The Significance and Challenges of the Korea-China FTA from the Perspective of East Asian Economic Integration

Dr. Jeong Hwan-woo is a Research Fellow at the Center for Regional Studies, Korea Institute for International Economic Policy (KIEP).

Korea's First Regionally Integrated FTA

As the Korea-US and Korea-EU Free Trade Agreements (FTAs), which are the most significant trade issues, are nearing completion, Korea has entered the phase of the Korea-China FTA, whether it wants to or not. The joint government-industry-academia study, which was the pre-negotiation stage, concluded long ago, and Korea had proposed to expedite the process a year ago. More importantly, China's demands are too strong to delay any further. Moreover, given Korea's political calendar, it will be difficult to initiate negotiations next year, making a decision unavoidable in some form. While the decision rests with the highest policymaker, it is time for Korea to comprehensively review the significance, issues, and strategies of the Korea-China FTA.

To this end, it seems necessary to first clearly understand the nature and significance of the Korea-China FTA, as this will lay the groundwork for its importance, direction, and characteristics. The characteristics of the Korea-China FTA can be summarized in three aspects concerning its importance, direction, and nature. First, regarding its importance, the Korea-China FTA will be an FTA with Korea's largest trading partner. In 2010, China accounted for 25.1 percent of Korea's exports, and its share in overseas investment reached 40 percent in 2005. The Korea-China FTA will be another test case that determines Korea's re-emergence or decline.

Regarding its direction, the Korea-China FTA will be an FTA with the world's largest growth market, investment partner, and trade surplus country for Korea. For Korea, it will be the first aggressive FTA, aimed at overseas expansion. Therefore, the Korea-China FTA should not merely stop at expanding exports by eliminating tariffs but should be utilized as an opportunity to remove all barriers related to business in China. Unfortunately, there are significant differences in views between Korea and China on this issue, but the reduction of non-tariff barriers and investment barriers, as well as service liberalization, must become our important goals.

However, the most significant characteristic of the Korea-China FTA is that it will be Korea's first regionally integrated FTA. FTAs can be categorized into FTAs between distant countries and FTAs between proximate (neighboring or regional) countries, depending on their scope or the distance between parties. While FTAs between distant countries, pursued for various objectives such as geopolitical considerations, securing regional trade hubs, and resource acquisition, still account for a considerable proportion despite a decrease since the establishment of the World Trade Organization (WTO) in 1995, they have certain limitations in establishing stable and sustainable cooperative systems through the expansion and deepening of economic integration among countries within the region, despite their contribution to expanding global trade and investment networks.

Conversely, FTAs between neighboring countries in a region are often pursued to serve as a starting point for regional economic integration. This type of FTA began to spread in earnest after the advent of the WTO system, when it became difficult to achieve significant results from further trade liberalization at the global level in a short period. It subsequently evolved into a trend of regionalism, establishing FTAs as a dominant force. In particular, in East Asia, characterized by intra-regional division of labor and external sales of final products (to the US, EU, etc.), the consensus on the need for regional integration rapidly expanded following the two financial crises of 1997 and 2008. There has been growing pressure, both within and outside East Asia, to reduce reliance on external markets and resolve global imbalances by consuming more products manufactured within East Asia within the region itself.

Despite these significances, regional integration-type FTAs face limitations, as they are prone to encountering difficulties during negotiations or causing adverse effects due to economic development disparities, institutional differences, and historical experiences among related countries. The reason why regional integration efforts like FTAs have been sluggish in East Asia, compared to North America with the North American Free Trade Agreement (NAFTA) or South America with the Southern Common Market (Mercado Comun del Cono Sur: MERCOSUR), despite a growing consensus, is precisely due to regional disparities and historical experiences. In other words, despite being a rapidly developing type globally in recent times, not a single case can be found in East Asia, including South Korea. This is both a characteristic and a limitation of regional integration-type FTAs. Conversely, these limitations represent the current state of East Asian economic integration and also the significance that can be found in the Korea-China FTA.

Ambitious Goals, A Long Road Ahead

What, then, are the characteristics of the first FTA pursued within Northeast Asia, specifically within East Asia? In a nutshell, it might be described as having ambitious goals and a long road ahead. Specifically, three aspects can be considered. First, while multilateral economic cooperation involving all member states would be most desirable for regional integration, East Asia lacks the centripetal force for such an endeavor, which is both a characteristic and a limitation. As shown in [Figure 1], East Asia has various bilateral and multilateral FTAs being pursued independently, but no multilateral FTA encompassing the entire region. While South Korea, China, and Japan are each pursuing FTAs with ASEAN (Association of Southeast Asian Nations) and India, the three Northeast Asian countries and ASEAN are building FTA networks according to their respective strategies. In this context, even ASEAN, which has built the most extensive FTA network in East Asia, is insufficient to lead regional integration.

[Figure 1] Major FTA Networks in the Asian Region

(Source: Compiled by the author based on various sources)

The simultaneous pursuit of different FTAs within the same region carries a significant risk of losing momentum for economic integration and causing confusion and potential conflict within the region. Therefore, unless the Korea-China FTA serves as a model case leading other regional FTAs, the existing complex and fragmented landscape of regional FTAs will only become more chaotic. Furthermore, by predicting and assessing the FTA strategies of actors like Japan, Hong Kong, Macao, and Taiwan, the Korea-China FTA cooperation framework must be established to avoid future conflicts between regional FTAs.

Second, the Korea-China FTA must be pursued with the vision of regional economic integration rather than as a mere bilateral FTA. Given the global trend, particularly the growth trend in East Asia, regional integration is inevitable. This is because the region has faced pressure from excessive reliance on external markets and trade imbalances from external consumer countries like the United States, due to the shared growth achieved by selling goods produced in processing and manufacturing bases in China to advanced external markets. However, regional economic integration requires long-term and arduous efforts. This is especially true in a region like East Asia, where complex historical experiences, unique inter-state dynamics, and national disparities are intertwined. Therefore, while the Korea-China FTA will ultimately serve as a starting point for economic integration, it may face numerous challenges. It is an FTA that cannot and should not be settled in one go. The significance can be maximized only by pursuing negotiations with a view toward a sustainable and robust cooperation framework.

Third, it is a highly significant negotiation not only economically but also in terms of diplomacy and security. Regional integration-type FTAs, conducted between neighboring countries, have a significant impact on regional diplomacy and security. In particular, the Korea-China regional integration-type FTA is being pursued in a region where the only Cold War-era confrontation in the world has not yet ended. The Korea-China FTA will, in one way or another, influence this Cold War dynamic.

However, it is necessary to clearly understand the difference between diplomatic/security relations and FTA relations. Some raise concerns that the Korea-China FTA could weaken the Korea-US alliance and destabilize the situation in Northeast Asia and the Korean Peninsula. While it is true that many countries pursue FTAs with diplomatic and security considerations, FTAs and alliances at the diplomatic and security level are fundamentally different. The outcome of an alliance is a bloc, whereas the outcome of an FTA is a hub. As shown in [Table 1], FTAs are the most rudimentary form of regional economic integration among Regional Trade Agreements (RTAs). Unlike the next stage, a customs union, there is no common external tariff burden for member countries. Therefore, signing an FTA with any country, or signing separate FTAs with multiple countries, poses no problem. For instance, it is not contradictory for South Korea to sign an FTA with China while already having an FTA with the US; rather, it could position South Korea as a hub connecting China, the largest market in East Asia, and the US, the world's largest market.

[Table 1] Types and Scope of Regional Trade Agreements (RTAs)

Of course, it is clear that FTAs are closely related to diplomatic and security relations, making FTA negotiation strategies that consider these relations very important. For example, when pursuing an FTA with China, it is necessary to structure the negotiation framework in a way that clearly communicates that it will not undermine existing diplomatic, security, and trade relations with third countries outside the region, and that it does not represent an exclusive economic bloc. In particular, structuring the negotiation framework to encourage North Korea's openness and its inclusion in the East Asian trade order is a key task, not only economically but also in terms of diplomacy and security.

Therefore, this paper focuses on the Korea-China FTA as a regional integration-type FTA and aims to present its significance, expected effects, potential issues, and South Korea's negotiation strategy. Specifically, it will first examine the expectations and concerns of both countries surrounding the Korea-China FTA, introduce the expected issues, and then propose measures to harmonize the expectations and issues of both sides.

Expectations and Concerns

Expectations

Despite the pronouncements of regional integration in Asia, such as the 'East Asian Community' under the Kim Dae-jung administration, the 'Northeast Asian Era Initiative' under the Roh Moo-hyun administration, and the 'New Asia Initiative' under the Lee Myung-bak administration, South Korea's FTAs have actually been pursued multilaterally with external countries. In other words, South Korea has generally pursued FTAs with various countries with the goal of maximizing effects through FTAs with advanced, large economies. This gap between pronouncements and actual policy demonstrates the significant realistic challenges in pursuing East Asian regional integration, despite its importance. However, it should not be overlooked that South Korea has achieved results in pursuing FTAs with external countries that other East Asian countries have found difficult to match. Since its inception in mid-2001, South Korea has signed and brought into effect FTAs with Chile, Singapore, the European Free Trade Association (EFTA), ASEAN, India, the EU, and Peru. Notably, it is the only country in East Asia to have FTAs with advanced, large economies like the US and the EU either in effect or on the verge of effect, positioning itself as an economic hub in the East Asian region. However, the lack of substantial progress with neighboring countries such as China and Japan has been pointed out as a limitation.

Therefore, focusing on the Korea-China FTA as a regional integration-type FTA, the first expected effect for South Korea is that it will serve as an opportunity to expand the global FTA network it has built into East Asia. As a medium-sized industrialized country in East Asia, South Korea, unlike regional giants like Japan and China, has pursued an open trade strategy and, as mentioned earlier, has become the only country in East Asia to simultaneously sign FTAs with large economies such as the US and the EU. In this context, initiating FTA negotiations with China, which is emerging as a global economic powerhouse, would make South Korea the first non-Chinese major country in East Asia to begin FTA negotiations with China. Through the Korea-China FTA, South Korea will have the opportunity to link its FTA network formed with external countries to its regional FTA network and, at the same time, to seriously pursue regional integration efforts that have been relatively overlooked until now.

Second, it is the pioneering of the Chinese domestic market. As is well known, East Asian countries have achieved shared development by forming an 'East Asian international division of labor structure,' where countries like South Korea and Taiwan have used China as their production base. However, through the recent global financial crisis, China's domestic market, which has continued to grow rapidly, has emerged as the world's largest market. Developed countries like the US are also increasing pressure for China and the entire East Asian region to shift towards a domestic demand-driven growth model. In particular, the Chinese government, after its opening, pursued growth policies aimed at quantitative expansion of exports and foreign investment, but has now reflected that this has only invited scrutiny from major developed countries without substantial benefits, and is focusing on domestic demand-driven growth. This signifies that South Korea, which has utilized China as a processing base, has reached a point where it must improve the conditions for pioneering the Chinese domestic market. The importance of FTAs, which are the most effective means of pioneering the Chinese domestic market, is thus bound to increase.

Third, there is the need to strengthen the capacity to respond to the economic integration of the Chinese economic sphere, such as the Closer Economic Partnership Arrangement (CEPA) between China and Hong Kong, and the Economic Cooperation Framework Agreement (ECFA) between China and Taiwan. With the signing of FTAs between China and Hong Kong and between China and Taiwan, it is no exaggeration to say that the Chinese economic sphere has effectively entered a stage of integration. In particular, as a result of the accumulated implementation of the CEPA between China and Hong Kong, investment and service liberalization have reached a considerable level. The ECFA between the two sides of the Taiwan Strait, which began negotiations in March of this year, will also comprehensively address investment and service sector liberalization. However, what cannot be overlooked here is that, as pointed out at the beginning, all FTAs, including the China-ASEAN FTA, Korea-ASEAN FTA, ECFA between the two sides of the Taiwan Strait, CEPA between China and Hong Kong, and the Korea-China FTA, are inseparable from the vision of East Asian regional integration. Therefore, each FTA must be able to cooperate and maintain balance with the others.

China has even greater expectations for the Korea-China FTA. Since joining the WTO in 2001, China has actively pursued FTAs with the aim of building a trade network centered around itself. Accordingly, China has prioritized FTAs with neighboring countries, including the Chinese economic sphere, major trading partners, and countries with which it can enhance diplomatic and security ties. FTAs with Hong Kong, Taiwan, ASEAN, and Pakistan can be seen as examples pursued for these purposes. While China has been evaluated as placing importance on diplomatic and security factors in relation to FTAs, it has generally employed diverse FTA policies depending on the target and objective.

This year, China has also presented principles for FTA promotion that it had not explicitly stated before. In the '12th Five-Year Plan' (2011-2015) released in March, China first articulated its direction and objectives for pursuing FTAs. Specifically, it stated: 'Accelerate the pursuit of FTAs to strengthen economic ties with major trading partners and deepen practical cooperation with emerging market economies and developing countries.' Furthermore, China's criteria for signing FTAs have been presented: first, neighboring regions; second, resource-rich countries; third, emerging powers; and fourth, countries/regions with crucial interests. China also plans to pursue negotiations with the Shanghai Cooperation Organization (SCO) and maintains an open stance towards an FTA with India, with whom it is in competition in many respects.

In light of China's FTA strategy, South Korea is one of the most important target countries. This can be understood from South Korea's position in China's external economic strategy and the utilization value of South Korea's technology and market. Firstly, South Korea is one of the most important countries in China's external economic strategy. As pointed out earlier, since the full-scale opening, particularly since joining the WTO in 2001, China has strived to build an East Asian economic order centered around itself. South Korea meets three of the four criteria for selecting FTA target countries presented above – neighboring country, emerging market, and country of crucial interest – making it a highly significant nation. However, while China has pursued these efforts in Southeast Asia with ASEAN and the Chinese economic sphere (Taiwan, Hong Kong, Macao), it has not achieved significant results in Northeast Asia, which is more important in terms of economic scale and development level. In this context, trade liberalization with a country of South Korea's scale and development level, which also plays a role on the world economic stage, can be seen as a golden opportunity to move one step closer to establishing a regional economic order centered around China.

Second, more directly, there is the expansion of exports to and market access in South Korea, particularly the utilization value of South Korea as an FTA hub, which is emerging as a central point for FTAs. Since its reform and opening, China has achieved high-speed growth through exports, but it regrets that this has led to scrutiny from major countries. At a time when an alternative export base is needed, an FTA with South Korea, which has emerged as a key trade hub in East Asia by signing FTAs with large markets like the US and the EU, holds immense significance for China. This is an opportunity that China cannot obtain through FTAs with Hong Kong and Taiwan, with which it has made significant efforts, but can only be provided by South Korea. (Continued)