By Sharon Lam
The conclusion of Korea-U.S. FTA effective March 15, once again marks Korea’s success in launching trade deals with its major trading partners.
Amongst Korea’s top five trading partners, Korea has signed FTAs with three of them, namely EU, the U.S. and ASEAN, which accounted for 33 percent of Korea’s exports in 2011 and have brought in a total of $61.7 billion trade surplus (5.6 percent of GDP).
We see three positives that FTAs will bring to the Korean economy:
FTAs will help increase Korea’s competitiveness both externally and internally. The impact of an FTA on external competitiveness is straight forward. By eliminating or reducing import tariffs, it makes Korean products cheaper and therefore more competitive in that market. This will further boost its market share gains on top of the Korean won depreciation in recent years and ever improving product quality. Reducing transaction costs will also allow more room for Korean producers to undertake marketing campaigns.
FTAs will also help to raise Korea’s competitiveness internally and to develop its service sector productivity. Korea will have to open up its service sectors including legal, accounting, financial services and entertainment industries, under the FTAs. Some people are critical that the opening up of Korea’s service sector will weaken these industries as they will face tougher competition from overseas operators.
However, we believe this will help raise the competitiveness of Korea’s service industries as they have to embrace global standards. One good example is the opening up of the retail sector some years ago that brought in the global supermarket chains, Walmart and Carrefour. This did not destroy the local retailers as feared, but rather motivated them to upgrade to outgrow the foreign competitors. Korea needs to speed up the development of its service sector which is falling behind its top-notch manufacturing sector.
FTAs can help to attract more foreign direct investment (FDI) into Korea. Korea has been losing FDI in the last decade to countries with cheaper production costs, namely China and some other emerging countries. Now with its stronger access to the two largest consumer economies in the world, it gives incentive for foreign manufacturers to produce in Korea in order to enjoy the eliminated/reduced tariff in EU and the U.S. This is especially so, since Korea is the only Asian country that enjoys such a privilege. It will become attractive for foreign manufacturers who are considering establishing a production base in Asia. Even though this privilege may not be permanent, Korea definitely benefits from first-mover advantage.
FTAs will benefit domestic consumers over the long run. The immediate and direct impact on manufacturing and service industries can easily be seen as mentioned above. Nonetheless, we believe ultimately the biggest beneficiaries of FTAs will be consumers over the long run as their purchasing power will be enhanced by cheaper imports. For example, Korea’s food prices are among the highest in the world. Introducing cheaper imports can save food bills for the average consumer in Korea. More importantly, consumption dynamics will be improved through increased competition and increased selection. We think rising consumer power is particularly essential for an aging society like Korea. To maintain growth, Korea needs to have a more vibrant consumption sector in order to raise its living standards to counter against the decreasing population.
What’s next? Although we think the economic benefits from the FTAs that Korea have concluded are significant, it would be unfair to ignore the sectors that could be potentially hurt, such as the agriculture sector in Korea. The government will need to subsidize farmers not just by compensating them in monetary terms, but it should also help them to improve productivity. Amongst its top five trading partners, there are two countries that Korea has not concluded FTAs with ― China and Japan. China is Korea’s largest export destination and Japan is fifth. Although Korea is in talks with both countries on free trade deals, we believe they will be more complicated than other FTAs since China and Japan are also Korea’s competitors in the global market.