Long-run Effects of the Korea-China Free-Trade Agreement

Abstract

(ProQuest: ... denotes formulae omitted.)I. INTRODUCTIONIn recent years, Korea has successfully signed free-trade agreements (FTA) with a number of partners including the U.S., EU and ASEAN. Korea and China officially launched FTA negotiations in May 2012 and a major breakthrough recently happened after 14 rounds of negotiations in November 2014, when the two parties signed on the final chapter of the agreement. Under the agreement, the two countries will remove their import duties on about 90 percent of all import items over the next twenty years. China will remove tariffs on 20 percent of the Korean items that it buys immediately after the deal takes effect and Korea will do so for 50 percent of the total imported items from China. This is equivalent to 44% (52%) of import goods into China (Korea) based on the import value. The FTA agreement is expected to take effect in 2015 after ratification by the congress in both countries.The FTA between Korea and China can have a significant impact on the Korean economy because of the close economic relationship between the two countries. Korea is the world's 12th largest economy with $1.6 trillion GDP and 49 million consumers while China is the world's 2nd largest economy with $12.6 trillion GDP and 1,350 million consumers.1 The Korea-China bilateral trade in 2012 was about $256 billion.2 China is Korea's biggest trading partner, while Korea is China's third-largest export market and its second-largest source of imports.Free trade agreements (FTAs) have a potential to significantly affect the economies of participating countries. They can increase the volume of trade and significantly affect the pattern of specialization and trade. Some industries, which do not have competitive advantage, may be negatively affected, while competitive industries may expand dramatically. The employment in those industries would be significantly affected as well. A free trade agreement may also affect countries other than those signing the agreement. For example, if Korea and China sign an FTA, some goods that were previously imported to Korea from Singapore may now be imported from China instead. This phenomenon is called trade diversion.The Korea-China FTA can give several advantages to Korea. First, since the US and EU already have FTAs with Korea but not with China, the Korea-China FTA can give Korea a strong advantage in penetrating Chinese markets before the EU and US. Korea can playa Hub country role in connecting trades between China and the West through FTAs. Second, the Korea-China FTA can provide institutional framework in China to protect Korean firms and people working in China. It is believed that more than 22,000 Korean firms are currently operating in China. Third, using the already-implemented FTA with ASEAN, Korea can play a crucial role in leading potential Asian economic cooperation including East Asia and ASEAN.This paper examines the potential effects of the Korea-China FTA on the Korean economy, in particular industry structure and employment, using a computable general equilibrium (CGE) model.3 The model is based on solid economic theory and has been tested and evaluated in previous studies (Yaylaci and Shikher, 2014). Specifically, the model has been found to accurately predict the effects of NAFTA (Shikher, 2012a). Our forecast predicts which Korean industries would grow as the result of the FTA. In those industries, existing firms would increase sales and new firms would enter business. Our forecast can also predict which Korean industries would experience a decline in sales and, therefore, employment.The model in this paper covers 53 countries and 15 industries. Trade in the model is affected by technology, trade costs, cross-industry supply of intermediate goods, and tastes. For each industry and country, the model can predict changes in trade, output, employment, prices, cost of production, wages, and welfare. We also plan to quantify the magnitude of the trade diversion that would occur as the result of the FTA. …