Purchasing Power Parity and Market Integration: The Effects of South Korea s FTA

Abstract

The main purpose of free trade agreements is to reach market integration among its member countries. There are, however, few Korean studies investigating the effects of FTA from a market integration perspective. This study fills in the gap. We explore whether market integration between South Korea and its FTA partners occurs based on evidence of Purchasing Power Parity (PPP). For our analysis, we utilize three kinds of unit root tests-IPS panel unit root test, Kwiatkowski-Phillips-Schmidt-Shin (KPSS) unit root test, Dickey-Fuller generalize least squares (DF-GLS)-over the sample periods: January 1998-April 2017. We find limited evidence of PPP after FTA between South Korea and its FTA partners, but we see some evidence of market integration after the FTA, specifically, a decline in trade barriers such as tariffs, a decrease in exchange rate volatility, and an increase in trade volume. We conclude that it may be misleading to rely on evidence of PPP to assess the realization of market integration.