Will the KORUS FTA Have an Encore?

March 27, 2017 10:00 AM

Five years have passed since the Korea–US Free Trade Agreement or KORUS FTA took effect.1 Both countries promised that the KORUS FTA would propel a big boost in bilateral trade and investment, but so far the results have not matched expectations. Trade has not grown significantly, and the Trump administration has signaled that—as with the North American Free Trade Agreement—it wants to renegotiate the accord to fix problems with KORUS provisions and their implementation.

Hailed as a “state of the art” pact when it took effect, the KORUS FTA substantially eliminates tariffs and many other barriers affecting about $150 billion annually in two-way trade in goods and services. Any deal can be improved and the KORUS FTA is no exception. Its flaws stem from the long process of negotiation before it took effect—years of negotiations followed by revisions as the Obama administration and Congress reconsidered its provisions in the ratification process. Yet the perceived shortcomings of the pact are not a major cause of the tepid growth in bilateral trade. Macroeconomic factors and the slow recovery from the global financial crisis have been a major factor; so, too, have Korea’s new FTAs with other trading partners, which increased competition in the Korean market during the long hiatus between the signing and entry into force of the KORUS FTA. Simply put, delays in implementing the KORUS FTA diluted some of the anticipated benefits from the bilateral trade preferences.

Since the KORUS FTA went live, bilateral trade growth has been sluggish. To be fair, the agreement’s tariff liberalization in some import-sensitive areas was deferred, so the pact has not yet been fully implemented. Still, US merchandise exports have not increased since 2011, while imports from Korea have risen by more than 20 percent. In 2016, the US merchandise trade deficit with Korea was $27.7 billion (census basis), though the US services surplus with Korea increased to $9 billion in 2015 (latest data available).  

Predictably, the KORUS FTA has been criticized by members of Congress and Trump administration officials, who blame the poor US export performance on inadequate implementation of the deal by Korean officials along with currency manipulation. The criticisms have some merit but are exaggerated. US officials previously cited a few specific KORUS implementation issues that have impeded US shipments of farm goods and autos as well as the provision of financial services in Korea by US firms; substantial progress has been made to resolve all of them. 

The currency issue is more contentious. The US Treasury has not charged Korea with manipulating its currency, though it put Korea on its currency monitoring list in April 2015 because “Korean authorities have intervened to resist won appreciation in the context of a large and growing current account surplus” (US Treasury, April 2015). Korea’s current account surplus has exceeded 6 percent of GDP for the past four years, and in 2016 it reached $99 billion, or more than 7 percent of GDP. Korea’s foreign exchange reserves now total about $375 billion. 

Korean officials argue that they need to hold a large amount of foreign exchange reserves as a precaution against disruptions from economic and political shocks in the region. They also argue that the jump in their current account surplus is due to many factors, including a sharp drop in their oil import bill and demographic trends in Korean society. Those arguments are forced: Korea’s aging society has been a challenge for several decades and thus cannot explain the recent spike in savings, and lower oil prices have reduced annual Korean imports by only 2 to 3 percent of GDP. The recent jump in Korea’s current account surplus and the high level of precautionary reserves held by the Bank of Korea seem excessive.

But there is a simpler reason why US-Korea trade has underperformed: US firms face stronger competition in the Korean market.

During 2004–12, before the KORUS FTA entered into force, Korea implemented FTAs with Chile, Singapore, the European Free Trade Association, the Association of Southeast Asian Nations, the European Union, and Peru.  Following KORUS entry, Korea added FTAs with Turkey, Australia, Canada, China, New Zealand, Vietnam, and Colombia.2 As a result, many firms from many countries now receive preferential access to the Korean market comparable to the benefits initially accorded to US firms. The delay in KORUS implementation cost US exporters and investors “first-mover” benefits in the Korean market, which had become much more competitive in March 2012 than when KORUS talks concluded in early spring 2007.

Will the KORUS FTA have an encore? Until recently, the logical next step was for Korea to join the Trans-Pacific Partnership (TPP). In fact, Korean officials had been preparing to do so for some time. And their participation in the recent high level dialogue on Asia-Pacific integration initiatives held March 14-15 in Chile suggests their continued interest in participating in some future iteration of a trans-Pacific trade pact.

But first the United States and Korea will likely revisit their bilateral pact. While the Trump administration has not set out an agenda for new FTA talks, US officials likely will want to revise specific market access concessions, including autos (rules of origin, Korean emissions standards), rice (exempted from KORUS liberalization), and financial services (restrictions on crossborder flows of data). They also will want to add obligations to avoid currency manipulation, comparable to those that Congress required for new US trade pacts in the Trade Facilitation and Trade Enforcement Act of 2015.

Renegotiating the KORUS FTA could be difficult and politically painful for the new Korean government, as the US side will likely insist on new quotas for autos and rice as well as rules imported from the TPP in areas such as environment, labor, and state-owned enterprises. Officials need to be sensitive to the risk that new US demands might provoke a strong anti-American backlash in Korea. Given the current tensions on the Korean peninsula, neither side wants trade frictions to undercut or even signal discord in the US-Korea strategic alliance.

For that reason, the reformist zeal in new KORUS talks is likely to be tempered. More likely, the KORUS deal will be updated with only minor revisions to Korean import policies and new currency rules comparable to those adopted by TPP signatories, while the core agreement is basically left intact. My bet is that the KORUS FTA will have an encore, and it will be short and harmonious.

Notes

1. Almost ten years have passed since the conclusion of the original KORUS negotiations—though that deal went through a series of revisions after the agreement was signed before ratification in Congress and the Korean National Assembly. For an analysis of the original deal signed in 2007 and the revisions added in late 2010, see Schott (2007) and Schott (2010).

2. Korea has negotiated FTAs with almost every signatory of the Trans-Pacific Partnership (TPP) except Japan and Mexico. It also is participating in negotiations on the Regional Comprehensive Economic Partnership (RCEP) among the 10-member ASEAN community and its six FTA partners and in trilateral FTA talks with China and Japan.  

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