The KORUS FTA: Commercial and Strategic Implications for Korean Firms

 I. KORUS FTA Significance and the Prospects for Ratification

The KORUS FTA was agreed upon on April 2 after an arduous period of negotiation. The FTA is highly significant for Korea in terms of its economic and political implications. Korean firms now have chances to leverage new opportunities to enhance their international competitiveness and prospects for growth.

The KORUS FTA needs approval from each country's respective legislature and must be signed by both presidents before it can be officially implemented. The entire ratification process will proceed as follows.

Ratification Process (expected) of the KORUS FTA at Korea's National Assembly and the US Congress by the Year’s End

First, Korea and the US will write legislative bills based on the signed FTA agreement. A committee of the National Assembly of Korea and a committee of the US Congress will review the bills. At that point, each country's president will sign the text, which will then be deliberated by the Assembly and the Congress who will ultimately decide whether the bill will be put to a vote. 1 The final text and the law, being ratified and approved, will be signed by both presidents and then implemented.

Currently, however, substantial opposition exists in both countries to the proposed FTA jeopardizing its passage. In particular, vulnerable industries, trade unions and civic groups in Korea have voiced opposition to the FTA.

Meanwhile, numerous influential legislators in the US have also expressed disappointment regarding certain provisions in the FTA and threatened to block its passage. In particular, politicians from auto and beef producing states have expressed opposition unless Korea agrees to further liberalize beef and auto markets. 2 The AFL-CIO also voiced dissatisfaction over the proposed FTA, noting the bilateral trade imbalance of cars, designation of an "outward processing zone", which will acknowledge products made in the Kaesong Industrial Park as South Korean-made, and no enforceable protections for core workers' rights.

In spite of these obstacles, the KORUS FTA is expected to be ratified in late 2007 at the earliest and 2008 at the latest. In Korea's case, President Roh's strong commitment to the FTA, coupled with its strategic importance, puts the odds of passage around 55-70% before the end of 2007. Without a clear deadline and with an upcoming contentious Presidential race, though, it is possible the ratification process will extend into 2008. The possibility of the FTA ratification looks brighter in the US, based on robust support from the business community and possible adverse effects from ratification failure. There is a possibility, however, that discontent amongst powerful constituencies may delay the FTA's passage until 2008.

II. Impact of the KORUS FTA on Korea's Major Industries

1. Opportunity for Export Sector to Restore Competitiveness

The US, once Korea's largest export market, has fallen to number two in 2004 due to burgeoning economic ties with China. Accordingly, Korea's market share in the US import market decreased from 3.3% in 1995 to 2.5% in 2006, in a sharp contrast to the increase from 6.1% to 15.2% in China's market share. Even though Korea enjoyed brisk exports in some industries such as cars and semiconductors, it recorded poor export performance in a number of industries including textiles because of deteriorating competitiveness. For example, the growth rate of textiles export to the US has been shrinking every year, with -18.1% and -14.3% growth rates recorded in 2005 and 2006 respectively. The KORUS FTA will serve as the best chance for Korean firms to restore their competitiveness in the US market, if they wisely take advantage of the KORUS FTA. Therefore, it is imperative that companies leverage opportunities provided by the agreement.

2. KORUS FTA Impact by Industry and Desirable Responses of Korean Firms

The KORUS FTA will have a different impact across industries based on the final tariff agreement. The auto and textile industry export competitiveness to the US will strengthen as high tariffs on imported goods will be removed. In the machinery industry, both countries have considerable room for cooperation due to technologically complementary relationship of both countries. The pharmaceutical industry will likely experience wide-scale restructuring as the result of lower tariff barriers for imported drugs. Broadcasting and communications industries will not be opened up by the FTA, but have to allow US companies' operation in Korea. Textiles, cars, pharmaceutical, machinery and broadcasting/communications will be affected most by the FTA in this order.

Cars : expanding new product development and improving brand power

In the auto industry, Korea has agreed to tariff elimination as well as streamlined taxation system. Korea has to remove tariffs instantly on all products except for environmentally-friendly cars (for which a 10-year grace period is granted). The US pledged to immediately abolish tariffs on passenger cars with an engine displacement below 3000cc and auto parts. Tariffs on passenger cars with an engine displacement of over 3000cc will be phased out within three years and pickup trucks within 10 years. Korea will simplify both the Special Consumption Tax on autos and the Annual Vehicle Tax into three tax rates. It has also agreed to the rule of origin for cars, safety and environmental standards, innovative expedited dispute settlement process and cooperation for harmonizing standards.

The FTA will expand automobile exports to the US further while intensifying competition domestically with some (but not considerable) increase in car imports from the US. Korean firms are advised to come up with a mid- to long-term strategy to take the FTA as opportunities to develop top quality pickup trucks and other higher-priced products. In the short run, it ought to set up a plan to take advantage of higher revenues from increased exports and lower tariffs in developing environmental technology and enlarging sales networks. This will help enhance the brand image of Korean cars in the US market.

Machinery: serving as a supply base of parts and equipment for US companies

In this area, Korean companies will have some time to boost competitiveness as the Korean market will open up more slowly than the US market. According to the final text, the US has to scrap tariffs on 82.1% of industrial machinery immediately after the implementation of the FTA, compared to Korea's 38.3%. Besides, the two countries have a highly complementary relationship in this industry. Korean companies mostly specialize in general-purpose machinery and parts while their US counterparts specialize in dedicated machinery. This means that under the FTA, Korean companies may increase export of processing machine tools (which are representative general machinery) to the US where they compete with Japanese firms, taking advantage of enhanced cost competitiveness coming from the FTA. Imports of some machinery from the US will significantly increase as Korean firms shift the procurement source from Japan to more cost-competitive US.

In this area, Korean companies are advised to pursue a growth strategy through which they will become the supply base for the US of the next-generation machinery parts for environmental technology and alternative energy source development. Currently, the US companies lead the competition in basic technology, but areso far behind Japan and Germany in cost competitiveness that they see even the base of their industry shaking. Against this backdrop, with their technology rapidly improving, Korean companies can take a chance to emerge as cooperation partners with their US counterparts in terms of parts and products development.

Textiles : laying the groundwork for increased cost competitiveness

Regarding textiles, both sides have agreed to eliminate tariffs, to partially waive the Yarn Forward rule 3 and to retain a provisionary 10-year safeguard on textile exports to the US. Korea is supposed to remove tariffs on 85.4% of US textiles within a three year period; the US will abolish tariffs on 61.2% of Korean textiles immediately. As for the remaining 38.2%, the US will lift tariffs on 18.6% within five years and on the final batch within 10 years. Yet, Korea has gained by excluding items that cannot meet the Yarn Forward rule or for which yarn supply is not adequate  4 from the rule. Tariffs elimination as a result of the FTA is expected to raise Korea's textile export to the US while making little change to import from the US since garments imported from the US could most probably be very highly priced ones.

After the FTA is in place, the textile industry of Korea may use it as a good opportunity to increase sales in the US market. To this end, they had better upgrade their products to high-value-added ones by improving productivity and using technological cooperation with the US. They could enhance productivity by establishing the vertical production network ranging from yarn to textiles to apparel and the vertical integration for export ranging from textiles and dye to sewing to converters. This is because the vertical network and integration will help differentiate their products from other countries, especially China. Also, it would be a good idea for Korean companies to consider strengthening strategic partnership with or acquire US companies with high brand power.

Pharmaceutical : developing bio-original medicines

In pharmaceutical patents, Korea and the US have agreed that Korea will bring patent protection up to the global standard. They have also agreed in principle to set up a system to suspend the approval process of a generic drug when the original developer files a complaint about patent violation against a generic maker that applies for product approval. Under current US law, a patent infringement suit leads automatically to a 30-months suspension of the drug approval process. Stronger patent protection will reduce the market share of domestic generic drugs and even may drive some generic makers out of the market. This, coupled with Korea's positive list system (only cost-effective drugs will be covered by the National Health Insurance), will likely intensify competition in the Korean pharmaceutical market and lead to wide-scale industrial restructuring including massive M&A among drug manufacturers.

Following the FTA ratification, all these mean that Korea's pharmaceutical industry needs to enhance productivity and efficiency through restructuring. But there are some bright spots. Korean companies now can bet on the possibility of mutual recognition arrangement (MRA) on generic drugs. The conclusion of the FTA has laid the foundation for Korean pharmaceutical companies to be able to comply with international GMP. 5 Generic drugs made by Korean companies are not yet recognized as generic internationally, but under the FTA, Korea and the US have agreed to work together for US recognition of Korean generic drugs. Korean firms should take advantage of this opportunity to enter the US market. As for original drugs (new ones), Korean companies are recommended to look to and focus on a niche market for new biodrugs. 6 Korea has already numerous bio-t ech companies that can easily enter biodrug business. Related, they may consider enhancing their market recognition in a short period of time through M&A with US bio-pharmaceutical companies.

Broadcasting Communications : establishing a bridgehead for Korean communications companies to advance into foreign markets

The US agreed to keep market access at the current level without further opening measures. At present, the US broadcasting and communications market is open to foreign investors except in the area of wireless telecom.

In that industry, foreign investors are allowed to take shareholdings up to 20%, but face no limit in making indirect investment. They can also turn to MVNO. 7 Under the FTA, shareholding ceilings that used to be imposed on foreign investors will be removed for Korean telecom service providers (excluding KT and SKT) and program providers (except for news, general service and home shopping). This is the only substantial market opening provision under the FTA. Besides, Korea will ease partially 'domestic content requirement' (the broadcasting quota) and 'one nation quota'. 8 All in all, the FTA will have little effect on Korea's telecom market. But, regardless of KORUS FTA or not, Korean firms need to look outside. Korea's telecom market is almost saturated. Therefore, it is high time that Korean telecom service providers and program providers should give a serious thought to advance into foreign countries. The US market will be a good starting point since it is the world's largest telecom market and has recorded a higher growth rate than those in the other developed nations. They can count on the fact that Korea leads the world in the advanced telecom services such as the third generation (3G) telecommunications and Internet Protocol Television (IPTV). Particularly, in the area of wireless broadband Internet, they can team up with their US counterparts. The lifting of shareholding ceilings will also help. In the long term, Korean program providers may export their contents to the US market, largely in Asian Americans communities.


FTA Impact by Industry

 

III. Companies' Potential Response Strategies

After the KORUS FTA ratification, companies will be the main focus of attention. They may use the KORUS FTA to go out of the 'Nut Cracker' situation. Recently, Korean companies have been likened to "nuts" that are squeezed in a "nut cracker." They are being relentlessly chased by Chinese competitors in terms of cost competitiveness and by Japanese firms in terms of technological prowess. Judging from the details of the agreement, even most of benefits to Korean companies will be concentrated for only five years after it takes effect. Therefore, they had better be armed with refreshed mindset of 'offense' rather than 'defense' to make the maximum of opportunities opened by the FTA and to become a serious player in the US market.

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1. In Korea, the plenary session of the Assembly voted on whether to ratify and approve the final text. In the US, the United States Trade Representative (USTR) will introduce 'Implementation Law', an edited version of the text, to the Congress. Within 90 days, the Law will be voted on by the House of Representatives and the Senate.
2. In particular, the Democratic Party has recently demanded that labor and environmental standards be inserted in the FTA text.
3. Under the rule, the origin of apparel follows the origin of the yard used to make it. For example, if a shirt is made in Korea, but made out of the yard of China, the shirt is sold as China-made.
4. In the KORUS FTA, the Yarn Forward rule is based on that in NAFTA and CAFTA. The former does not designate an available period, but the latter ensures the rule is valid for five years after the ratification (renewal possible on the bilateral agreement). In the former, both countries agreed on items whose yarn is not sufficiently supplied while the latter decided to follow the decision by an importing country.
5. Good Manufacturing Practices - the control and management of manufacturing and quality control testing of pharmaceutical products.
6. The new biodrug market has a short history of 30 years. Biodrugs refer to all drugs that are completely made out of bio materials such as proteins, hormones, genes and cells.
7. MVNO (Mobile Virtual Network Operator) provides telecommunications service to customers independently by leasing an allocation of spectrum of MNO (Mobile Network Operator) with a radio spectrum license.
8. This limits import from one country in a variety of areas, such as films, animation and pop music. Currently 60% to→80% after the FTA.
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