By Troy Stangarone
On May 2, Korea and China announced that they would begin talks on a bilateral free trade agreement. In many ways, this is a significant step in bilateral relations between Korea and China. The two countries only formally established relations in 1992, and in two short decades the relationship has blossomed on an economic level. In 1992, Korea and China did very little trade with each other, but today China is Korea’s largest trading partner surpassing the United States, Japan, and the European Union by wide margins.
A Korea-China FTA would link Korea with its largest trading partner, but would also make Korea the only nation with free trade pacts with the world’s three largest economies – the United States, the European Union, and China, potentially turning Korea into a regional FTA hub. With talks set to begin soon, what should we expect from a Korea-China FTA?
1. What Will a Korea-China FTA Look Like?
While Korea has pursued high level, comprehensive agreements with the United States and the European Union, an FTA with China will likely fall short of that standard. China has largely pursued FTAs for strategic reasons tied to geopolitical or resource considerations rather than broad market openings. While China did conclude a high quality agreement with New Zealand, Korea is a much larger economy and China may be reluctant to make concessions on major trade irritants related to subsidies, state owned enterprises, or regulations outside of a multilateral agreement.
This means that we are likely to see a range of exceptions in this agreement, and along those same lines both sides have agreed to negotiate in two stages. If they are unable to agree on what exceptions should be contained in the agreement, it will not proceed forward. One interesting thing to look at here will be the services sector. China has excluded services in some of its agreements, but with Korea’s increasing emphasis on services the inclusion of a robust services chapter could be a sign of a higher level agreement on the Chinese part.
2. What Are the Benefits for Korea of an FTA with China?
While countries such as the United States have seen their trade deficits with China widen since it joined the WTO, Korea has seen its trade surplus with China grow from $2.9 billion in 2001 to $39.3 billion in 2010. Korea’s exports to China have grown from $10.4 billion in 2001 to $111.3 billion in 2010, about $19.4 billion more than the United States.
Given Korea’s success in the Chinese market, and that China is still a significant platform for Korean exports to the United States and Europe, Korea would seem to have a good deal to gain from an FTA with China. One study has indicated that an agreement could increase Korea’s economic output up to 1.25 percent within five years and by 3 percent within 10 years of the FTA taking effect.
Korea has done well in exports of electronics and steel to China, despite China’s own success in these areas. While China may be reluctant to address a wide range of subsidies or regulations, the FTA does represent an opportunity for Korea to seek reductions in states subsidies or improved regulations related to foreign direct investment that would benefit Korean producers in key areas.
3. What are Some Potentially Sensitive Issues for Korea?
With both the United States and the European Union, agriculture was a sensitive issue for Korea. However, in both of those agreements, along with expectations for potential agreements with Australia and New Zealand, Korea opened up significantly to foreign agricultural products. On one level this is necessary as Korea only has the arable land to grow about half of its food, but its prior FTA partners are also developed nations with higher cost agricultural products. But opening up to China’s agricultural sector would be different. China is both geographically closer and more likely to directly compete in the products that Korean farmers grow. There are also likely to be greater concerns regarding the sanitary aspects of Chinese produce. In terms of the economic impact of agriculture from China, the Korea Institute for International Economic Policy estimates an FTA with China would cause farm production to fall about 15% within a decade. Just as Korean farmers protested against the U.S.-Korea FTA, they have already begun protesting against an agreement with China.
4. What About North Korea?
Korea and China have both indicated that they are open to discussing the inclusion of outward processing zones in the agreement. It seems likely that the two sides will strike a deal to allow goods from the Kaesong Industrial Complex and China’s own potential zones in along its boarder with North Korea to receive preferential treatment. While this would provide a boost to production in Kaesong in the short-term, it could in the long-run lead to conflicts with the United States. The sanctions on North Korea currently prohibit the importation on any non-Office of Foreign Assets Control approved goods or parts. If goods assembled in China were to include parts manufactured in Kaesong, they would run afoul of these sanctions.
5. What are the Broader Implications?
While some have speculated that an FTA between Korea and China would bring tensions between the United States and Korea, this seems unlikely. As has been previously mentioned, the agreement between China and Korea will unlikely rise to the level of the KORUS FTA and the agreement is more directly a response by China to the KORUS FTA. In terms of the alliance, it is doubtful anyone in Washington or Seoul will confuse this for more than a commercial agreement between two key economic partners.
However, beyond the question of the alliance, the agreement could have implications for trade in East Asia. With the push for a broader Trans-Pacific Partnership (TPP) agreement, questions have become more focused on what Asian economic integration should look like. In the trade arena, there are competing visions of an East Asian FTA centered on ASEAN and the TPP. Because of Korea’s size as a trading nation, it could have significant influence on this process. However, there is also the possibility that once it has an agreement in place with China, the Korean preference could be to maintain its bilateral agreements and not become involved in what some view as a competition between China and the United States.
Troy Stangarone is the Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his own.
Photo from Korea.net photo stream on flicker creative commons.