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Why the U.S.-Korea Free Trade Agreements Matters
By Choong Yong Ahn

DURING the 8th round of formal negotiations for a free trade agreement with the United States, Korean negotiators delivered an ancient poem to their U.S. counterparts in the hope that it could induce concessions from the U.S. side and facilitate further progress. The poem, written by General Eulji Mundeok of the Goguryeo Kingdom and sent to the commander of China Sui Dynasty during the Goguryeo-Sui Wars between 598 and 614, captures the spirit of Korea anguish and hope for a deal that almost never happened.1


A HISTORIC FREE TRADE PACT

With several deadlines coming and going and negotiators for both sides involved in high-stakes brinkmanship, South Korea and the United States finally concluded a historic bilateral free trade agreement (FTA) on April 2.

 

The FTA, which is the biggest such deal ever for Korea and the largest for the U.S. since the North American Free Trade Agreement (NAFTA) in 1993, came in the most dramatic fashion possible, just three months before President George W. Bush Trade Promotion Authority expires on June 30. By the barest of margins, it gave the U.S. Congress the mandatory 90-day review period before Bush authority ends.

 

Although some sensitive sectors were excluded, the Korea-U.S. Free Trade Agreement (KORUS FTA) is highly significant. After all, this is an agreement between the worldã…¤ largest economy and the 11th largest. It is the biggest ever cross-pacific free trade deal and it will be watched closely around the world.

 

Both the implications and the significance of the deal are evident in the remarks of the trade ministers of the two countries when they launched the negotiations some ten months before the deal happened. For Korea, it was seen as a critical turning point, a chance to deepen the country commitment to becoming a sophisticated, advanced and truly open economy. Korean Trade Minister, Kim Hyun-chong, called the talks between the two countries the most important event for Korea since the signing of the U.S.-Korea Military Alliance at the end of the Korean War in 1953.

 

For the U.S., it is the most significant FTA in over 15 years and deepens an already strong relationship in Northeast Asia. As Ambassador Rob Portman, then the U.S. Trade Representative, noted, countries better represent the promise of open markets, democracy, and economic reform than Korea.

 

For the U.S., Korea is its seventh-largest trading partner in terms of two-way trade, with nearly US $72 billion in trade between the two countries in 2005. Korea is the sixth largest market for U.S. agricultural goods and the second largest for U.S. services in Asia. The United States is Korea third-largest trading partner and its largest source of foreign direct investment.2 Several studies suggest that KORUS FTA will boost bilateral trade volume by as much as U.S. $20 billion.

 

The two countries aimed originally to conclude the trade negotiations in the early morning of March 31, Seoul time, but failed to agree on lower barriers on beef, automobiles and textiles. For both sides, these are the most sensitive issues, arousing virulent opposition from would-be losers in Korea and warning letters on the deal from the Democrats now in control of the U.S. Congress, who want to see a deal which reduces the U.S. trade deficit with Korea. In a presidential election year in Korea, political leaders, even those who support a deal, have been careful to talk tough for domestic consumption. While the absolute numbers of protesters against the deal in Seoul were not very large, the emotional intensity reached its height with the tragic self-immolation of a Seoul taxi driver outside the talk venue in a Seoul hotel. He screamed invectives against the deal as he lit himself on fire just hours before the pact was signed.

 

Considering such strong domestic opposition, negotiation strategies hardened in the final week of high-level talks as the two sides became increasingly tough minded over details. Bush and President Roh Moo-Hyun even had a 20-minute telephone call on March 29 to discuss the deal and reiterate their commitment to conclude an agreement by empowering their negotiators to use aximum flexibility.

 

ROCKY ROAD TOWARD A 'MEDIUM QUALITY' FTA

 

The talks began with an initial round in Washington in June 2006. Originally, both countries agreed to finish the pact by the end of 2006 but extra rounds were added to make a total of eight through mid-March 2007, alternating between Washington and Seoul.

 

It was never easy. The two countries had a rocky road to traverse and they failed to narrow some crucial differences until the final minutes of a shifting deadline. In the eight formal meeting rounds, negotiators succeeded in nailing down details for eliminating tariffs and non-tariff barriers in just four out of 17 areas: customs, administration, government procurement, and competition policy. They also narrowed differences substantially on eight other issues, but there were still many disputes, including intellectual property and exact tariff cuts in agreed sectors. At the end, the negotiators were able to come up with a edium-quality FTA, which was what many analysts expected from the beginning, including the author of this paper. The toughest sectors are listed, with the proposed final agreements in Table 1.

 

1

 

At the final formal negotiations, the most sensitive issues, including rice, beef, automobiles, and textiles, could not be resolved. They were thus transferred to the final high-level ministerial talks that began March 26, just one week before the absolute deadline of March 31. Both sides implicitly recognized that there were deal-breaking issues before them, which could not be put on the table any earlier. One case in point is the opening up of the rice market for Korea. The other case is the opening up of the coastal logistic service market for the U.S.

 

To the disappointment of many FTA supporters, the U.S. and Korea failed to narrow differences on the stickiest issues. Korea wants wider access to the U.S. textile market. Korea proposed that the U.S. accept looser textile-origin rules then the strict yarn-forward rule. Korean negotiators believe that U.S. concessions on tariff reductions on textiles and automobiles fell far short. Koreaã…¤ shopping list also included the easing of trade rules, such as anti-dumping measures and countervailing duties, and labeling products made in the inter-Korean Gaeseong industrial complex in North Korea as being of South Korean origin.

 

On the other hand, the U.S. stood firm with its request that Korea phase out tariff and non-tariff measures on beef, automobiles, and pharmaceuticals. Washington wanted to open financial and other service sectors earlier than proposed by Korea. The U.S. demanded that state-run banks be competitive with private institutions. Except beef and automobiles, the rest of the issues were resolved while leaving the Gaeseong goods as a built-in agenda to be discussed at a later date.

 

Opposing the talks, Korean farmers, unionists, and left-wing activists staged protests, some of them violent. They say that a deal would take away their livelihood. At present, Korea farm sector is at a turning point. Most farmers are too old to even consider a career change, never mind benefiting from transition training. Korea traditional crops, such as wheat, barley, cotton, corn and some fruit, have all but disappeared due to Korea active trade in agriculture with the United States. The only remaining significant crop, rice, is of particular economic and cultural significance, having been a historical staple for centuries; it provides Korean farmers with about one half of their income.

 

At this point, truly competitive rice farming would require a substantial structural adjustment period. Consequently, Korea was firm on rice from the beginning. If the U.S. were to insist on bringing the issue to the negotiation table, many Koreans would view it as a stubborn roadblock. On a positive note, recent trends towards venture-farming, though nascent and on a very small scale, may pave the way for needed structural adjustments in the agricultural sector.

 

FACING A RISING CHINA

 

For the past half century, the ROK-U.S. military alliance has contributed greatly to helping war-torn Korea emerge from a state of dire agrarian poverty to become an advanced country and a member of the OECD. The U.S. provided Korea with both a strong security umbrella and economic assistance during the post-Korean War rehabilitation period. In the mid-1960, South Koreaã…¤ per capita income was roughly one third of North Korea and the Philippines per capita income, respectively. Now, the picture is completely reversed. South Korea per capita income is more than 30 times greater than that of North Korea and 12 times that of the Philippines. Indeed, Korea ompressed Growth Model "“ an export-oriented development strategy that depended largely on the U.S. market "“ enabled Korea to achieve its economic miracle.

 

Since the Asian Financial Crisis in 1997, Korea, under the mandates of the IMF financial assistance program, has undergone a painful restructuring process of its financial, corporate, labor, and public sectors to upgrade to global best practices.3 As a result, Korea corporate and banking sectors have introduced a new governance system, disclosure standards, and strengthened shareholders rights. The average debt-to-equity ratio of Korean corporations before the crisis was above 400%, but now has been reduced to less than 100%. As a result of these sweeping reforms, Korean workers suffered extensive layoffs.

 

Korea has also faced great challenges caused by the rapidly advancing Chinese economy. China 9% annual growth over the past two decades has changed the economic landscape of East Asia and the world. Recently, China replaced both the U.S. and Japan as Korea number one trading partner in exports and imports, respectively. China also became the number one destination for Korea outbound foreign direct investment (FDI).

 

Both the U.S. and Korea face the challenge of a rising China. Singapore Lee Kuan Yew predicted that China GDP would equal that of the U.S. within next two decades. China could overwhelm Korea in its premier competitive sectors "“ semiconductors, electronics, shipbuilding, steel, and automobiles, unless Korea rapidly develops new high value-added service sectors and upgraded manufacturing. The KORUS FTA is likely to allow Korea to reduce its excessive dependence on the Chinese economy and for the U.S. to help offset Chinaã…¤ economic hegemony in East Asia.

 

KOREA'S SEARCH FOR A NEW DEVELOPMENT PARADIGM

 

Given Korea position, sandwiched between China, the rising behemoth, and Japan, the world second largest economy, the country needs a new development paradigm to respond to both regionalism and globalization. Many businessmen warn that Korea is at risk of being squeezed by high-tech Japan and low-cost China. To address these concerns, both deregulation and globalization are needed to reactivate domestic corporate investment and induce foreign direct investment.

 

Given Korea paucity of natural resources, its new engine of growth should come from knowledge-based industry, upgrading existing premier manufacturing capacity and dramatically enhancing service industries, which are still in the early stages of development.

 

BENEFITS OF THE U.S.-KOREA FTA TO THE GLOBAL TRADING SYSTEM

 

While Korea has participated in multilateral negotiations, it has adopted, somewhat belatedly, a multi-track approach to regional trade arrangements.4 Of these arrangements, the Korea-U.S. FTA is the most important. A comprehensive FTA would lead to greater economic growth, consumer welfare gains, production surpluses, and job creation for both countries through increased trade and investment. It is well-documented by various think tanks that a deal would be mutually beneficial for both economies.5

 

The Doha Round under the World Trade Organization aimed to boost the global economy by lowering trade barriers across all sectors, with particular emphasis on helping poor countries develop through export growth. Unfortunately, the global trade liberalization talks were suspended indefinitely in July 2005, bringing an end to more than five years of talks, largely due to subsidy disputes as members of the G6 (the US, the EU, Japan, Australia, India, and Brazil) failed to agree on rules for farm and industrial goods. While the U.S. and the EU disagree on where to place the blame for the rupture, many experts predicted that the indefinite suspension of the Doha round would trigger numerous bilateral and regional trade deals.

 

An FTA between the U.S. and Korea and the subsequent impact on other possible FTAs in East Asia could even help revive the oha round by the back door, which is also a U.S. priority.6 This means that the bilateral pact should be consistent with the WTO, complying with Article XXIV in GATT and Article X of the GATS.7 Perhaps, the U.S. can utilize the KORUS FTA to set a benchmark with other important countries elsewhere.

 

U.S. LEADERSHIP AS THE ANCHOR ECONOMY IN AN INTERDEPENDENT EAST ASIA

 

Both countries needed to make strategic decisions on the free trade pact if they were to push it through within Bush fast-track time constraints. Both needed to make concessions to iron out a deal but it was never easy. In general, bilateral high-quality FTAs tend to be concluded rather quickly with more aggressive concessions initiated by the anchor economy. In this case the deal does not qualify as high-quality.

 

Many Koreans believe that despite strong domestic opposition, Korea has preemptively resolved long-standing U.S.-Korea bilateral trade issues, including reducing the existing screen quota by half, resumption of boneless beef imports, and easing barriers for U.S. automobiles. This is seen as a clear indication that Korea was determined to push a deal through.

 

Needless to say, the U.S. economy is the most advanced and open economy in the world, 17 times larger than Koreaã…¤ and also the most important rule-setter for global trade. Because of this economically asymmetric relationship, the Korea-U.S. negotiation is viewed by many Koreans as fight between whale and shrimp, to borrow from a traditional Korean proverb.

 

The average tariff rate in 2004 on entire sectors, including agriculture and fisheries, were 11.9% for Korea and 4.9% for the U.S. Of course, the difference indicates a relative degree of openness but more importantly they reflect the relative stage of development of the two countries and the requirement that Korea undertake further painful restructuring of its economy.

 

As the KORUS FTA talks moved to a final destination, Koreans remain deeply divided but the feeling is that more support the deal than oppose it. But some prominent economists argue that Korea is not ready for the deal and that it should be suspended. Korea needed more time to settle crucial details, some would argue, and a number of nationalist intellectuals warned that the FTA would make Korea the 51st state of the U.S., losing its economic sovereignty.

 

Rather than see the negotiations stalled due to impasses over concessions, a edium quality FTA was a better option than suspending talks indefinitely. In this regard, the U.S. needed to take a leadership role by making concessions in order to conclude the bilateral talks within the deadline.

 

U.S. INTEREST IN EAST ASIA BEYOND THE KORUS FTA

 

The U.S. needs to recognize that East Asian economies are increasingly coming under China influence, requiring them to adjust to a China-dominant integrated East Asian economic landscape. Due to the rapid growth of China export-oriented economy, the trade interdependence in 2005 of Asean +3 (China, Japan, Korea) is greater than the inter-regional dependence of NAFTA and it is likely to approach that of the EU, as shown in Table 2.

 

2

 

With China being Korea largest trade partner and investment destination, the trend is clear. As the gravity model in economic theory suggests, the geographical proximity between China and Korea can explain why.

 

Furthermore, China triggered intra-East Asian FTAs by proposing a China-ASEAN FTA in 2000. Two years later, Japan followed suit to maintain Japanen bloc in East Asia. Korea also joined the Intra-East Asian FTA bandwagon. In this way, China, Japan, and Korea have all been sending out mating calls to ASEAN.8 At present, a de-factouan bloc is emerging between Southern China and ASEAN economies dominated by overseas Chinese businessmen, despite U.S. influence. In this regard, a KORUS FTA can serve the U.S. as not only an effective link to the emerging East Asian economic community, but as a counterbalance to China expanding economic power.

 

However, we need to recognize that China economy is still operating under a legacy of socialist economic management, and largely perfunctory intellectual property rights enforcement. A KORUS FTA also is likely to serve as an example of a mature democratic market economy for China as it approaches on-going and potential FTA negotiations in Asia. Given this strategic value for the KORUS FTA, the U.S. needed to avoid being seen as a capricious power driven by narrow domestic interests and ideological imperatives.

 

At this point, it is worthwhile to take a look at the leadership Beijing displayed in forging the China-ASEAN FTA agreement. Here, China offered an early arvest Package to less developed economies within ASEAN by eliminating tariffs for about 280 agricultural products. Perhaps, this could be seen a political decision by an anchor economy to implement an FTA that satisfied mutual interests.

 

In view of the rapidly changing geo-economic dynamics in East Asia, it is very encouraging to note a convincing remark by Deputy U.S. Trade Representative Karan Bhatia, who was the head the U.S. delegation at the final ministerial negotiation in Seoul. He told a U.S. congressional hearing just before the high level talks:9

 

Any let-up in focus that results in our inability to complete agreements with major emerging-market economies like South Korea could have unfortunate consequences. It would likely result in a shift of the region attention from strengthening their relationship with the United States to doing deals with other major trading partners. A successful FTA pact with South Korea could provide an important boost to U.S. efforts to remain an active economic presence in a strategically vital East Asia region.

 

KOREA'S HOMEWORK

 

Given strong opposition from domestic osers, the Korean government must not waste any time coming up with a viable structural adjustment program for agriculture and the service sector. Unless domestic negotiations with losing sectors — a difficult task in a presidential election year — comes through successfully, there is no guarantee that the Korean National Assembly will ratify the deal.

 

It should also be pointed out that the KORUS FTA is not a panacea for resolving Korea recent structural economic stagnation. In the past four years, Korea potential growth rate has continued to fall due to a rapidly aging population, the lowest birth rate among OECD members, and very sluggish growth in domestic investment. In the first half of the year, Korea outbound FDI was $ 7.1 billion, whereas inbound was just $ 4.9 billion. This was the first time that outbound FDI exceeded inbound FDI, a worrisome development. Furthermore, the growth rate of capital formation in the same period was only 2.9% a year, dropping very sharply from 5% annual growth the previous decade. What can we do to improve the situation? On the one hand, Seoul needs to encourage Korean firms to invest more aggressively at home. On the other hand, Korea should continue a policy of proactively seeking more foreign direct foreign investment.

 

After the Asian financial crisis, Korea changed its traditional policy of borrowing foreign capital to finance domestic investment projects to an FDI-inducement policy, in part to adhere to the IMF mandate and partly to meet Korea own need to become fully integrated with the globalizing world economy. Indeed, Korea has been very active in attracting foreign investment by setting up comprehensive service institutions to provide one stop service.10 In this regard, Korea is still learning how to attract foreign capital and the country needs a more transparent legal framework, better practices and a foreign-investor friendly environment. In this context, Koreans should view KORUS FTA as an offensive tool to upgrade Korea socio-economic system.

 

Hyundai Motor Co. invested US $1 billion and created 7,000 new jobs in Montgomery, Alabama two years ago. Similarly, larger scale inbound FDI commitments of U.S. companies into Korea, especially in the R&D and high tech sectors, clearly demonstrate to the Korean public that an FTA is beneficial for Korea both to upgrade its economic infrastructure and to create jobs, which Korea needs very badly.

 

SHARING COMMON VALUES

 

In the years to come, through bilateral FTAs, the U.S. and Korea can work together to spread the values of democracy and a market economy in East Asia, which remains a region filled with old legacies. In response to an increasingly dynamic and powerful East Asia, with its identity awakened after the 1997 financial crisis, the U.S. must view itself as an Asia-Pacific power and join in all aspects of life in Asia.

 

Concluding this free trade deal between the U.S. and Korea was a tough, slow grind for both sides but it should renew and cement the relationship between these two old allies. What began in the ashes of war is now ready to enter a new phase of economic partnership between two modern nations facing the challenges of the 21st century.

 

Choong-yong Ahn, who is on the Editorial board of Global Asia, serves as Chair Professor of the Graduate School of International Studies, Chung-Ang University, and the KOTRA Foreign Investment Ombudsman; he is a former President of the Korea Institute of International Economic Policy.


Notes

1 Korea Herald, March 13, 2007

2 U.S.-Korea Business Council and American Chamber of Commerce in Korea, US.-Korea Free Trade Agreement Position Paper p.6

3 See Ahn (2001) for details of Korea financial and corporate sector restructuring since the Asia financial crisis

4 Compared to other East Asian neighbors, Korea is a latecomer in concluding FTAs. The first Korean FTA partner was Chile (April, 2004), and then Singapore (March, 2006), EFTA (September, 2006), and ASEAN (May, 2005)

5 Korea Institute for International Economic Policy has done a series of KORUS impact studies

6 An FTA covering in trade in goods may be considered WTO-consistent under Article XXIV if it covers substantially all trade and other regulation, and if there is a clear implementation period of normally not more than 10 years, and if external barriers to non-members are not raised as barrier to members are reduced

7 An FTA covering in trade in goods may be considered WTO-consistent under Article XXIV if it covers substantially all trade and other regulation, and if there is a clear implementation period of not more than 10 years, and if external barriers to non-members are not raised as barrier to members are reduced

8 For the proliferation of sub-regional FTAs and subsequent implications, see Ahn & Cheong (2007 forthcoming)

9 Korea Times, AFP Report March 22, 2007

10 For this purpose, the Korea Trade-Investment Promotion Agency (better know as KOTRA), Invest KOREA and the Foreign Investment Ombudsman, KOTRA


References

Ahn, Choong Yong. 2001. "Financial and Corporate Sector Restructuring in South Korea: Accomplishments and Unfinished Agenda," Japanese Economic Review, 52(4), December.

_____ 2001. "Search for Robust East Asian Development Models after the Financial Crisis: Mutual Learning from East Asian Experiences," Journal of Asian Economics, 12(3).

Ahn, Choong Yong and Cheong, Inkyo (2007 forthcoming). "Search for Closer Economic Relations in East Asia," Japanese Economic Review.

U.S.-Korea Business Council and American Chamber of Commerce in Korea. 2006. U.S.-Korea Free Trade Agreement Position Paper.

Back to Issue
    With several deadlines coming and going and negotiators for both sides involved in highstakes brinkmanship, South Korea and the United States finally concluded a historic bilateral free trade agreement on April 2. It is the biggest such deal ever for Korea and the largest for the U.S. since NAFTA in 1993.
    Published: Mar 20, 2007
    About the author

    Choong Yong Ahn is Chairman of the Korea Commission for Corporate Partnership and Distinguished Professor at the Graduate School of International Studies, Chung-Ang University, Seoul.

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