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Op-ed

Korea's FTA Conundrum

by Jeffrey J. Schott, Peterson Institute for International Economics

Op-ed in JoongAng Ilbo
November 10, 2003

© JoongAng Ilbo


After a protracted courtship, Korea and Japan finally agreed last month to start negotiations on a bilateral free trade agreement (FTA). The decision seems to have been prompted by three broad considerations:

  • Prospects for WTO talks have dimmed after the collapse of the ministerial meeting in Cancún last September.
  • An FTA could help both countries confront the growing competitiveness of China in the region.
  • Neither country would have to do battle with their domestic farm lobbies.

All true. But a Korea-Japan FTA will have more far-ranging implications than officials in either country may realize. Almost assuredly, it will unleash demands for comparable trade initiatives from countries whose exporters will face new discrimination in both Northeast Asian markets. The United States will lead that charge; China may follow suit. And agriculture will be a central focus of their demands.

Why did Korea agree to negotiate with Japan? A number of economic models predict that Korea's welfare would be slightly reduced by an FTA with Japan, and its bilateral trade balance would deteriorate. In comparison, a Korea-US FTA could produce significant Korean welfare gains and positive but substantially smaller US gains (though excluding agriculture would reduce those gains by half).

Interestingly, Korea would benefit the most from a Korea-Japan-China FTA, according to these simulations. Indeed, some speculate that the Korea-Japan pact is meant to catalyze negotiations with China on a broader Northeast Asian FTA. China became Korea's largest export market in 2002 with shipments slightly higher than those to the United States. Korean imports from the United States are still larger than those from China, but Chinese suppliers are gaining market share quickly at the expense of both US and Japanese companies-which explains in part the growing interest in a regional trade pact with China at the same time that Korea pursues its FTA with Japan.

Either way, the United States will likely act to counter discrimination against US firms in the important Northeast Asian market. Why? Japan sells Korea many of the same products that US firms export to Korea. Preferences to Japanese firms will lead Koreans to buy more Japanese products instead of US products (particularly semiconductors and telecommunications equipment). US industries and farmers will demand that trade officials "level the playing field" by negotiating similar trade preferences in a Korea-US FTA.

A Korea-US FTA could provide substantial economic benefits to both countries while reinforcing important political and security relations. An FTA would revitalize Korea-US trade, which has been stagnant for several years due to a slowdown in both economies and the imposition of contentious trade restraints. Overall, the United States still is Korea's most important trading partner. Two-way merchandise trade totaled $56 billion in 2002.

If the United States wants an FTA with Korea, it will have to put long-standing US barriers to Korean exports of textiles, apparel, and steel on the negotiating table. That's where Korea gains. But to sell the US Congress on liberalization in those import-sensitive sectors, US negotiators will have to receive commitments to significant Korean reforms in areas of US export interest, including agriculture. Note that an FTA does not require free trade in agriculture. But a deal must include substantial new trade opportunities for US farmers. If US trade officials can't level the playing field by lowering Korean import barriers, then they may be pressured to do so by imposing new restrictions on Korean exports to the US market.

To date, Korean officials have declined to talk about farm reforms until forced to take minimalist steps in GATT negotiations to avoid international censure for blocking agreements. Their caution has been costly but understandable, given the overrepresentation of farming interests in the National Assembly.

But that policy may not be sustainable for very much longer. Both the United States and China will insist on farm reforms in any FTA. And a prospective deal in the WTO will only be possible if the major trading nations, including Korea and Japan, agree to liberalize their farm trade barriers.

Changing demographics suggests that Korea could deflect at least some of the domestic opposition to farm reforms by switching from trade protection to income support for Korean farmers. Indeed, this is the direction that European policy seeks to go in its reform of the Common Agricultural Policy. A combination of "decoupled" support for Korean farmers and substantial, albeit incomplete, reform of import barriers could provide a big boost to Korea's economy. Such reforms could be phased in over time to mitigate the economic adjustment pressures and to help manage the political fallout.

Thus Korea's trade conundrum: Engaging in FTAs will inexorably lead to demands by Korea's most important trading partners to liberalize its farm trade barriers; so, too, will WTO negotiations. Otherwise, Korea will likely become isolated in trade talks in the region and in the WTO. If Korea wants more open and secure access to foreign markets and a stronger economy, it will have to reform its agricultural policies.