KDI - Korea Development Institute - RESEARCH - Research Areas

Summary

Research Monograph KOR Korean Unique Regulations in Housing Market

We study regulations in the housing market, which are very unique and have great influences in Korea. Due to COVID-19, the housing market have experienced rapid changes. Thus, the government responded boldly with unprecedented policies. Among others, 3 special regulations are on the table for discussion. The first is the Land Transaction Permit, which was implemented to reduce demand on housing in specific regions. Second, the Price Cap on New Houses is investigated for housing supply policy. The final is a regulation on the contract renewal claims in the housing rental market.

Chapter 2 analyzes the direct and indirect price effects of the Land Transaction Permit (LTP), a selective regulation introduced in 2020 for high-priced houses in Seoul to stabilize skyrocketing prices. The LTP is an administrative regulation that requires local governments to permit transactions in designated "areas," and as of 2022, the total area covered by the LTP is about 9% of Seoul's land area.Houses in the LTP zone can only be purchased by buyers who are either homeless or will eventually become single-family homeowners, and they must actually live in the houses for two years immediately after purchase. In this study, we analyzed the price and transaction volume of LTP regulated and unregulated houses, focusing on "Jamsil-dong, Samsung-dong, Daechi-dong, and Cheongdam-dong," which were designated in June 2020. In the regulated area, the LTP scheme directly reduced transaction volumes by 38.3% and prices by 4.3% compared to unregulated areas. However, the LTP scheme unexpectedly had a positive price appreciation effect on homes located closer to the regulated areas. When unregulated dwellings are categorized according to their distance from the regulated area, we estimate that dwellings closer to the regulated area increased in price by 2.3% relative to dwellings further away, and this effect is larger the closer they are to the regulated area. It appears that some of the demand in the regulated area shifts to nearby unregulated areas with higher substitutability. The different direction of the direct effect on regulated areas and the indirect effect on nearby areas suggests that selective regulation, such as LTP, may not be the right regulatory approach to achieve the goal of stabilizing the housing market.

The next chapter, Chapter 3, examines the effects of the Price Cap on New Houses. This price cap, which limits the price of new homes, is one of the controversial regulations that raises concerns that it may limit housing supply in the future. However, this study's analysis found no evidence that the price cap reduces the supply of new homes. Although the pre-sale price cap limits the profits of housing construction projects, it is operated by reflecting all the costs of land and construction for housing supply. Even if the prices of newly supplied homes are limited by the price cap during the period when the housing price is on the rise, the sales of new homes is likely to increase as well. Thereby housing development projects are profitable enough to cover all the costs. Therefore, there appears to be no empirical evidence for concerns that future housing supply will be reduced by this price cap implemented during the housing market boom. However, these results are contradictory to the results of existing studies, so caution needs to be taken when interpreting them further.

Chapter 4 investigates the price impact of the deposit control imposed on the housing repo contract in Korea, known as Jeonse. Jeonse is a unique housing repo contract in Korea where the landlord borrows a deposit from the tenant, using the house as collateral. The tenant is granted the right to occupy the house during the contract period at the expense of the deposit’s opportunity cost. In July 2020, the Korean legislature passed a law granting tenants the right to renew the Jeonse contract once, with the new deposit amount not exceeding a 5% increase from the original amount. While this new regulation has been heavily criticized as the primary driver of the surge in Jeonse deposits during the pandemic, its actual price impact has not been properly estimated.

We estimate the value of the Jeonse renewal option monthly using option pricing techniques, based on reasonable assumptions about the housing price process and information gathered from the current term structure of interest rates. Our estimation results indicate that the deposit control regulation raised Jeonse deposits nationwide by only 0.97% and by 4.80% in Seoul at the time of the introduction of the regulation, a magnitude significantly lower than previously discussed in both media and academic circles. Furthermore, we demonstrate that the renewal option does not have any intrinsic value over the past 10 years, suggesting that the option can be considered pure insurance against an unexpected increase in the equilibrium level of Jeonse deposits by the time of expiry. Based on the background of the regulation and the results of our analysis, we provide policy suggestions.

Summary

KDI FOCUS Restructuring Platform Merger Review

Platform mergers differ significantly from traditional mergers. In platform mergers, foreclosure issues, which are crucial in traditional vertical mergers, carry less significance but may still arise indirectly. Platforms, moreover, can favor their own businesses potentially disadvantaging competitors, and leverage their market power to new businesses. Lastly, entry barriers could increase as a result of platforms’ multi-service provisions. Nevertheless, platforms can enhance consumer welfare, especially through product (service) bundling. Thus, we need to overhaul the merger review system to incorporate the aforementioned characteristics of platform mergers.

- Amidst the escalating debate on platform regulation, there has been a surge in platform mergers, leading to a corresponding increase in the need for platform merger reviews.

- There is a need for new guidelines for platform merger review to reflect the unique characteristics of such mergers. These guidelines should outline the review methodology and the assessment of potential competitive constraints.

- Indirect network externality plays a crucial role in locking in users to specific platforms.

- Platform firms provide a diverse range of services, offering multiple ancillary service platforms that revolve around a few core platforms or other businesses associated with the platforms.

- Platform firms often pursue mergers to expand into new revenue-creating areas or to strengthen their competitiveness in core services.

- One significant concern regarding anticompetitive practices in platform mergers is the potential for excluding competitors via selfpreferencing in the new markets.

- The addition of new ancillary services through a merger can potentially raise entry barriers in both the platform’s core service areas and the overall platform ecosystem.

- If a vertical merger leads to the foreclosure of purchasing or sales channels, it can seriously harm market competition.

- In mixed mergers, leveraging market power from one market to another can occur through tying.

- The determination of whether a merger is vertical or mixed is bound to be confusing when a platform, acting as an intermediary between consumers and small and medium-sized vendors, seeks to merge in order to add an auxiliary service for these vendors.

- Platform operators have the ability to foreclose competitors in other sectors but only indirectly, using accessibility to users.

- Without tying, platform operators can leverage market power from their core business area to ancillary service areas by raising rival’s costs.

- Platform mergers can raise barriers to entry not only in new markets but also in existing core service areas and the overall platform ecosystem. In some cases, the creation and reinforcement of entry barriers may be a deliberate objective of the merging parties.

Summary

KDI Policy Forum Impacts of Climate Policies on Industrial Competitiveness in Korea

■ As carbon reduction targets are being strengthened globally, it is increasingly important in Korea to comprehend the impact of two major greenhouse gas (GHG) reduction policies, Target Management System (TMS) and Emissions Trading System (ETS), on industrial competitiveness.

- ETS relies more on individual firms’ economic incentives compared to TMS, which is a command-andcontrol regulation.

■ While the transition from TMS to ETS in 2015 is found to have partially alleviated the burden for manufacturing firms, there is a need to enhance policy effectiveness by acknowledging their limited performance in reducing carbon emissions thus far.

- While TMS was introduced in 2011 with the aim of enforcing emissions reduction and enhancing energy efficiency across different sectors, heavy emitters have been managed separately through ETS since 2015.

- Knowing the low abatement performance in the manufacturing industry after mid-2010, the reduced burden can be attributed to two factors: i) improvement in efficiency resulting from the transition, and ii) alleviation of the burden through the provision of free allocations.

- The policy efforts should aim for a greater reduction by strengthening the targets for the regulated firms, which is in line with the reinforced policy goals announced in October 2021.

■ Stricter goals are inevitable in the future, and therefore, policymakers must endeavor to bolster the sustainability of the manufacturing sectors by developing a detailed roadmap based on multiple indicators.

- Taking into account the varying impacts of GHG reduction policies on the competitiveness based on the energy intensity and emission intensity of each sector, the roadmap needs to be carefully crafted in order to impose a feasible burden on the regulated firms.

Summary

Research Monograph KOR Digital Payment Innovation and Financial Consumer Protection

○ Even with weak legislative support, the digital economy is gaining momentum, propelled by the recent progress in contactless financial services and digital finance’s growing convergence with other sectors.
- As the primary legal framework for digital finance, the Electronic Financial Transactions Act (EFTA) had an amendment proposal in November 2020, but the bill is still pending at the National Assembly.
- Despite its vital importance in the Korean economy as a legal foundation for financial innovation, the EFTA has remained largely intact since its enactment in 2006 and has not been sufficient institutional support for critical technological changes like the rise of fintech and big tech.

○ Key point of the amendment is opening up payment services to non-banking financial institutions, such as tech firms (big tech) and credit card firms.
- Payment services are an essential amenity in our everyday life, encompassing payment for goods and services, cash deposit and withdrawal, salary transfer, domestic and foreign remittance, and utility bill payment.
- The amendment bill introduces a license of Comprehensive Payment Service Provider (CPSP), which is allowed to provide all payment services by directly offering a checking account like banks.
- Once the bill passes, some big tech firms as well as conventional nonbank financial institutions like credit card issuers are expected to get the license of CPSP.

○ The significance of payment services lies in that this sector is the basis for nonbank entities to expand into other areas, such as banking, insurance, and financial investment in the mid-to-long term.
- Because every economic activity involves the act of paying, CPSPs can accumulate vast user data.
- Also, these operators can bring in a massive amount of funds that customers deposit for payment transfers. Such funds can be used to launch new customized investment products or expand their business to other financial markets.

○ In the longer term, opening up digital payment services may thrust the financial industry to the next level by stimulating competition from within.
- A single app or metaverse platform is all it takes for users to carry out the whole array of financial services and e-commerce, not to mention payment transfers. Also foreseeable are crumbling barriers between different subsectors within the broad financial sector and spurring competition across the entire industry.

○ Some are rather pessimistic about the open-up because they perceive it as flinging open the door of banking; however, this study does not regard it as harming financial stability.
- The required regulatory level should be on par with banking regulations when deeming CPSPs as banks, but as nonbank payment service providers the degree of restrictiveness and protection would decrease.
- This study views the core function of banks as financial intermediation, which transfers customer deposits into illiquid loans. Since payment service operators cannot provide loans, it is reasonable to regard them as nonbank payment institutions (refer to Chapter 4).

○ On the other hand, financial consumer protection remains crucial agenda.
- Since most payment service users place their funds in demand deposit accounts, protecting these funds and guaranteeing service users’ rights are critical.
- The amendment bill contains some protective measures, but in the UK, where a similar scheme has been in operation, several payment service providers went bankrupt without returning customer funds.

Summary

KDI Policy Forum The SME-Suitable Industry Reservation Policy: Economic Effects and Policy Direction

■ After marking the ten-year milestone since the adoption of the SME-suitable industry reservation policy, this study investigates whether the policy has enhanced the competitiveness of SMEs by safeguarding them as intended and offers implications for its future implementation.

- This SME policy involves the selection of specific products to protect the business territories of SMEs and limit the entry or expansion of large enterprises; however, evidence-based discussions on its effectiveness have been limited.

- While the production and employment of large businesses decreased after the adoption, the business activities of SMEs did not change much.

■ This reservation policy aimed to "ensure the competitiveness of SMEs through their protection." It successfully fulfilled its protective role by reducing the likelihood of SMEs exiting the market. However, the reservation policy had limited impact in terms of improving their performance or competitiveness.

- Following the designation of a set of industries (products) reserved for SMEs, the probability of exit for SMEs engaged in the production of those specific products significantly decreased. However, these SMEs did not show significant differences compared to other product producers in terms of most performance and input indicators.

- The industry-level analysis shows that the policy contributed little to the performance of overall industries to which the designated products belong.

■ The disappointing outcomes of the policy’s stringent measures highlight its limited effectiveness, as the restrictions on the expansion or entry of large enterprises did not lead to significant improvements in the performance of SMEs.

■ Based on the findings, it is recommended to suspend new applications for the designation of SME-suitable industries and gradually phase out the already designated reserved industries.

- In any business field, when there is greater uncertainty about future market restrictions, firms are less incentivized to engage in that market and invest in domestic production facilities.

- A policy that restricts production activity in a specific business area solely based on firm size may inadvertently undermine the efficiency of resource allocation in the broader economy.

■ Instead of protecting specific business areas, a win-win policy between SMEs and large firms should prioritize providing effective support for the growth of capable SMEs through appropriate regulatory measures to address anti-competitive and unfair practices.

Summary

Research Monograph KOR Designing the Criteria on the SME Support Policy: Focusing on the Definition of SME and Small-Scale Reservation Policy

Government support programs for small and medium enterprises (SMEs) and regulations for large firms are all size-dependent policies. The purpose of this study is to evaluate the effectiveness of the SME definition and the small-scale reservation policy on SMEs' performance. This study intends to provide policy implications when designing the criteria for the SME support policy.

Chapter 1 introduces the criteria for defining SMEs and presents the distribution of firms according to the SME size categories. In Korea, SMEs account for over 99% of the total number of business enterprises, meaning that the definition of SMEs is broad enough to include most firms. There are numerous policy programs and tax benefits for SMEs in Korea and this chapter lists those support policies according to various size categories.

Considering all SME policies are size-dependent, Chapter 2 examines the effect of size-dependent policies overall, not of individual and specific policy, by analyzing changes in firm performances and employment with a change in the criteria used to categorize SMEs. We exploit the changes in the SME status of each individual firm by the change in the criteria to measure the effects. The result shows that the criteria change from the employment size categories into the turnover size categories has little impact on achieving the intended growth in employment. However, newly designated SMEs show significantly increased sales. This finding can be interpreted as indirect evidence of positive effects from tax benefits and support programs targeting SMEs, but further research is needed to find direct evidence. We also found that there is a significant decrease in sales per employee for the firms whose SME status is withdrawn, suggesting that there exists an incentive to maintain the status.

Chapter 3 demonstrates the economic effects of reservation policy for SMEs. Among an array of size-dependent policies, the reservation policy is one of the most restrictive policies since it directly regulates the entry and production activities of large enterprises for specific goods. The analysis demonstrates that although reserving certain markets may temporarily safeguard the SMEs producing the products, this effect is temporal and not beneficial to the industry's overall growth. The reservation policy may be of little use in securing the competitiveness of SMEs and can potentially exacerbate the misallocation of the resources among the enterprises within the economy. This study also points out that even in the markets not reserved for SMEs, investment incentives may shrink on the uncertainty that their production activities could be restricted at any time.

The findings of this study are consistent with recent studies arguing that the diverse distribution of firm characteristics such as productivity and size should be considered when designing SME policies. The overall productivity of an economy can increase when resource allocation shifts from low-productive firms to high-productive ones. In turn, it shows the need to check whether a policy operates against efficient resource allocation when examining the impact of a specific policy on the economy as a whole. Furthermore, this study is relevant to the field of measuring the effectiveness of SME policy by providing empirical analysis at enterprise or establishment levels.

Summary

Policy Study KOR Impacts of Climate Policies on Industrial Competitiveness in Korea

This study quantifies the impact of major climate policies on industrial competitiveness in manufacturing sectors that require large-scale decarbonization in the future. Two climate policies, the Target Management System for GHG and Energy (TMS), a command-and-control type policy introduced in 2011, and the Emission Trading System (ETS), a market-friendly policy introduced in 2015, are mainly considered, where both policies cover selected companies that emit heavily. Based on pathways through which climate policies can affect industrial competitiveness, we estimate impacts of the abatement burden through channels of the level of energy intensity (energy consumption per production) and the level of emission intensity (emissions per energy use) by covering 2011~2019. Furthermore, based a firm-level survey, we estimate determinants that drive and hinder the implementation of abatement practices and determinants that enhance environmental and economic performance.

As a result of the analysis, during the last 10 years (2011-19) it was confirmed that the higher the level of energy intensity and emission intensity, the negative impact on production cost and value added, which are direct indicators of the manufacturing industry’s competitiveness, was greater. Impacts become greater when limiting to the energy-intensive and emission-intensive sectors, such as “iron and steel”, “non-ferrous metals”, “chemicals”, “petroleum refining”, and “non-metal” industries. Meanwhile, it is found that there is no signficant impact on sales. Overall, it is understood that the upward pressure on production costs was at a level that could be endured through a decrease in value added rather than leading to a decrease in production. Furthermore, it is confirmed that while negative impacts on competitiveness through energy-intensity has gradually increased during the analysis period, that through emission-intensity has decreased after the introduction of ETS. Meanwhile, burden of carbon abatement has not yet been realized in earnest for some large companies that have been active in introducing abatement measures. Nevertheless, in line with the strengthening of climate policies in the future, policy considerations to ensure the sustainability of the manufacturing sector should be accompanied.

Policy suggestions this study provides are tow-fold. First, it is necessary to understand the extent to which TMS and ETS actually affect and to identify detailed impact pathways. Considering the results of previous studies and this study, there is a possibility that in the manufacturing industry the distribution of abatement burden is not proportional to that of emissions. Therefore, it is essential to broaden the perspective and consider impact pathways at the level of the production and supply chain. Second, it is necessary to set TMS targets and allocate ETS allowances using multiple indicators. Industries with high direct emissions such as fuel combustion can lower their emission intensity through their own strategies (switching to environmentally friendly fuels, etc.), while in industries with high indirect emissions, energy intensity adjustment may be a more effective means than emission intensity adjustment. Altogether, it needs to enhance the sustainability of manufacturing industry in the process of decarbonization by differentially allocating as much burden as necessary to the firms under TMS and ETS, and by alleviating the burden that firms outside the system may bear in a disproportionate way to their emissions.

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