Tariffs will be phased out on almost all imports and exports within three years

By Dilip K. Das

South Korea has earned accolades for being an economic success story. Since the latter half of the 1960s, Korean economy turned in stellar export performance.

This performance was supported by a liberal domestic external regime, robust growth in multilateral trade volume under the sponsorship of the various rounds of multilateral trade negotiations (MTNs) of the General Agreement on Tariff and Trade/World Trade Organization (GATT/WTO), improvement in the competitiveness of large firms in Korea and availability of large open markets in the European Union (EU) and the United States.

Geographically Korea is a small-size country, with only 0.7 percent of the world population. It is a medium-sized economy and the seventh largest trader in the world. In 2010, value of its merchandise exports ($466 billion) was close to that of France ($521 billion), a mature industrial economy. It accounts for 3.1 percent share in multilateral exports.

This performance is not far behind France, the 6th largest economy with 3.4 percent share in the multilateral exports. Korea’s top trading partners are China, the EU, the U.S. and Japan, in that order. The EU is the largest trading bloc of 27 countries, accounting for $1,787 billion in exports, which is 15.0 percent of the multilateral exports.

EU-Korea goods and services trade

In 2009, the EU was the second largest market for the Korean exports accounting for 13 percent of total Koran exports, after China which accounted for 24 percent. The EU is the third largest source of Korean imports accounting for 10 percent of the total, China (17 percent) and Japan (15 percent) account for higher proportions.

During the 2000-09 decade, EU-Korea trade grew at an annual rate of 8.4 percent. Please note that 2009 was a financial crisis year and global trade had contracted by 12 percent and Korea EU trade had also contracted. Since 2005, in terms of volume, EU-Korea trade as been higher than Korea-U.S. trade.

Principal export items from Korea to the EU are automobiles, semiconductors, computers, ships and wireless telecommunications devises. The EU exports machinery, semiconductors, jewelry and a range of chemicals.

An overwhelmingly large proportion of EU-Korea trade is in manufacturing products. Over 80 percent of EU exports to Korea came in this category. So did 87 percent of Korean exports to the EU. Machinery and transportation equipment were the principal items for the two sides. The same product range dominating trade of the two partners implies intra-industry trade, which implies export and import of the same products or similar products within an industry. This reflects vertically integrated production and trade networks that operate in Korea and the firms in the EU are involved in it.

Although bilateral trade in services also increased, it is smaller than that in merchandise. EU exports in the services sector increase 42 percent over 2004-08 period, while Korea’s export of services increased by 36 percent over the same period.

The two sides exported to each other the same set of services, namely, transportation services, business services, travel and receipts and royalties from the use of intellectual property. Although the EU is a provider of financial services to Korea, there is little reverse trade in financial services. While Korea has enjoyed a surplus in trade in merchandise since 1999, the EU has had a substantive surplus in trade in services. This medium-term trend has persisted.

Creating a free trade agreement

Korea is an attractive bilateral FTA partner for the EU from an economic and non-economic perspective. In the early 1960s it was a penurious agricultural economy. It succeeded in transforming itself into a successful industrial economy by the 1990s. Korea impressed the academic and policymaking conclaves around the globe by its economic dynamism.

According to the World Development Indicators 2011 Korea’s 2009 per capita income in current dollars was $19,830, which is comparable to countries like Portugal ($21,910) and several new EU members.

No doubt it was almost half that of the EU ($34,358) average. Measured in purchasing power parity (PPP) terms it was $27,249. With GDP of $16.4 trillion, the EU is the largest global economy. It is also the largest trading group in the global economy; its market size is approximately eighteen times larger than that of Korea.

There is strong economic rationale for Korea to pursue an FTA with the EU because it is a credible instrument for expanding its exports and increase GDP. The external sector is an important source of growth and employment for the Korean economy. In the recent years, exports were more than 45 percent of the Korean GDP.

Under the FTA protocol, tariffs and non-tariff barriers (NTBs) are to be lowered and eliminated in a phased manner over a transitional period. This would enable domestic producers to adapt to lowering of existing trade restriction. Implementation of the FTA protocol will benefit consumers in both countries by lowering the prices and producers by enhancing competitiveness.

Wide coverage

The EU-Korea FTA is a comprehensive one. It is expected to phase tariffs out on 96 percent of imports from the EU to Korea within three years and almost all (99 percent) Korean exports will enter the EU without any tariffs. The objective is to lift all tariffs, with minor exceptions, in five years on trade in manufactured goods.

The FTA also addresses NTBs on trade in manufactured goods, agricultural products and services. Tariffs on trade in autos will be eliminated in three to five years, which will benefit auto trade in both the economies.

Coverage of FTA also includes services, harmonization of regulatory measures and provisions on investments both in services and industrial sectors. The EU took a great deal of interest in the liberalization of services sector.

The EU negotiators carefully studied the on-going negotiations of the Korea-U.S. FTA and pressed for at least comparable degree of liberalization in the services sector. The finally agreed to gradually opening up several services sectors, including legal services. Korea also consented to reforming the domestic legal system.

The two FTA partners will allow wider market access to each other in telecommunications and environmental services markets. Trade-related activities as government procurement, strong discipline in intellectual property rights, labor rights and environmental issues have also been included in the EU-Korea FTA. In trade parlance such a comprehensive coverage makes this FTA a something of a “deep” regional integration endeavor.

Sensitive sectors

There are sensitive sectors for both the partners. Given its recent history, automobiles are a highly sensitive sector for the EU. There were apprehensions among trade economists that the FTA may not be ratified by the European Parliament because of its effect on the European auto industry. There was a misperception among European policy makers that the FTA would result in a Korean car invasion of its auto markets.

Services, agriculture and processed foods were the sensitive sectors for Korea. Therefore Korea secured special treatment on rice and barley in the FTA. Korea has been given a long enough period to make transitions in its agriculture sector. The forthcoming reforms in the common agricultural policy (CAP) may turn out to be beneficial for Korea. Businesses in Korea will need to quickly prepare for wine and pork imports from the EU to Korea.

The EU-Korea FTA is being seen as the first of the “new” FTAs, or a “next generation” FTA. Conventional FTAs focus on tariff reduction and they completely avoid sensitive sectors. The EU-Korea FTA is a departure from the conventional type and is more ambitious than the previously concluded FTAs with ASEAN and EFTA. It focuses on the NTBs. For both the FTA partners NTBs are a nuisance in that they have become significant barriers to trade.

According to one estimate, they have the protection effect of a tariff level of 76 percent in Korea and 46 percent in the EU. Average tariffs in both are fairly low. Owing to various rounds of MTNs and unilateral trade liberalization tariff barriers are low in most large trading economies. In Korea they are 12.2 percent and in the EU 5.6 percent.

Dilip K. Das is the director of Institute of Asian Business at SolBridge International School of Business, Woosong University, in Daejeon.