Bridges Weekly Trade News Digest • Volume 12 • Number 34 • 16th October 2008

Korea TPR: Sound Fundamentals, but Further Reform Needed to Sustain Growth

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Prudent macroeconomic and structural reforms, including liberalisation of its trade and investment regimes, have contributed to Korea’s steady growth of 4.8 percent per year since 2004, a WTO assessment of the country’s trade policies concluded last week. But the report said that the country’s economy could make further gains by improving its investment climate, promoting greater economic flexibility and bolstering productivity and competitiveness.

Trade drives growth, but FDI inflows drop

Korean per-capita income mirrored GDP growth, rising from US$ 14,173 in 2004 to over US$ 20,000 in 2007. Both the country’s capital and current accounts enjoy a surplus, with foreign exchange reserves having risen from US$ 199.1 billion in 2004 to US$ 258.2 billion at the end of May 2008. And while Korea maintained its position in the high category of the UN human development index, ranking 26th out of 177 in 2006, the country has been forced to come to terms with an aging population and rising income inequality, challenges that the government has tried to address by raising taxes and cutting expenses.

The Trade Policy Review report for Korea (WT/TPR/S/204) reveals the importance of foreign trade as the engine for Korea’s economy. According to the report Korea’s economy has continued to become more outward oriented, with trade in goods and services rising from 83.7 percent of GDP in 2004 to approximately 90 percent in 2007. China, the EU, the US and Japan were the primary destinations of Korean exports. Korea’s imports in 2007 were mainly from China, Japan, the US and Europe.

The report pointed to a downturn in Korean’s inflows of foreign direct investment which, despite incentives, declined from 1.2 percent of GDP in 2004 to 0.4 percent of GDP in 2007, a low figure by OECD standards. The drop has been attributed to the increasing cost of doing business in Korea, unduly burdensome regulation, and possibly the appreciation of the Korean won against the US dollar until March 2008.

Intensive pursuit of Free Trade Agreements

The report noted that despite Korea’s commitment to the strengthening and liberalisation of the multilateral trading system, the country has intensively pursued free trade agreements with its major trading partners: Seoul has already penned deals with the US and Singapore, and is working to establish new ones with the EU and some emerging economies. Korea has also extended unilateral trade preferences to more goods from least developed countries just since the beginning of this year, and is an active member of the Generalised System of Trade Preferences.

While Korea has opted to retain developing country status in the WTO and other international fora, the practical relevance remains limited as only Norway and the Russian Federation have accorded Korea developing country preferences. The report notes that the main rationale for retention of developing country status is linked to concerns that the country’s agriculture sector remains vulnerable.

Tariffs remain Korea’s main trade policy instrument

Tariffs are still Korea’s main trade policy instrument and serve as a major, though declining, source of tax revenue (4.6 percent of total tax revenue in 2006). The average applied rate has remained at the 2004 level of 12.6 percent. The average applied customs duty on agricultural products, at 53.5 percent, is eight times that of the average for non-agricultural goods (6.5 percent). Korea has bound 90.8 percent of its tariff lines: 98.7 percent of agricultural lines (excluding mainly rice) and 89.5 percent of its non-agricultural lines.

Korea also applied Tariff Rate Quotas (TRQs) to agricultural imports with 0 to 50 percent applying to imports within the quota with rates on imports outside the quota reaching 800.3 percent. Rice remains the only product subject to import quotas. Import prohibition and licensing requirements were maintained on health and environmental grounds.

Korea also maintains export restrictions on certain products such as rice (in place since 2007) in order to ensure adequate domestic supplies which, according to the report, also possibly encourage downstream processing. Export restrictions were also in place to protect animal rights and endangered species and to conserve natural resources.

During the course of WTO Members’ discussions of the report, some delegations expressed concern about Korea’s recourse to anti-dumping actions and to changes in its calculation of dumping margins. Certain Members also sought clarifications on some aspects of Korea’s technical standards and SPS practices.

Government procurement used to promote development

The report noted that, while Korea is a party to the WTO’s Government Procurement Agreement, some of its procurement policies, such as those from small and medium enterprises are not covered by Korea’s multilateral commitments. It pointed out that government procurement is still used to promote regional and industrial development. The share of foreign suppliers in tendering bids has fallen due to increasing sophistication and competitiveness among Korean suppliers as well as the discontinuation of government purchases financed by international public loans that required competitive tendering.

The report also noted that Korea had strengthened its competition laws. Large Korean conglomerates known as chaebols are now subject to restrictions in terms of share-holdings in domestic firms.

Farm subsidies persist

Agriculture, which accounts for only 3.2 percent of Korea’s GDP, continues to receive substantial domestic support, worth up to 3.3 percent of GDP. The review pointed out that Korea’s subsidies to agriculture mean that consumers pay more than double average world food prices.

Korea’s volume of farm imports has risen despite self-sufficiency in certain products such as rice. The report noted that Korea has used the special safeguard provisions under the WTO Agreement on Agriculture, a measure intended to protect domestic producers from import surges or price declines. Measures are in place to tackle rising food prices as well as facilitate among others, environmentally friendly farming. Direct payments have increased significantly since they were introduced to support production in paddy fields in 2005.

The report also noted that Korea has taken some steps to reduce over-fishing, although fishing subsidies remain in place and total allowable catch in Korean waters has increased. Adjustable duties have also been raised on 9 fish species to protect domestic producers.

While the manufacturing sector’s contributions to GDP (27.8 percent) and employment (17.6 percent) have declined, the sector has continued to remain outward oriented, with Korean business conglomerates dominant domestically and maintaining a leading position globally. The report noted that subsidies to the domestic ship-building industry, which were due to be phased out at the end of 2006, have been extended until the end of 2009. Subsidies to coal destined for power plants have also persisted.

The banking sector: the silver lining in services

The report struck a gloomier note on Korea’s services sector, which it said was characterised by relatively low labour productivity (little more than half the level in manufacturing) and declining growth in total factor productivity. The report attributed the weak services sector to insufficient competition as a result of unduly burdensome regulation, the predominance of state owned enterprises, and low foreign presence, among other factors. State ownership persisted in the financial, telecommunications and transport services, the report concluded, and ceilings on foreign ownership existed in several sectors including the telecommunications, air-transport, coastal maritime and financial services.

The report however acknowledged that the services sector would benefit from regulatory reforms in line with Korea’s multilateral and regional or bilateral commitments. The banking sector especially would benefit from such reforms, the report said.

While highlighting the soundness of Korea’s economic fundamentals, the review nonetheless cautioned that sustained growth will require continued reform aimed at improving Korea’s investment climate and addressing labour market rigidities and a decline in labour force driven by an aging population. Together with privatization and continued regulatory improvements, such reforms would increase Korea’s economic flexibility and responsiveness to foreign competition. Korea also needs stronger services productivity, which should be underpinned by structural reforms and increased foreign and domestic competition, the report said. In this regard, the report emphasised the importance of successful WTO negotiations in improving the outlook for the Korean economy despite the emphasis that Korea has placed on FTAs.

ICTSD reporting.