Sunday, November 16, 2014

Shady projections on Korea-China FTA

First published in The Korea Herald.

Now that the dust has settled, and the free trade deal between Korea and China has been sealed, it is time to look at the validity of various claims being made on its economic impact once it is implemented sometime next year.

I am not referring to the merits or demerits of the FTA and the bruises to the agricultural sector, but to the economic projections that are being thrown around by the government officials.

There is no denying the high expectations for the trade deal compared to the FTAs with the U.S. and the European Union, since China is Korea’s largest trading partner, with a massive market. Moreover, it is bang next door, and offers a definite advantage compared to other economic blocs.

Under the deal, Korea will eliminate its tariffs on 79 percent of all products, or 9,690 items, imported from China within 10 years following the implementation of the deal. China, meanwhile, will eliminate its import duties on 71 percent, or 5,846 products, shipped from Korea over the same period.

On the face of it, this is an opportunity not to be missed. For this reason, the government ― which rushed to wrap up the deal, ignoring the side effects ― went to town after the announcement in Beijing on the sidelines of the APEC summit.

The Ministry of Trade, Industry and Energy immediately rushed in to state that the FTA was “expected to help boost the countries’ annual bilateral trade to $300 billion in 2015. This will mark a 39.5 percent hike from $215.1 billion in 2012. It will help bring Korea’s per capita income to over $30,000.” The ministry also said that as a result of the deal Korea’s gross domestic product would go up by 2-3 percent in the short term.

Reading this, I wondered on what basis the projections were made, and that got me digging. In the past 10 years since I settled in Seoul ― and, coincidentally, since Korea started along the path to becoming an FTA juggernaut ― these types of projections have been made by the government after every deal is inked.

From Korea’s first FTA with Chile to its latest with China, government officials have always highlighted the supposed impact on GDP, trade and per capita income. This was done when eight other FTA were implemented in the past decade ― including with major economies such as the United States, the European Union, India and ASEAN ― and even when FTAs with Colombia, Australia and Canada were concluded recently.

I have noticed a pattern in these “official economic projections.” All of them are from the joint feasibility studies that were conducted before the respective FTA negotiations began.

It is the Korean government’s usual practice to carry out a joint study with a candidate country to examine the feasibility of an FTA before it starts negotiations. The joint study ― normally done by the state-run Korea Institute for International Economic Policy and an institute from the partner country ― examines such issues as the economic effect of the FTA, sectorwise impact, the scope and coverage, and negotiating modalities.

When the joint study ends with the conclusion that the proposed FTA will bring benefits, a public hearing is held and then negotiations with the partner country commence. It takes several years for the negotiations to be completed and then many more months or years till they are finally ratified by the National Assembly and enforced.

The process for the Korea-China FTA started in November 2004 when former Chinese President Hu Jintao and former Korean President Roh Moo-hyun declared the launch of an unofficial feasibility study. Completed in 2006, this study concluded that the FTA would be mutually beneficial and a win-win for both countries.

In November 2006, both the countries then decided to upgrade the unofficial study to a joint study made by government, business and academia, which concluded in May 2010. After a public hearing in February 2012, official negotiations started and were wrapped up after 14 rounds in November 2014.

In other words, there was gap of four years since the report of the joint study was published and the deal was announced by President Park Geun-hye in Beijing on Nov. 10.

But that is not all. Interestingly, the joint study report ― a comprehensive and detailed 170 page analysis of the impact on various sectors and trade mechanisms ― did not use its own estimation based on any economic model to talk about the overall impact on the economy vis-a-vis GDP, bilateral trade and per capita income. It instead refered to the economic projections made by the earlier unofficial study conducted by the Development of Research Center of China and KIEP that was published in 2006. Moreover, the first analysis used the 2001 statistical database, which at that time was the latest updated version of the Global Trade Analysis Project model, to derive these projections.

I have no issue with the use of the GTAP model, which aggregates different levels of sectoral and regional details, but the date of the estimates and the statistics used raise a lot of questions about the validity of the projections being made today. More so because it shields a whopping 10 percent of all goods exchanged between the two sides from tariff abolition, the result of negotiators simply throwing out contentious items as they rushed to seal the deal.

While being gung ho about the FTA, the government relied on 13-year-old data and an 8-year-old analysis to make the claim about the economic impact. One can only take their assertions with a bucket load of salt.

We will have to wait for a more recent analysis by KIEP or any other reputed academic institution to gauge the actual economic impact of the agreement on the Korean economy. Even then, there are other economic variables and global economic situations that could come into play.

It is safer to keep the government macroeconomic projections on the deal at an arm’s length and concentrate on the sectorwise costs and benefits. Especially since there are still many hurdles to cross before the deal is ratified by the National Assembly and finally implemented.