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KWON Hyuk-Jae

Obstacles to the Korea-China FTA

KWON Hyuk-Jae

May 8, 2012

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Negotiations for a Korea-China Free Trade Agreement (KCFTA) are expected to begin in May after years of exploratory talks. A deal promises to be the most beneficial FTA to the Korean economy as advanced economies face prolonged sluggish growth. But it also would intensify competition in several sectors.

The initial step to a KCFTA was taken in 2004 when Korea and China agreed to launch a joint study on restructuring their bilateral trade. From 2005 to 2007, private research institutions from both countries conducted a FTA feasibility study and in the next three years, a joint committee of government, academia and business representatives examined the nuances of an agreement. In January, the green light on formal negotiations came out of the Korea-China summit.

The long lead up far exceeded the preliminary steps to the Korea-US (KORUS FTA) and Korea-EU FTAs because of the huge advantage China's agricultural products have over those produced in Korea. Current comparative analyses show China's farm output is 10 and six times cheaper in production costs and prices, respectively. Furthermore, China's geographical proximity means cheap shipping costs. Thus, the threat to Korea's farmers and fishermen is much greater than the FTAs with the US and EU.

In February, farmers disrupted and stalled the first public hearing on the KCFTA, voicing their disapproval at an earlier stage compared to their demonstrations against the KORUS FTA. Even stronger protests can be expected against the KCFTA.

However, the expected economic benefits from the trade agreement are expected to far exceed any of Korea's current FTAs. According to SERI's analysis, the KCFTA would add 2.72% to Korea's GDP, compared to the 1.02% under the Korea-EU FTA and 0.56% under the KORUS FTA.

China has been Korea's largest partner in trade since 2004. Bilateral trade in 2011 totaled US$220.6 billion, with exports to China taking up 24.1% of Korea's total exports and Chinese goods accounting for 14.5% of total imports. The trade surplus with China last year was the highest of any country, at US$45.3 billion.

In terms of investment, the total amount to China comes in only second after the US. However, if Hong Kong's place as third is considered, China is first. Therefore, once the tariffs are removed, trade and investment will become an even bigger contributor to economic expansion.

Agricultural products, industrial products, and service and investment will be the broad issues of the KCFTA. Considering China's advantage in agricultural products and traditional protectionism of Korean farmers, Korea will be on the defensive. The two countries recently came to an agreement to conduct a two-part negotiation, which will entail discussing the list of sensitive products before negotiating the liberalization of others. Therefore, a deal similar to the Korea-ASEAN FTA may transpire in that especially sensitive products are excluded from tariff elimination or have a prolonged process of tariff elimination. As such, the KCFTA will not be as relaxed as the KORUS FTA and Korea-EU FTA, where there are no stipulations on sensitive products.

In industry, the differences are obvious. China has an overall competitive edge in the labor-intensive industries and Korea has the edge in the high-value added high-tech industries. Therefore, Korea can be expected to be on the offensive to widen the footprint of its automobile, steel and electronics industries in the Chinese market. However, Korea also must be mindful of Chinese industries rapidly closing the technology and productivity gaps against their Korean peers. Thus, negotiations are expected to become especially heated on highly competitive industries such as chemicals.

Finally, in the service and investment sector, Korea is positioned to have the upper hand in negotiations, having already worked out liberalization processes in FTAs with the US and EU. Korea will most likely seek "national treatment." That is, Korean service companies and investors would get the same treatment in China as a Chinese counterpart. This idea will probably prompt a chilly response from Chinese negotiators. China has a competitive edge in education, health and movement of natural persons and will want to protect those segments just as Korea will want to shield Korean farmers as much as possible.

Over the long-term, a FTA obviously would be mutually beneficial to the Korean and Chinese economies. But to get there, both countries will be at a crossroads between protecting weak industries and maximizing trade liberalization. The trade deal will inevitably produce winners and losers in both economies. The biggest challenge in the negotiations will be to strike the proper balance in terms of gains and sacrifices.

This column originally appeared in Korea JoongAng Daily.
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