By Troy Stangarone
South Korea’s ambition to become a regional free trade hub in East Asia took another step towards reality as South Korea and China announced the outline of a conclusion of their bilateral FTA negotiations at the opening of the 2014 APEC summit. Once the FTA has been implemented, Korea will find itself in the unique position of having an FTA with the two largest developed markets in the United States and the European Union, as well as the world’s largest developing market, China.
While a significant achievement, the Korea-China FTA is still a work in progress with details still to be finalized and the prospect that some provisions could be negotiated further in the future. Despite these issues, there are three questions that come to mind when considering the Korea-China FTA:
Is the Korea-China FTA part of a challenge to the U.S. led economic system?
With China playing an increasingly prominent role in East Asia and its recent establishment of the Asia Infrastructure Investment Bank (AIIB), questions are being raised about U.S. economic leadership in the region. The AIIB, which the United States has discouraged its partners in the region from joining unless it meets the standards of established international lending institutions, is seen by many as an effort by China to develop an alternative economic structure for the region in which it offsets the influence of the United States. This narrative is further strengthened by the failure of President Obama to secure the Trade Promotion Authority needed to conclude the Trans-Pacific Partnership and establish an FTA covering much of the Asia-Pacific region. However, does the Korea-China FTA fit into this broader narrative of declining U.S. influence and increasing efforts by China to develop an alternative economic structure?
According to the Wall Street Journal Liu Qiao, assistant dean with the Guanghua School of Management noted that “Beijing wants to show it has friends in the region,” and the Korea-China FTA is … “is more symbolic. The advantage is, they want to bolster their trade partners in the region, starting with South Korea and then others.” While Andrew Collier, managing director of Orient Capital Research and former president of the Bank of China International’s U.S. office remarked that “China is eager to replace the U.S. trade clout and influence in the region and this deal with South Korea is another nail in the coffin”.
Additionally, the New York Times quotes Patrick Low, formerly chief economist of the World Trade Organization, “It’s a real attempt to exert leadership and to project a responsible image in wanting to lead the whole of Asia — they’re all very much linked politically,” in regards to the AIIB, the South Korea FTA, and other trade deals that China has pursued.
While perhaps understandable that some analysts might reach this conclusion given current trends in the region, it fails to understand the broader issues at play. The Korea-China FTA rather than an effort to undermine the U.S.-led economic order is in fact an effort by China to draw even with the U.S. in its trading relationship with Korea. After the conclusion of the U.S.-Korea FTA, China immediately announced that it would like to begin negotiations with Korea on its own FTA. However, rather than enter into negotiations with Beijing, Seoul instead chose to open talks with the European Union on a free trade agreement. It was only after the KORUS FTA and the EU FTA had been approved by all of the respective parties that Korea engaged in its FTA with China, which it did so as part of its own strategic efforts to become a hub for FTAs in the region. Korea is now the only country with an FTA with the three major global trading powers.
At the same time, in contrast with its skepticism regarding the AIIB, the United States has consistently supported South Korea’s efforts to conclude a high quality FTA with China. Any agreement with China that moves Beijing closer to international standards on trade and investment, while further opening the Chinese market, reinforces rather than undermines the current global economic system.
How Does the Korea-China Compare with Korea’s FTAs with the United States and the European Union?
South Korea’s FTAs with the United States and the European Union are two the highest quality FTAs in the global trading system. How does the recent agreement with China compare to those two agreements?
In the first 10 years of the agreement, South Korea will eliminate tariffs on 79 percent of its products, while China is expected to eliminate tariffs on 71 percent of its products. After 20 years South Korea is expected to eliminate 92 percent of its tariffs and China 91 percent. In contrast, under the KORUS FTA 95 percent of all trade becomes duty free after 5 years with nearly all remaining tariffs being eliminated after 10 years. At the same time, Korea’s FTA with the EU immediately eliminated 82 percent of Korea’s tariffs and 94 percent of the EU’s tariffs. After seven years both South Korea and the EU will eliminate 98 percent of tariffs, with the EU eliminating 99.6 percent tariffs.
Beyond the quicker and more significant phase outs, there are additional details that make the agreement with China less ambitious than other agreements South Korea has signed. Under the KORUS FTA Korea eliminated 92.5 percent of its tariffs on agriculture and fisheries, while only 40 percent will be eliminated in the agreement with China. In addition, 30 percent of Korea’s tariffs by value on agriculture and fisheries have been permanently excluded from the agreement, something which South Korea has not previously done in its FTAs. While this reduces the ambition of the agreement, it likely will help to ease concerns among farmers who had been strongly opposed to the agreement.
Additionally, what makes Korea’s FTAs with the EU and the United States of such high quality is their provisions on services and investment. One of the key achievements of the Park Administration was the announcement at the 2013 Park-Xi summit that both sides would negotiate on these issues simultaneously with the negotiations on goods and seek a high quality agreement. Many of the details on services and investment have yet to be announced, but we should expect that as in goods that they will be significant, but not to the same level of standards as the KORUS or EU FTAs.
While no one expected Beijing to be ready for the standards of the United States FTA with South Korea or that are being negotiated in the Trans-Pacific Partnership, the initial Korea-China FTA reports do seem to indicate a significant step forward in trade policy for China. If later details indicate that South Korea secured significant provisions, even if not to the standards of KORUS and the EU FTA, the Korea-China FTA could be an important achievement for Korea in securing access to the Chinese market while also moving China closer to international standards on free trade.
What Does the Korea-China FTA Mean for North Korea?
As China is North Korea’s only significant partner, it is natural to ask what the agreement means for North Korea. Initial reports indicate that China agreed to South Korea’s request to include goods from the Kaesong Industrial Complex in the FTA. Unlike many of South Korea’s other FTAs, the goods will not be limited to a select number or items or future approval as with Korea’s FTAs with the EU and the United States.
The inclusion of Kaesong in the FTA could serve as a boost to North and South Korean efforts to internationalize the complex as it removes any disincentive that China’s current tariffs may have on shipping goods from Kaesong and recognizes them as South Korean. While significant issues related to internet access and the political risk of operating in North Korea, but the prospect of duty free access to the Chinese consumer market from the zone could enhance its appeal to foreign investors.
One issue that is unclear at the moment is if China’s economic zones, such as in Rason, have been included in the agreement. If so, and the ability to produce across the zones is encouraged, it could serve as a catalyst for needed infrastructure investment in North Korea to move goods between the zones, while at the same time helping to reduce the political risk of foreign firms operating in Kaesong as a production halt in one zone would impact production in another. Hence, by coupling the zones together it raises the political risk for North Korea in shutting down Kaesong in the future as it could potentially impact Chinese firms operating in zones along the border with China.
Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are the author’s alone.
Photo from Korea.net’s photostream on flickr Creative Commons.