GRAVITY MODEL BY PANEL DATA APPROACH: IN WHICH WAY SHOULD SOUTH KOREA (REPUBLIC OF KOREA) TURNS TO THE REGIONAL INTEGRATION, TPP OR ASEAN?

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1 GRAVITY MODEL BY PANEL DATA APPROACH: IN WHICH WAY SHOULD SOUTH KOREA (REPUBLIC OF KOREA) TURNS TO THE REGIONAL INTEGRATION, TPP OR ASEAN? BY CHAN MAN LEE STUDENT NO A PROJECT SUBMITTED IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR THE DREGREE OF BACHELOR OF SOCIAL SCIENCES (HONOURS) DEGREE IN CHINA STUDIES ECONOMICS CONCENTRATION HONG KONG BAPTIST UNIVERSITY APRIL 2013

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3 HONG KONG BAPTIST UNIVERSITY April 2013 We hereby recommend that the Project by Miss Chan Man Lee entitled Gravity model by panel data approach: In which way should South Korea (Republic of Korea) turns to the regional integration, TPP or ASEAN? be accepted in partial fulfillment of the requirements for the Bachelor of Social Sciences (Honours) Degree in China Studies in Economics. Dr.Hung Wan Sing Project Supervisor Dr. Second Examiner

4 Acknowledgements I would like to thank my supervisor Dr. Hung Wan Sing for suggesting the research topic and guiding me the entire study, assisting me in computing works, the use of Eview and providing me the needed data and materials. Thanks are also due to HKBU library for the online resources and necessary reference. Student s signature China Studies Degree Course (Economics Concentration) Hong Kong Baptist University Date:

5 TABLE OF CONTENT 1. Introduction South Korea, Why TPP or ASEAN? Background Information and Some Historical Background 2.1 Korea and FTA What is Trans-Pacific Partnership? What is ASEAN? Motivation of building Korean-China ASEAN FTA, TPP and advantages and disadvantages from the economic integration 3.1 Background of Economic Integration in Asia-Pacific Region Political Factor National Security and Geographical Factor Industrial and Social Factor Economic Factor The Gravity model- Introduction Data sources and Selection of Data Estimation Methods and methodology Results and analysis Discussion (latest news) 4.1 Uncertainty raised by Japan Alternative plan- forming a China-Japan-Korea Free Trade Agreement Conclusion Bibliography/Reference

6 Abstract As China becomes a great superpower in the global market and become one of the largest exporting countries in world. We can find a lot related research about miracle of the export growth in China. However, one country cannot maintain its growth without the cooperation with the other country. In order to have a more comprehensive picture for the world economy, we should have a better understanding of our neighboring country. In this paper, we are going to discuss how s South Korea, one of the major trading partner with China, should turn for the regional integration. Trans-Pacific Partnership (TPP) tends to be a global economic bloc that is under U.S influence while ASEAN is a more pro- China regional integration bloc. South Korea's eagerness for an overall growth had impaled it on the horns of a dilemma, forcing a choice between political and economic benefit. Therefore, we will first give a brief introduction of ASEAN, TPP and provide some background information of Korea Free Trade Agreement. Then, we will analyze whether Korea should join ASEAN or TPP in political, geographical sense, with full explanations and graphs. Then, the gravity model of bilateral trade is adopted to predict and estimate the trade flow. Finally, we will come to the discussion and conclusion part which suggest that, in which way South Korea should go for her economic integration.

7 1. Introduction South Korea, Why TPP or Asean? 1 TPP was first launched by Chile, New Zealand, Singapore, and Brunei in 2005 and it has become one of the most influencing economic integration blocs in the Asia-Pacific. U.S, Australia, Malaysia, Peru, and Vietnam are actively involved while Japan, Canada, and Mexico have expressed their interest on TPP. South Korea is invited by joining TPP but is still under consideration. Why it is the case? Since 2 South Korea, as the world 15th largest economy, should have a greater potential for trade development. Any step made by South Korea will cast a great impact on the future of East Asian economic integration. China, which shows an aggressive support to ASEAN+3, is already turning its direction on negotiating the ASEAN+6. These changes in the trade environment will have significant influence on the future of the South Korean economy. China has traded with 3 South Korea since the 1970s and a remarkable improvement of bilateral trade was shown since establishment of formal diplomatic relations with South Korea in China, as the world's second-largest economy in terms of nominal GDP and Nevertheless, the 1 New Zealand Ministry of Foreign Affairs & Trade (2005). The official TRANS-PACIFIC STRATEGIC ECONOMIC PARTNERSHIP AGREEMENT (PDF document).retrieved from: 2 World Bank(2011). Gross domestic product (PDF document). Retrieved from: 3 Ministry of Foreign Affairs- Countries and Region- Asia & Pacific-list of countries. Retrieved April 9, 2013, from: nu=m_30_10 1

8 establishment of FTA has attracted a lot foreign direct investment from South. Korea. Under the assumption that ASEAN+6 and TPP centered on the United States will clash, in the following sections, we will analyzes the possible reasons and effects of this the two blocs on the Korean economy, political and social aspect. We will then evaluate either TPP or ASEAN would be more desirable. Since the major difference between TPP and ASEAN is on their political standpoint, we will have an overall evaluation on all areas. Before we start, we should be familiar with some of the background information of these two economic organizations. The following graph shows the trend of trade of South Korea from 1990 to 2011 and we can see that China is growing more and more important to South Korea. Figure 1: export value from (MEXICO, RUSSIA, INDONESIA, INDIA, CHINA,U.S, SINGAPORE,JAPAN, HK) Data Source: International Financial Statistics (IFS) 2

9 2. Background Information and Some Historical Background 2.1 Korea and FTA What Is a Free Trade Agreement? Free trade agreement (FTA) is a mutual economic agreement which two countries (city/ economic organizations are also applicable) both agree to waive most or all tariffs, quotas, taxes special fees or another barriers when they are engaging trade services. The purpose of free trade agreements is to increase the attractiveness for more business opportunity, and at the same time, ensure a smooth and efficient transaction between the countries/areas. It is rather important that both countries should benefit from FTA and to encourage the counter export and economic growth Connection with South Korea Until 2012, South Korea has conducted a list of bilateral free trade agreement with the following countries or economic organizations, including 4 ASEAN, which is what we called ASEAN+3 agreements, Chile, India, Peru, Singapore, Switzerland, United States, European Free Trade Area (EFTA), European Union(EU). Apart from the above countries, South Korea is now negotiating or is planning to have bilateral trade agreements with the following countries and blocs; they are including Mexico, Canada, China, Japan, Gulf Cooperation Council (GCC). It is getting more and more attractive to 4 Ministry of Knowledge Economy (2013). Policies Issue, FTA. Retrieved April 9, 2013, from: 3

10 conduct FTA with South Korea, as we can see from Figure 2, Korea is having a tremendous growth on both GDP and export value from 1990 to 2011 and it is predicted that it s going to be more important in world economy. Figure 2: Gross Domestic Products, Export Value, Population Data Source: International Financial Statistics (IFS) 2.2 What is Trans-Pacific Partnership? What is TPP? The 5 Trans-Pacific Strategic Economic Partnership Agreement (TPP) is a U.S lead Economic and trade integration organization that is intended to be a high standard and broad-based free trade agreement that aims to integrate the economies of the Asia Pacific in the 21st century. It is a relatively newly developed regional cooperation and it is foreseeing that TPP will act as a bridge to strengthen the control of the Asia-Pacific economies by U.S government and at the same time, enhance the Asia-Pacific-Global economic integration. 5 Office of the United States Trade Representative (2013). The United States in the Trans-Pacific Partnership. Retrieved April 9, 2013, from: s-pacific-partnership 4

11 2.2.2 Aims of TPP The aims of Trans-Pacific Partnership are as obvious as to show a significant impact on both political and economic aspect. U.S wants to use TPP as a mean for getting as much influence as in Asia. Eventually, the goal is to include additional Asia-Pacific countries in an intensive way and to cluster them in order to have at least 40 % of the world coverage and at least half of the economic output so that U.S can maintain its power as the Dragon Head. Moreover, as a high-standard regional agreement, it gives the member states a superior statue that they are heading to the most modern multi-national cooperation. For instance, one of the major concerns for TPP is to have bilateral trade on protecting each other s intellectual property rights. With the global law, the member state can trade freely and securely. Since property rights obtained the greatest share of U.S export, the implementation of these rules will then change the trend on the enforcement of property rights. Then, U.S can have further control on the domestic laws and policies of its member states by both the external and internal pressure Current member states: The current members are 6 Singapore, Chile, New Zealand, Brunei, Australia, Peru, Vietnam, Canada, Malaysia, Mexico and United States. In addition, South Korea expressed its interest on this economic integration bloc and she was invited to join TPP in December 2010 by United States. Since Korea 6 Ministry of Trade and Industry Singapore(2013) On-going Negotiations at a Glance. Retrieved April 9, 2013, from: 5

12 already has bilateral trade agreements with other TPP states, it is easier to have mutual understanding and further bilateral trade agreements. We can know the trend of the total FDI among the TPP member states form the following table. Apparently, it doesn t cast that much influence to the GDP from the ratio. Table 1: Country Bilateral Investment Treaties and Flows for TPP Countries Total FDI (Inward) Total FDI Aboard (outward) Total Investment(inward& outward) To GDP ratio Australia Brunei Canada Chile Malaysia Mexico New Zealand Peru Singapore United States Vietnam FDI, FDI to GDP ratio United States International Trade Commission(ITC) Data Source: International Financial Statistics (IFS) & USITC Interactive Tariff and Trade Database Analysis: Congressional Research Service (CRS) Problems of TPP The U.S leaded TPP aroused critics in a sense that this regional cooperation focuses more on political but not economic aspect. The FTA doesn t really benefit either U.S or its fellow members. With more and more voice for anti-globalization, people accuse the TPP of going far beyond the area of tax free and mutual trade cooperation, but giving power to U.S to influence the local trade practice, labor, and environmental affairs. With more intervention from U.S government, the autonomy will be greatly reduced. 6

13 And for the U.S local, they don t support this scheme either. One complaint is that more than three million U.S. jobs with middle-class wages have been outsourced to foreign countries since 1994 (Gordon M. Lewis, 2011). With more economic advantages and welfare, it is predicted that it will worsen the employment situation in U.S. With more and more controversial issues leaked out of more during negotiation, a lot people or even countries show distrust on TPP What is ASEAN? What is ASEAN The Association of Southeast Asian Nations, or ASEAN, was 7 established on 8 August 1967 in Bangkok, Thailand, with the signing of the ASEAN Declaration by the founding countries of ASEAN, including Indonesia, Malaysia, Philippines, Singapore and Thailand. Brunei joined on 1984, Vietnam on 1995, Lao and Myanmar on 1997, and Cambodia on These ten countries together making up the today s ASEAN. The formation of ASEAN were due to the common interest on concentrating on nation building, the common fear of communism, mistrust of western powers in the 1960s, and a desire for economic development and integration to strengthen its regional competiveness Expansion with ASEAN+3 or ASEAN +6 During the 1990s, ASEAN experienced an increase in both membership and 7 ASEAN Official Website (2013). About ASEAN- Overview. Retrieved April 9, 2013, from: 7

14 the request of having further integration appeared. 8 In 1990, Malaysia once proposed the creation of an East Asia Economic Caucus, together with the existing members of ASEAN as well as China, Japan, and South Korea, purposing on counterbalancing the growing influence of the U.S in the Asia-Pacific Economic Cooperation (APEC) and in the Asian region as a whole. This proposal turned out to be a failure due to the opposition by U.S and Japan. Yet, the negotiation didn t stop and finally in 1997, a revival of the Malaysian proposal was established in Chiang Mai, so we called the 9 Chiang Mai Initiative, establish a formal integration for ASEAN member states as well as the ASEAN Plus Three countries, that is China, Japan, and South Korea Aims of ASEAN ASEAN aims at accelerating economic growth, social progress, and cultural development among its members. Also, protection of regional peace and stability, and provide a flat form for its member countries to discuss contrast in a peaceful way. In another words, it has emphasized regional cooperation through three aspects that are security, social cultural integration, and economic integration. 10 The ASEAN members has shown a significant economic growth, for example, the average economic growths of ASEAN's member during were, Singapore with 6.73%, Malaysia 8 ASEAN Official Website (2013). About ASEAN- ASEAN member states. Retrieved April 9, 2013, from: 9 T Richard Stubbs (2002). ASEAN PLUS THREE Emerging East Asian Regionalism? University of California Press, ASEAN official website (2013). Resources, ASEAN statistic. Retrieved April 9, 2013, from: 8

15 with 6.15%, Indonesia with 5.16%, Thailand with 5.02 %, and the Philippines with 3.79%. In general, the economic growth for ASEAN members due to the economic integration, is far more success than the other economic bloc like APEC Current Member States The 11 Current members are Indonesia, Malaysia, the Philippines, Singapore and Thailand, Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam. + China, Japan and South Korea, ASEAN +3. The following table shows the volume of trade value and share to the total trade. Table 2: Intra-ASEAN trade Extra-ASEAN trade Total trade Country Value Share to Share to Value total trade total trade Brunei Cambodia Indonesia Laos Malaysia Myanmar Philippines Singapore Thailand Vietnam ASEAN Data source: ASEAN Finance and Macro-economic Surveillance Unit Database, ASEAN Merchandise Trade Statistics Database, ASEAN Foreign Direct Investment Statistics Database (compiled/computed from data submission,publications and/or websites of ASEAN Member States' national statistics offices, central banks and relevant government agencies, and from international sources) Problems of ASEAN ASEAN was criticized by Western countries for just focusing on economic interest but forgone to promote human rights and democracy in 11 ASEAN official website (2013). About Us. Retrieved April 9, 2013, from: 9

16 Asia-Pacific region. For example, at 2010, the world, especially the western countries blamed the Miyama s military government for cracking down on those peaceful protesters in Yangon. Yet, ASEAN has refused to suspend Myanmar as a member and also rejects proposals for economic sanctions. Thus, European Union, the potential member states, had certain dubious and refused to conduct free trade negotiations at a regional level for these political reasons. In other words, ASEAN is not that trust-worthy and they never really take real action on enhancing the democracy or moral standard. This violates its aim that is not only focusing on trade but also cultural development. 10

17 3. Motivation of building Korean-China ASEAN FTA, TPP and advantages and disadvantages from the economic integration 3.1 Background of Economic Integration in Asia-Pacific Region Figure 3: Source: Motoshige Itoh (2012) Why Choose the TPP? A consideration of the Issues from the Perspective of the System of International Trade Nira Opinion Paper (No.6) March 2012 The above figure is the world map showing the concentration of the different economic integration blocs. They tend to diverse or spread their cooperation with each other. One of the important reasons why Asia-Pacific region speeded up the regional integration is that among all these countries, they suffered a lot from the Asia-Pacific crisis in The weak linkages 11

18 among all the nations intensify the seriousness of the crisis. In order to recover from the hardship, regional cooperation seems to be the optimal solution; especially they take a reference from the European Union, which is regarded as a success in recovering the European Economy. Since then, in 2001 the East Asian Vision Group, suggested that Asia-Pacific regional integration can be based on these three aspects that are economic, security, and society (MUNAKATA Naoko, 2002). Due to various political and economic reasons, including the need to keep up with trade liberalization, cooperation while didn t violate the political rules, it seems that economic or trade integration is the least controversial and easiest to start over and developed. Figure 4: Import Value (ASEAN, ASEAN+3, TPP) Data Source: International Financial Statistics (IFS) Why all the East-Asian countries are now focusing on not only regional integration on economics, but also the global economic cooperation, apparently with U.S, E.U or China? We can conclude them into the following reasons. As far as we know, in nowadays society, globalization is 12

19 a trend which no one can avoid. Outsourcing from the developed countries is a common practice and at the same time, the less-developed countries in Asia-Pacific regions are trying to absorb their technology and improve its infrastructure for further development. Colonial Empire is in a form of economic competition, not solely by the political influence. Closer economic ties between Korea, Southeast Asia, and the United States and China can be pursued within regional and trans-pacific frameworks. No nations will against integration in the view point of economic means, as well as China. If you just refuse to join or take part in, you will be leaving behind. Economic integration is the most mature developed for both East Asian and trans-pacific integration. The closer economic ties means that no nations can make a step for its own interest without the others consent and these structures offer a formal excuse but a private space for unpublicized meetings, which can be fit easily within this framework. And for China, since she is also a member of both APEC and the various ASEAN-centered groupings, she cannot complain about being excluded. If Korea, Southeast Asia, and the United States are to take advantage of regional and trans-pacific frameworks to cooperate more fully, there must be a high degree of convergence in their goals. Table 3 shows the economic situation of ASEAN, ASEAN+3, ASEAN +6 and TPP and we can know their economic scale as well as their purchasing power. From the figure, it seems like TPP members are having the largest economic scale, in terms of GDP. However, is it really the case? Or is it because of U.S and Japan? Or how important it is in APEC group? 13

20 Table 3: Economic Bloc ASEAN+3 ASEAN+6 TPP Economic Indicator of major Economic Blocs in the Asia-Pacific Region States Population Econmic Scale (GDP) GDP per capita (million) million USD South Korea Japan China Sub total Brunei Cambodia Indonesia Laos Malaysia Myanmar Phillipines Singapore Thailand Vietnam Sub total Total India Australia New Zealand ASEAN Total Brunei Chile New Zealand Australia Malaysia Peru USA Vietnam Canada Japan Mexico Singapore Total Export Value (ASEAN, ASEAN+3,ASEAN+6, TPP) Data Source: International Financial Statistics (IFS) 14

21 The second feature that we can observe is that throughout these twenty years, South Korea are getting a closer and stronger relations with most countries in Asia-Pacific, or East Asian in both political and economic aspect. This trend draws attention from both U.S and China, in which they want to rope in South Korea, and the other South East Asian nations to maintain their political influences. From the standpoint of most of the East-Asian countries, including South Korea, They want to enjoy the benefit share by these big nations and thus regional and Trans-Pacific organizations provide a convenient, open-ended space which closer relations with U.S can be achieved. Yet, China s fierce criticism on U.S act on TPP may exacerbate China s next step. We can foresee that the income gap of ASEAN may be enlarged and the risk of those non TPP members will fall further behind. Grasping this point, China can have a good propaganda by involving the untied of East Asian regionalism without Western control and in the future there may even be room for North Korea, that is something South Korea is afraid of. Therefore, South Korea is now facing a challenges, how to balance with U.S and China. Undoubtedly, The Korea-US free-trade agreement (KORUS FTA) is being implemented and South Korea should join the TPP and get a closer relationship with U.S. Meanwhile, ASEAN members are speeding up of economic reform and trade liberalization with China s support that is also beneficial for South Korea to sustain its political and economic status as the future head of Asia. 15

22 3.2 Political Factor The Asia-Pacific region is becoming more important to U.S in political view, and in fact she is driving to have political influence in connection with TPP. Obviously, in nowadays Asia, China is the greatest potential risk to U.S, no matter in political, economic, military or even national security. China is influencing the Asia-Pacific, as well as the global economy by actively participating in ASEAN. If U.S want to fight against China, establishing and consolidating the trade relations with other countries so that China starts feeling more pressure about fulfilling all kinds of western standards, including the basic rights and increase its transparency. TPP is strongly criticized by China as another continuous example of Cold War. (Bonnie Glaser, 2012). However, we cannot deny the truth that ASEAN may also regard as a tool to fight against U.S or prevented that China will be surrounded by the U.S power. In general, TPP is regarded as a open-door regional integration bloc. If any country agrees to meet certain standards or carry out reform in order to obtain the approval of joining it, they are welcomed and can enjoy the privilege of the membership. Although at this initial stage, China is not invited to join and at the same time, China refused to join TPP too. ASEAN is more or less like a competitor with TPP in a political sense. ASEAN has a long history on encouraging regional cooperation and China continues to carry out domestic economic reform steadily for further integration with ASEAN. Yet, if TPP grows up and succeeds, non-tpp members of ASEAN may take the risk of leaving behind. 16

23 Afraid of losing the political status, most Asian countries are now considering enjoying both benefits from TPP and ASEAN. However, it may not be that easy and that s the problem exactly South Korea is facing now. South Korea is an important trading partner with both U.S and China. However, South Korea is having a closer diplomatic relationship with U.S as the South Korean government was established with the help of U.S in 1954 after the Korean War. The basic assumption of the Korean government is to adopt a very democratic system is election and all areas. This act is to strengthen its political power in the world, especially in Asia-Pacific region during the cold war period. However, we are now at the 21the century and the former strategy doesn t work. All the government is now trying to adopt a comprehensive economic means, for example, reduce the trade barriers or forming economic integration bloc to lurking control the other nations. And of course, China as the largest trading partner and with the greatest potential growth, South Korea is now observing the winds blow, in order to get ties with the future strongest nation in the world. Therefore, in this aspect, it seems joining ASEAN and form a big family with China is much more beneficial in all aspect. 3.3 National Security and Geographical Factor South Korea is situated at the southern part of the Korean peninsula, on the northern part of this peninsula, it is the communist empire ruled by the 17

24 Kim-Jeong-en, which is what we called North Korea. 12 These two countries are split into two in 1953.Its neighbor includes China that is on the west and directly connected with North Korea; Japan, which is on the east. South Korea covers a total area of 99,392 square kilometers and lies in the North Temperate Zone with a continuous mountainous terrain with limited natural resources. Figure 5: Source: GOOGLE MAP China is always an ally with North Korea of their same background of communism. During the cold war and the Korean War, China provided all kinds of military support to N. Korea and indirectly help split up of Korean Peninsula. Due to the support of North-Korea, South Korea and China are in a tense condition for the past twenty years and a formal diplomatic relationship is finally established in Their relations have improved 12 Seoul Museum of History (2013). Exhibition, Development of Seoul. Retrieved April 9, 2013, from: 18

25 steadily and these two countries are improving bilateral relations by lifting the trade embargo. What China focusing now is to use economic interest to expand its influence to the world, and ASEAN is the best bloc to get involved. U.S and South Korea have strong economic, diplomatic, and military ties and South Korea is one of the most developed alliance countries in Asia. The alliance between the U.S and South Korea remains a key factor in controlling the security in Northeast Asia. This alliance has served well to counter the threats from North Korea, but also China and Russia. Their comprehensive strategic partnership is based on enjoying the common values, which is the free market mechanism. Furthermore, they have shared interests and common fear of the again rise up of communism. U.S showed great support to South Korea, especially on military offenses and they always stage a joint military drill in order to stop North Korea for its provocative act. TPP is another mean to get more influence in Asia. Figure 6: Republic of Korea (SOUTH KOREA) Major diplomatic condition No diplomatic relations Allies Cuba United States Macedonia North Korea Syria Source: Ministry of Foreign Affairs, Republic of Korea Japan ( implicit) Republic of China- (taiwan) (implicit) South Korea is now facing the difficulty of approaching China or increase the strategic partnership with U.S, especially at this initial moment. North 19

26 13 Korea vows to tear up Korean war ceasefire agreement on and blocked all the connection with South Korea. Even these two big nations are peacefully cooperation with each other, but we know that underneath they are competing aggressively in all aspect. What we can predict is that once South Korea decided to deepen collaboration with ASEAN and China, U.S may turn out to be less supportive to hers national offenses. If North Korea declared wars on South Korea, China, as the biggest ally will definitely provides platform for its attack. While at the same time, U.S may refuse to help and step back on this issue. Thus, in this case, South Korea may go through the human dilemma. Therefore, Joining TPP or ASEAN cannot be solely determined by economic reasons. In somehow it determines whether South Korea will adopt a pro- U.S or pro-china direction, as well as the attitude towards North Korea. 3.4 Industrial and Social Factor South Korea relies heavily on exports to the growth of the economy. The major exports types are finished products such as electronics, semiconductors, LCD panel, mobile phone, computers related, television, motor vehicle, steel, ships and petrochemicals. They occupied more than 70% of the total export of South Korea. And we can see that the Smart phones made by Samsung or LG are invading the global mobile market and 13 The Guardian (2013, March 5). North Korea vows to tear up Korean war ceasefire agreement. Retrieved April 9, 2013, from: 20

27 can even compare with Apple. For the trading partner, the main export countries are China, European Union, U.S. and Japan. Among these four world-leading nations, China is the biggest trading partner with its strong internal demand for advanced I.T products. The following firgure shows the export commodities of South Korea from 2005 to 2011 and we can thus have a more comprehensive picture for their export. Figure 7: Export Commodities from (SOUTH KOREA) Data Source: International Financial Statistics (IFS) One interesting phenomenon we can observe in South Korea society is that in nowadays Korea, Korean are much more welcome Chinese than U.S people. The nowadays younger s from South Korea, mainly the university undergraduate, they showed a positive support to have more cooperation with China and ASEAN, other than with U.S, and the reasons are as follow. Firstly, U.S is no longer the global head in the coming future, to be accurate, 21

28 its influences in all areas is deteriorating. It is not only the problems of U.S, but also the other European Countries. With the Euro zone crisis and the Quantitative Easing 3 emitted by the U.S, South Korean started to lose faith on these western Power nations. With the rising up of the Asian power simultaneously, particularly China, it seems like it would be favorable to turn towards China. What we can see is that the nowadays Korean society is pushing the next generation to learn Chinese (that is not encouraged by the Korean government for the past 20 years for the Desinicization). According to the news article 14 The openness and welcomes to Chinese tourists is so obvious, with at least one Chinese menu, one Customer Service Representative that can speak Chinese. Therefore, it is clear that the acceptance to Chinese is getting more and more. South Korea, as a countries being controlled for more than 50 years, she is more than excited to regain its national glory by not replying on western power but to develop its own specialty. Getting a seat in Asia for the coming future is what they are considering 3.5 Economic Factor The Gravity model- Introduction The gravity model of trade in international economics, similar to other gravity models in social science, predicts bilateral trade flows based on the economic sizes of (often using GDP or GNP measurements) and the geographical distance between those countries. It is usually used to 14 去漢字化后果尷尬韓前總理籲學漢字 ( 新浪新聞,2012 ) 擷取自網頁 : 22

29 examine one or two more Economic Bloc or Regional Trade Agreements at a certain period of time. The model was first used by Tinbergen in The basic model for trade between two countries (i and j) takes the form of: The gravity model of the bilateral trade is constructed as follow: Where X ij is the trade flow, Y i is the economic size of the exporting country while Y j is the economic size of the importing countries, D ij is the distance between the pair up countries and B 0 is a constant. The model has also been used in international relations to evaluate the impact of treaties and alliances on trade. Since then, the gravity model has been widely used and increasingly improved in empirical studies of international trade. According to this model, trade between countries is positively related to the size of the economy, but negatively related to the transaction cost. Sometimes, different kinds of variables are introduced like population, to explain for the negative effects on trade flows. Or a per capita income variable is often included to provide a good reason for the high economic growth, which is important in increasing export and import. In addition, several kinds of dummy variables will be employed (Linneman,1966) into the gravity formula to estimate the potential effect on bilateral trade, for example, cultural, common language and institutional factor. As time goes by, there are changes on gravity model. Log form of the equation dominated in most 23

30 of the research. The following are some of the econometric specification. In most of the previous empirical studies and research based on cross section estimation techniques, exports from a country i to a country j (Xij) are presented by the typical gravity equation as follow: log Xij = B0 + B1 log Yi + B2 log Yj+ B3 log Dij + B4 log POPi + B5 log POPj+ B6 log AREAj + B7 logareaj + B8EXRjt + B9DEFLATit + B10TAXjt + B11LANGij where POP refers to the population, AREA refers to the surface area of the country, EXR refers to the exchange rate, DEFLAT means the deflation rate, TAX refers is the International Monetary Fund (IMF) trade tax index for both importing and exporting country and LANG refers to a dummy which is 1 if to countries share the same language. All in all, I is the importing country while j is the exporting country and t refers to the particularly period of time. In the past, the main obstacles for international trade are due to the high transportation cost and the unfamiliar with the local languages and cultures. We would always expected that bilateral trade is beneficial of we can keep a close corporation with the neighboring countries. Therefore, international trade organization like APEC, European Union is established o strengthen this kind of relationship. And we can see that in the traditional Gravity model, a dummy variable is implied to test if two adjacent countries were sharing the benefit of closer boarder. Yet, due to the improvement of technology throughout these 10 years, 24

31 transportation cost and transaction cost is greatly reduced. Thus, the major concern now is whether the potential trade volume is large or not. The establishment of the TPP by the U.S is a way to ensure a closer trading partnership between U.S and Pan- Asia District. At the same time, ASEAN is now negotiating with China and see if China would join and become a permanent member of this economic organization. However, the decline of the U.S and Europe economy and the rise up of the China give so much uncertainty to the international trade. South Korea, as a rising power in Asia, as well as the world, has to make a very careful decision on which group she should join. The use of gravity model enables us to analyze the trade preference by adding dummy variables. We can then come out the conclusion, South Korea should join either TPP or ASEAN (with China) when economic factor is purely the consideration, in the case of a APEC group. Therefore, we will add certain dummies to represent different economic blocs. Having a comparison between countries and economic bloc, we can then have a better understanding on which way Korea should go into global integration Data sources and Selection of Data I study the bilateral trade between 23 countries from 1990 to The Countries involve APEC members ASEAN members, TPP members and their the trading partners, including China, South Korea, Japan, U.S, Canada etc. These countries are most important partners for South Korea and at the same time, they are also competing with each other. U.S accounts for 15% for the total amount of trade while ASEAN and China account for more than 25

32 1/3 of its total export. To estimate the trade potential between China, U.S, ASEAN, TPP and South Korea, this analysis is important and representative, in a sense that South Korea can determine its future trading direction, which is extremely important in the global economy. With twenty-two countries, where each of them has 22 country pairs, the sample is made of 506 groups and observations. The bilateral trade data are measured in nominal U.S dollars and most of them are obtained from International Monetary Fund, Direction of Trade Statistics. The Gross Domestic Product and taxes are from IFS, CD-ROM data base. For the population size and also the area, the data are from IMF as well. Membership in ASEAN, APEC and TPP are measured by a dummy variable in which 1 for member while 0 for non-members. Also, a dummy variable for languages is employed such that 1 for sharing the common languages and 0 does not Estimation Methods and methodology To explain the bilateral trade between countries I (importer) and the country X (exporter), based on the gravity model, we estimate equation of the form and we will use this basic model in the paper. Basic model: LogExportij = B0 + B1 log GDPi +B2 loggdpj+ B3 logexri + B4logDEFLATi +B5logPOPi+ B6logPOPj + B7logAREAi+ B8logAREAj +B9logDISTANCEij + B10COMMONLij + B11APECi 26

33 Where : Exportij is the bilateral trade flow from exporting country I to importing country j measured in dollar value in year T; GDPi is the GDP of country i in year T; GDPj is the GDP of country j in year T DEFLATi is the deflation value of country i in year T; Distanceij is the distance between country I and country J ; EXRi is the exchange rate in market value to U.S in year T; Popi is population of country i in year Y; Popi is population of country j in year Y; AREAi is the surface size of country i AREAj is the surface size of country j COMMONLij is a dummy variable which takes value 1 if country I and j share the same language; APECi is s a dummy variable which takes value 1 if country I are in the economic bloc of APEC Panel data of the variables are chosen as follow and in the following section, in the following section, I am going to explain why all these variables are included in the model. GDP (Gross Domestic Product) As we all know that GDP is relatively important in affecting one s nation trade. Two GDP variables and GDPi is for the importing country and GDPj is for the exporting country. In general, as income and output in each country increase demand for goods and services as well as production will increase.therefore, it is expected that a positive sign will be observed. EXCHANGE RATE EXRi is the exchange rate of the exporting country. Exchange rate is defined as the local currency to one U.S dollar. The higher the exchange rate, it means there s a depreciation of the local currency or a fall in 27

34 country s relative price. In this case, a positive sign will be expected for the exporting countries. DEFLATION Deflation means the continuous decrease in the general price level. Deflat i refers to a comparatively cheaper price for exporting countries. As far as we know, deflation is harmful to the economy and the society. Yet, it will increase one s purchasing power. The relative price of the exported goods will then be lower. Therefore, it is expected with a higher deflation rate, the higher amount of export and a positive sign is expected. POPULATION For both of the exporting countries and importing countries, POPi and POPj, the greater the population, the larger the countries, they need to be more self sufficient. As a result, they need to rely more on the imported goods while requiring more export Therefore, a negative sign is expected. AREA With a greater size in the area of exporting countries AREAi and importing country AREAj, the level of self sufficiency will increase and the chance of requesting the imported goods will reduce. On the other hand, the level of comparative advantage will also hinder the export rate. Therefore, the coefficient of AREA is indeterminate. COMMON LANGUAGE With a common language LANGij, it is often expected that they will have an easier communication and reduce the amount of transaction cost. Thus, trade volume will eventually increase. In this case, we will expect a positive 28

35 sign. DISTANCE DISTij is defined as the geographical or physical distance between exporting and importing countries. Shorter the distance, lower transportation cost is required so as with a higher trade volume. Therefore negative sign is expected. APEC AEPCi is defined when the exporting countries are belonging to the same economic bloc and it is a controlled dummy. We want to examine if APEC can affect the world trade proportion or not and the coefficient is indeterminate. Modified model To see how s each country can benefit most from the APEC group, the following equation is developed: Equation (1)- LogExport ij = the above+ B 13 US i +B 12 KOR i + B 14 CHN i + B 15 JPN i The following equations estimate under APEC, how Korea compete with the U.S,China and Japan, TPP, ASEAN and see which one can get the most benefit from bilateral trade. On the other hand, in order to examine how TPP and ASEAN is going to affect export for Korea, the following dummies are adopted and equation is formulated in the following: Equation (2) - LogExport ij = the above+ B 17 ASEAN i +B 12 CHN i Equation (3) - LogExport ij = the above+ B 15 JPN i + B 13 US i 29

36 Equation (4) - LogExport ij = the above+ B 17 ASEAN i +B 12 CHN i + B 16 TPP i Equation (5) - LogExport ij = the above+ B 16 TPP i + B 13 US i + B 15 JPN i Equation (6) - LogExport ij = the above+ B 17 ASEAN i +B 12 CHN i + B 15 JPN i + B 13 US i To examine whether Korea should join TPP or join ASEAN, dummy variables are added and the equation is extended. The dummy variables took the value of one if a country was a member of the related economic bloc or particular country and zero otherwise. The following equations are used for the estimation: Equation (7) - LogExport ij = the above+ B 13 US i +B 12 KOR i Equation (8) - LogExport ij = the above+ B 14 CHN i +B 12 KOR i Equation (9) - LogExport ij = the above+ B 15 JPN i +B 12 KOR i Equation (10) - LogExport ij = the above+ B 16 TPP i +B 12 KOR i Equation (11) - LogExport ij = the above+ B 17 ASEAN i +B 12 KOR i Equation (12) - LogExport ij = the above+ B 17 ASEAN i +B 12 KOR i + B 14 CHN i Where ASEANi is a dummy variable which takes value 1 if the exporting countries are in the same ASEAN bloc, 0 for otherwise; KORi is a dummy variable which takes value 1 if the exporting country is Korea, 0 for otherwise; TPPi is a dummy variable which takes value 1 if the exporting countries are in the same TPP bloc, 0 for otherwise; USi is a dummy variable which takes value 1 if the exporting country is U.S, 0 for otherwise; CHNi is a dummy variable which takes value 1 if the exporting country is China, 0 for otherwise; JPNi is a dummy variable which takes value 1 if the exporting country is Japan, 0 for otherwise 30

37 Table 4 : Summary for the Hypothesized Gravity Model for bilateral trade Determinants Sign, Hypothesized Exporter s GDP (GDPi) + Export volume Importer s GDP (GDPj) + Import demand Population of exporting country (POPi) - require self sufficiency Population of importing country (POPj) - less resources for exporting Deflation (DEFLATi) + cheaper relative export price Exporter's area (AREAi)? may have more Importer s area (AREAj)? uncertainty on comparative advantage Distance (DISTANCEij) - reduce transportation cose Exchange rate (EXRi) + fall in country s relative price Common Language (LANGij) + increase communication efficiency APEC (APECi)? relative importance is uncertain Results and analysis (I) Basic determinates of Bilateral Trade The following table reports the regression result for the basic model that is over all countries. The estimation confirms all the hypothesis sign above and the data and specification are consistent with other papers using gravity model. The first column shows the result using OLS applied to the pooled data set and the next column shows the results using random effect model. In this paper, we are going to analyze the trade between 23 countries and 3 different economic blocs. In general, the fixed effects model is known to provide more accurate results in estimating the gravity model. However, it cannot estimate the time-invariant effect, e.g. distance or area, so we will then adopt the random effect method as a trade-off. The entire coefficient except for DEFLATi and importer s population are 31

38 having different signs for random effect and pooled least squares methods. As expected, both GDP for exporting and importing country has a positive impact on trade and statistically significant. The estimated coefficient for geographical distance is and it is also highly significant. For the exporter s population, we can now confirm that self-sufficiency is difficult with the greater amount of population and more export is thus required. The estimated coefficients for exporter s and importer s area are negative and statistically significant, yet, the coefficients are just too small and apparently it does not affect that much on the total amount of export. Similar to the exchange rate, it is with an expected positive coefficient and statistically significant, it is also too small to have a strong influence on the overall export volume. The effect for common language is positive and statistically significant, which is consistent to the findings of other paper. The last one is about the dummy APECi. There s a bit difference between the two estimation methods The OLS method estimates for APEC indicate that APEC members tends to export more compare to the rest of the world, with a positive coefficient and statistically significant, while the REM tends to believe that whether you are members of APEC or not is insignificant. Estimation Result 1 : basic model Dependent variables: Export Pooled OLS Constant ** (21.41) Exporter's GDP ** ( ) Importer's GDP ** (72.42) Geographical distance ** (57.16) REM ** (10.38) * (58.01) ** (27.83) ** (14.10) 32

39 Exporter's population * ** (1.9) (2.52) Importer's population ** ** (5.04) (8.32) Exchange rate ** ** (7.72) (15.72) Deflation ** * (3.15) (1.94) Common Language ** ** (17.38) (3.22) Exporter's area ** * (14.51) (2.48) Importer's area ** ** (4.36) (5.38) APEC ** (24.06) (0.48) Observations SEE R Adjusted R-sqaured Notes: Absolute value of t-statistic is reported in parentheses * denotes significant at 5 percent ** denotes significant at 1 percent All individual effects are not reported (II) Country Effect The following result shows the relative competiveness on world export for different country or economic bloc. A result from this group of estimation first reveal is that the OLS method shows a more robust result by having a higher R-square. We can see how each country or trade bloc could gain in the world export market. Also, from the above result, we can see whether establish in bilateral FTAs in the Asia-Pacific region, that is ASEAN, can show very different trade intensities in their trade with the rest of the world. Among all these 5 countries, 3 of them, China, Korea and ASEAN tend to trade more and is competitive in the world market, with a positive coefficient and highly significant. It is estimated that they export 132%, 82.2% and 112% more than the rest of the countries, respectively. 33

40 Undoubtedly, China benefit most and this somehow fit the real trade pattern in nowadays world. Japan seems to trade less or diverse its trade into the other countries rather than those in APEC group with a negative coefficient. On the other hand, the U.S dummy variable shows negative coefficients or statistically insignificant, indicate that U.S trade roughly without regular pattern or no one can expected. One of the possible reasons is that these two countries faces serious current account deficit. However, U.S does trade with other countries other than APEC s country or those included in our model, for example Taiwan, Netherlands and etc. In conclusion, Korea, China and ASEAN are trade intensive- country while U.S and Japan is somewhat trade-deficient countries. Estimation Result 2 : Each country /Economic Bloc Dependent variables: Export Pooled OLS REM Constant 2.60 ** 5.62 ** (13.25) (8.26) Exporter's GDP 1.27 ** 1.17 ** (80.1) (58.64) Importer's GDP 0.78 ** 0.40 ** (73.08) (27.38) Deflation 0.78 ** 0.02 * (4.63) (2.06) Exporter's population ** ** (8.43) (2.93) Importer's population ** ** (5.86) (7.91) Exchange rate 0.07 ** 0.00 ** (4.80) (14.59) Geographical distance 0.00 ** ** (52.12) (12.79) Common Language ** 0.64 ** (18.86) (3.78) Exporter's area 0.87 ** 0.00 * (10.00) (1.69) Importer's area 0.00 ** 0.00 ** (5.03) (5.30) APEC 0.79 ** 0.45 ** 34

41 (16.17) (10.9) Korea 0.60 ** 0.64 * (7.55) (2.06) China 0.84 ** 0.8 ** (9.23) (2.38) U.S ** 0.04 (5.36) (0.03) Japan ** * (10.82) (1.74) ASEAN 0.75 ** 0.48 ** (14.40) (3.14) Observations SEE R Adjusted R-sqaured Notes: Absolute value of t-statistic is reported in parentheses * denotes significant at 5 percent ** denotes significant at1percent All individual effects are not reported (III) TPP V.S ASEAN This part comes to the comparison of TPP, ASEAN, China, U.S and Japan. We have divided it into the following group. The findings are correlated to the findings as above. When both ASEAN and China dummy are included in the equation, they are showing statistically significant results with positive potential. That means they export 56 % and 139% more, respectively. On the other hand, when both U.S and Japan dummy are included, we observe that US is showing a statistically insignificant negative coefficient while Japan tended to export less with a negative coefficient, statistically significant. One of the possible reasons is that, U.S and Japan are showing a declining trend of the world export, in terms of its proportion and the relative importance, especially in APEC group. When we are comparing ASEAN, China and TPP, the former two tends to 35

42 export more, while TPP tends to export less, with the entire statistically significant figure. One of the possible reasons may due to the weak linkage among all the members in TPP bloc. TPP is a relatively new regional integration and the expected trade outcome may not be observed in such a short period of time. Also, two major members who contributed most in TPP bloc, are found to have a diverse trade pattern and are not benefited from APEC group, it is able to foresee such an estimation result. If TPP, US and Japan are included and standing alone, all these three dummy show a negative coefficient and significant effect. It refers that somehow they are comparatively exporting less compare to the other countries. And finally if we put all four dummies ASEAN, CHINA, US and TPP together in one equation, it is similar to those finding above. ASEAN and China can export more while TPP doesn t generally, and U.S with a negative but insignificant coefficient. Estimation Result 3: TPP/ASEAN V.S each country/ economic bloc Equation 4 Equation 5 Equation 2 Equation 3 (ASEAN+China+ ( TPP+Japan (ASEAN+China) (Japan+U.S) TPP) +U.S) Dependent variables: Export Constant Exporter's GDP Importer's GDP Deflation Exporter's population Importer's population Exchange rate Geographical distance ** (8.65) ** (51.90) ** (27.35) (0.77) (1.43) ** (8.48) ** (12.34) ** (13.01) ** (10.13) ** (55.65) ** (28.20) (1.51) (0.53) ** (8.55) ** (12.62) ** (14.32) ** (8.82) ** (51.32) ** (27.32) (0.69) * (2.00) ** (8.47) ** (12.38) ** (12.99) ** (10.27) ** (55.70) ** (28.28) (1.55) (1.18) ** (8.57) ** (12.70) ** (14.27) Equation 6 (ASEAN+China +U.S+ TPP) ** (8.64) ** (55.12) ** (27.90) (1.53) ** (1.74) ** (8.47) ** (12.40) ** (12.97) 36

43 Common Language Exporter's area Importer's area APEC ** (3.45) ** (2.94) ** (5.42) ** (10.35) U.S / China ** (2.51) Japan / ** (3.15) ** (3.50) ** (5.56) ** (11.81) (0.30) / ** (2.50) TPP / / ASEAN (3.10)** / ** (3.53) * (2.43) ** (5.41) ** (10.30) / ** (2.40) / * (2.12) ** (3.10) ** (3.21) ** (3.13) (5.53) ** (11.87) * (2.25) / ** (2.59) * (2.25) / ** (3.52) ** (2.49) ** (5.37) ** (11.11) (0.24) * (2.30) / * (2.25) ** (3.17) Observations SEE R Adjusted R-sqaured Notes: Absolute value of t-statistic is reported in parentheses * denotes significant at 5 percent ** denotes significant at 1 percent Method: Random effect method All individual effects are not reported (IV) South Korea V.S major countries/economic blocs The following group is estimating how if only Korea and one particular country or economic bloc is included in our model. As we can see, the dummy Korea is positive and significant and this means that in general, Korea traded 80% to 169% compared to the rest of the world. This fits the reality that Korea is having trade surplus of USD $30801 billion in We observe that if we include both Korea and U.S dummy, the US dummy is having a negative coefficient and statistically insignificant. One possible argument is that there may be a high potential for U.S and Korea bilateral trade and uncertainty is raised. Another interesting 37

44 phenomenon we can observe is that, Japan export around 73% less if dummy Korea is included in statically significant. It may refer that Korea and Japan are competitor, especially in high-technology industry. Similar situation appear for dummy TPP and Korea. And from the above graph, we can see that TPP is rather insignificant to Korea s export and import, compare with ASEAN. And It may due to the weak trading power of TPP, with just few countries like U.S and Singapore are having high export but not for the others nation. For both dummy China and ASEAN, our result shows positive and significant effect. It may due to the high trading potential for these countries and as a whole, they can corporate with Korea and lead to a higher export. It implies that Korea s role may help stimulate the regional integration and global economies. It comes to the main point of our analysis, should Korea join TPP, ASEAN or ASEAN plus China? From the above regression result, we can make a comparison like follow. According to the estimation result, it is clear that Korean received the least benefit from joining TPP and then it makes not different for joining only ASEAN or ASEAN with China. Their coefficients are 0.42, 0.73 and 0.73 respectively. But Why Korean can benefit most from ASEAN in an APEC region? We can conclude into 2 reasons. The first one is about the Industry component. From the following graphs, we know that for South Korea, ASEAN and Korea are not competitor, they are cooperator. According to the export commodities, what occupy most 38

45 for South Korea s export are those electronic or semi-electronic products or vehicles. That s what those developing ASEAN countries desired. In a comparatively low price but good quality, they are demanding more and more goods from South Korea and they still have a big room for further cooperation on trade. Figure 8: Export Share from (South Korea) Data Source: International Financial Statistics (IFS) Figure 9: Export Share from (South Korea) Source: Diection of Trade (DOT), IMF 39