[University]Columbia University Networks Global Alumni
By Kwak Soo-jong
Research Fellow, Samsung Economic Research Institute
The KORUS FTA was agreed upon on April 2 after an arduous period of negotiation. The FTA is highly significant for Korea in terms of its economic and political implications. Korean firms now have chances to leverage new opportunities to enhance their international competitiveness and prospects for growth.
The accord needs approval from each country’s respective legislature and must be signed by both presidents before it can be officially implemented. The entire ratification process will proceed as follows.
First, Korea and the U.S. will write legislative bills based on the signed FTA agreement. A committee of the National Assembly of Korea and a committee of the U.S. Congress will review the bills.
At that point, each country’s president will sign the text, which will then be deliberated by the Assembly and Congress who will ultimately decide whether the bill will be put to a vote. The final text and the law, being ratified and approved, will be signed by both presidents and then implemented.
Currently, however, substantial opposition exists in both countries to the proposed FTA jeopardizing its passage. In particular, vulnerable industries, trade unions and civic groups in Korea have voiced opposition to the FTA.
Meanwhile, numerous influential legislators in the U.S. have also expressed disappointment regarding certain provisions in the FTA and threatened to block its passage. In particular, politicians from auto and beef producing states have expressed opposition unless Korea agrees to further liberalize beef and auto markets. The AFL-CIO also voiced dissatisfaction over the proposed FTA, noting the bilateral trade imbalance of cars, designation of an ``outward processing zone,’’ which will acknowledge products made in the Gaeseong Industrial Park as South Korean-made, and no enforceable protections for core workers’rights.
In spite of these obstacles, the KORUS FTA is expected to be ratified in late 2007 at the earliest and 2008 at the latest. In Korea’s case, President Roh’s strong commitment to the FTA, coupled with its strategic importance, puts the odds of passage around 55-70 percent before the end of 2007. Without a clear deadline and with an upcoming contentious presidential race, though, it is possible the ratification process will extend into 2008.
The possibility of the FTA ratification looks brighter in the U.S., based on robust support from the business community and possible adverse effects from ratification failure. There is a possibility, however, that discontent amongst powerful constituencies may delay the FTA’s passage until 2008.
Impact of KORUS FTA on Major Industries
The US, once Korea’s largest export market, has fallen to number two in 2004 due to burgeoning economic ties with China. Accordingly, Korea’s market share in the U.S. import market decreased from 3.3 percent in 1995 to 2.5 percent in 2006, in a sharp contrast to the increase from 6.1 percent to 15.2 percent in China’s market share. Even though Korea enjoyed brisk exports in some industries such as cars and semiconductors, it recorded poor export performances in a number of industries including textiles because of deteriorating competitiveness.
For example, the growth rate of textile exports to the U.S. has been shrinking every year, with minus 18.1 percent and minus 14.3% growth rates recorded in 2005 and 2006 respectively. The FTA will serve as the best chance for Korean firms to restore their competitiveness in the U.S. market, if they wisely take advantage of the pact. Therefore, it is imperative that companies leverage opportunities provided by the agreement.
The FTA will have a different impact across industries based on the final tariff agreement. The auto and textile industry export competitiveness to the U.S. will strengthen, as high tariffs on imported goods will be removed. In the machinery industry, both countries have considerable room for cooperation due to technologically complementary relationship of both countries.
The pharmaceutical industry will likely experience wide-scale restructuring as the result of lower tariff barriers for imported drugs. Broadcasting and communications industries will not be opened up by the FTA, but have to allow U.S. companies’ operation in Korea. Textiles, cars, pharmaceutical, machinery and broadcasting/communications will be affected most by the FTA in this order.
In the auto industry, Korea has agreed to tariff elimination as well as streamlined taxation system. Korea has to remove tariffs instantly on all products except for environmentally-friendly cars (for which a 10-year grace period is granted). The U.S. pledged to immediately abolish tariffs on passenger cars with an engine capacity below 3,000cc and auto parts. Tariffs on passenger cars with an engine capacity of over 3,000cc will be phased out within three years and pickup trucks within 10 years. Korea will simplify both the Special Consumption Tax on autos and the Annual Vehicle Tax into three tax rates. It has also agreed to the rule of origin for cars, safety and environmental standards, innovative expedited dispute settlement process and cooperation for harmonizing standards.
The FTA will expand automobile exports to the U.S. further while intensifying competition domestically with some (but not considerable) increase in car imports from the U.S. Korean firms are advised to come up with a mid- to long-term strategy to take the FTA as opportunities to develop top quality pickup trucks and other higher-priced products. In the short run, it ought to draw up a plan to take advantage of higher revenues from increased exports and lower tariffs in developing environmental technology and enlarging sales networks. This will help enhance the brand image of Korean cars in the U.S. market.
In this area, Korean companies will have some time to boost competitiveness as the Korean market will open up more slowly than the U.S. market. According to the final text, the U.S. has to scrap tariffs on 82.1 percent of industrial machinery immediately after the implementation of the FTA, compared to Korea’s 38.3 percent. Besides, the two countries have a highly complementary relationship in this industry. Korean companies mostly specialize in general-purpose machinery and parts while their U.S. counterparts specialize in dedicated machinery. This means that under the FTA, Korean companies may increase export of processing machine tools (which are representative general machinery) to the U.S. where
they compete with Japanese firms, taking advantage of enhanced cost competitiveness coming from the FTA.
Imports of some machinery from the U.S. will significantly increase as Korean firms shift the procurement source from Japan to more cost-competitive U.S.
In this area, Korean companies are advised to pursue a growth strategy through which they will become the supply base for the U.S. of the next-generation machinery parts for environmental technology and alternative energy source development. Currently, the U.S. companies lead the competition in basic technology, but are so far behind Japan and Germany in cost competitiveness that they see even the base of their industry shaking.
Against this backdrop, with their technology rapidly improving, Korean companies can take a chance to emerge as cooperation partners with their U.S. counterparts in terms of parts and products development.
Regarding textiles, both sides have agreed to eliminate tariffs, to partially waive the Yarn Forward Rule 3 and to retain a provisionary 10-year safeguard on textile exports to the U.S. Korea is supposed to remove tariffs on 85.4 percent of U.S. textiles within the three-year period; the U.S. will abolish tariffs on 61.2 percent of Korean textiles immediately.
As for the remaining 38.2 percent, the U.S. will lift tariffs on 18.6 percent within five years and on the final batch within 10 years.
Yet, Korea has gained by excluding items that cannot meet the Yarn Forward rule or for which yarn supply is not adequate from the rule. Tariffs elimination as a result of the FTA is expected to raise Korea’s textile export to the U.S. while making little change to import from the U.S. since garments imported from the U.S. could most probably be very highly priced ones.
After the FTA is in place, the textile industry of Korea may use it as a good opportunity to increase sales in the U.S. market. To this end, they had better upgrade their products to high value-added ones by improving productivity and using technological cooperation with the U.S. They could enhance productivity by establishing the vertical production network ranging from yarn to textiles to apparel and the vertical integration for export ranging from textiles and dye to sewing to converters.
This is because the vertical network and integration will help differentiate their products from other countries, especially China. Also, it would be a good idea for Korean companies to consider strengthening strategic partnership with or acquire U.S. companies with high brand power.
In pharmaceutical patents, Korea and the U.S. have agreed that Korea will bring patent protection up to the global standard. They have also agreed in principle to set up a system to suspend the approval process of a generic drug when the original developer files a complaint about patent violation against a generic maker that applies for product approval. Under current U.S. law, a patent infringement suit leads automatically to a 30-months suspension of the drug approval process.
Stronger patent protection will reduce the market share of domestic generic drugs and even may drive some generic makers out of the market. This, coupled with Korea’s positive list system (only cost-effective drugs will be covered by the National Health Insurance), will likely intensify competition in the Korean pharmaceutical market and lead to wide-scale industrial restructuring including massive M&A among drug manufacturers.
Following the FTA ratification, all these mean that Korea’s pharmaceutical industry needs to enhance productivity and efficiency through restructuring. But there are some bright spots. Korean companies now can bet on the possibility of mutual recognition arrangement (MRA) on generic drugs. The conclusion of the FTA has laid the foundation for Korean pharmaceutical companies to be able to comply with international GMP (good manufacturing practices).
Generic drugs made by Korean companies are not yet recognized as generic internationally, but under the FTA, Korea and the U.S. have agreed to work together for U.S. recognition of Korean generic drugs. Korean firms should take advantage of this opportunity to enter the U.S. market. As for original drugs (new ones), Korean companies are recommended to look to and focus on a niche market for new biodrugs. Korea has already numerous bio-tech companies that can easily enter biodrug business. Related, they may consider enhancing their market recognition in a short period of time through M&A with U.S. bio-pharmaceutical companies.
The U.S. agreed to keep market access at the current level without further opening measures. At present, the U.S. broadcasting and communications market is open to foreign investors except in the area of wireless telecom. In that industry, foreign investors are allowed to take shareholdings up to 20 percent, but face no limit in making indirect investment. They can also turn to MVNO (Mobile Virtual Network Operator).
Under the FTA, shareholding ceilings that used to be imposed on foreign investors will be removed for Korean telecom service providers (excluding KT and SKT) and program providers (except for news, general service and home shopping).
This is the only substantial market opening provision under the FTA. Besides, Korea will ease partially ``domestic content requirement’’ (the broadcasting quota) and ``one nation quota.’’ All in all, the FTA will have little effect on Korea’s telecom market. But, regardless of KORUS FTA or not, Korean firms need to look outside. Korea’s telecom market is almost saturated. Therefore, it is high time that Korean telecom service providers and program providers should give a serious thought to advance into foreign countries.
The U.S. market will be a good starting point since it is the world’s largest telecom market and has recorded a higher growth rate than those in the other developed nations. They can count on the fact that Korea leads the world in the advanced telecom services such as the third generation (3G) telecommunications and Internet Protocol Television (IPTV). Particularly, in the area of wireless broadband Internet, they can team up with their U.S. counterparts. The lifting of shareholding ceilings will also help. In the long term, Korean program providers may export their contents to the U.S. market, largely in Asian Americans communities.
Companies’ Potential Response Strategies
After the KORUS FTA ratification, companies will be the main focus of attention. They may use the agreement to go out of the ``nut cracker’’ situation. Recently, Korean companies have been likened to ``nuts that are squeezed in a nut cracker.’’ They are being relentlessly chased by Chinese competitors in terms of cost competitiveness and by Japanese firms in terms of technological prowess. Judging from the details of the agreement, even most of benefits to Korean companies will be concentrated for only five years after it takes effect.
Therefore, they had better be armed with refreshed mindset of ``offense’’ rather than ``defense’’ to make the maximum opportunities opened by the FTA and to become a serious player in the U.S. market.