academic journal article Contemporary Economic Policy

Asian Financial Crisis and Korean Trade Dynamics

Article excerpt

Since the Asian financial crisis in 1997, Korean international trade has gone up substantially in both volume and trade balances. The improvement is largely due to an expansion of international markets through various bilateral trade agreements and the structural changes in Korean exchange rates. This article investigates the exchange rate--trade balance dynamics, popularly known as the .1-Curve phenomenon. Employing the bounds-testing approach to cointegration and error-correction modeling on Korean bilateral trade for the pre- and post-Asian crisis periods, the study finds that support for the strict version of the .1-Curves has been fading after the crisis. While the weaker version of .1-Curve is generally supported in both pre- and post-crisis sample periods, we also notice patterns such as M. N. or W-Curves. There exists a long-run relationship among the Korean exchange rates, domestic income, foreign income, and Korean trading balances. (JEL F14, F32)

I. INTRODUCTION South Korean international trading has been expanding quite rapidly since the Asian financial crisis during 1997-1998. According to the Korea International Trade Association, Korean international trade has nearly tripled in total volume since 1998, mainly due to her rapid expansion into new markets opened up by WTO and various bilateral agreements. The total number of Korean bilateral agreements is currently reaching 329 compared with 50 in 1998. Korean trade balances have also improved dramatically from a $5 billion average deficit during 1988-1997 to a $20 billion average surplus in 2012 (Figure IA and 1B). The turnaround can be largely explained not only by an improvement of global economic environment but also by a significant structural change in the Korean real exchange rates since the crisis.

Until the crash in 1997, the Korean currency, won, was getting stronger against the U.S. dollar. Tantamount to a structural change, this trend reversed after the crisis (Figure 2) and the Korean trade balance improved substantially. However, the structural change in Korean exchange rates and its impact on her bilateral trade balances has not been clear. In this context, this article investigates the dynamic nature of Korean bilateral trading by investigating the J-Curve under the changing environment of Korean currency exchange rates.

According to the Marshall-Lerner condition, as long as the import and export demand elasticities add up to more than one, real depreciation of a currency improves the trade balance of a country. However, there have been circumstances under which this condition was met yet the trade balance continued to deteriorate (Bahmani-Oskooee 1985) following a currency devaluation/depreciation.' The focus, thus, shifted to the short-run dynamics that traced the post-depreciation time-path of trade balance to the J-Curve. Junz and Rhomberg (1973), Magee (1973), and Meade (1988) show that while exchange rates adjust instantaneously, it takes some time for consumers and producers to adjust to changes in relative prices. Moreover, since currency depreciations make the exports cheaper and the imports dearer, trade balance may actually decline for a while before showing any signs of improvement. Thus, short-run deteriorations followed by long-run improvements seem to characterize the post-depreciation time-path of trade balance. However, there is no consensus as such and it remains an empirically open issue.

Most of the papers investigating the J-Curve have employed aggregate trade data. See, for example. Bahmani-Oskooee and Rath.a (2004a) for an extensive review of the empirical literature investigating the J-Curve effect. A problem with using aggregate data is that the regressions potentially suffer from an aggregation bias--a country's trade balance (and/or terms of trade) could be deteriorating with one trading partner while at the same time improving with another. In order to overcome this problem Rose and Yellen (1989), Marwah and Klein (1996), Bahmani-Oskooee and Brooks (1999), and Bahmani-Oskooee and Ratha (2004b; 2004c) among others have employed U. …

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