Korean exchange rate and FTAs under the Roh Moo-hyun administration

Transcription

1 International Relations of the Asia-Pacific Advance Access published January 28, 2015 International Relations of the Asia-Pacific (2015) doi: /irap/lcu022 Abstract Korean exchange rate and FTAs under the Roh Moo-hyun administration Koonsam Im * International Center, Tokyo Metropolitan University, Hachioji-shi, Tokyo, Japan * i16hoursaday@gmail.com Accepted 28 November 2014 The Korean government s engagement in FTAs since the late 1990s has been enthusiastic. As of 2012, the Korean government concluded FTAs with small trading partners such as Chile, Singapore, EFTA, ASEAN, India, Peru, and Turkey, and major counterparts such as the European Union (EU) and the United States as well. However, the degree of each of the Korean administrations engagement in FTAs has shown discernible differences: While the Kim Dae-jung administration passively engaged in FTAs, the Roh Moo-hyun administration was proactive in that engagement. What explains the shift from the Kim administration s passive FTA policy to the Roh administration s comprehensive multi-track FTA policy? This article argues that the appreciation of the Korean won since 2001 made Korean exporters lose their price competitiveness in the global market, thereby forcing the Roh administration to offset Korean exporters lost price competitiveness by formulating a comprehensive multi-track FTA policy, with huge side payments for politically sensitive import-competing sectors. International Relations of the Asia-Pacific The author Published by Oxford University Press in association with the Japan Association of International Relations; all rights reserved. For permissions, please journals.permissions@oup.com

2 Page 2 of 30 Koonsam Im 1 Introduction Since the Korean government joined the General Agreement on Tariffs and Trade (GATT) in 1967, the Korean government has supported multilateral trade liberalization under the GATT/World Trade Organization (WTO) over alternatives such as bilateral and minilateral Free Trade Agreements (FTAs) and, together with Japan and China, had remained one of the very few major trading countries that had neither joined any regional trade bloc nor signed any bilateral trade agreement (Park and Koo, 2007, p. 261; Yoshimatsu, 2012, p. 193). However, against the background of the stalemate of WTO s multilateral trade liberalization since the late 1990s and the adverse effect of the 1997 Asian financial crisis on the Korean domestic economy, the Korean government dramatically shifted its main trade liberalization policy from multilateral trade liberalization to bilateral/minilateral FTAs by formally announcing its start of an FTA negotiation with Chile in November Since the historic promulgation of the beginning of the FTAs, the Korean government s overall engagement in FTAs has been remarkable (Koo, 2008, p. 1). The Korean government had succeeded in ratifying FTAs with nine trading partners, not only relatively small trading partners such as Chile in 2004, Singapore in 2006, the European Free Trade Association (EFTA) in 2006, the Association of South-East Asian Nations (ASEAN) in 2007, India in 2010, Peru in 2011, and Turkey in 2012, but also major trading partners such as the European Union (EU) and the United States in Even though the Korean government started FTAs later than other countries, Korea s coverage of FTAs in its total trade reached 35.2% as of 2012 (METI, 2013, p. 60). If the Korean government succeeds in concluding and ratifying an FTA with its largest trading partner, China, which started in 2012, Korea s coverage of FTAs in its total trade will reach 55.4%. If we compare the Korean government s formation of FTAs with that of Korea s Asian competitors, Japan and China, we can more clearly identify the Korean government s remarkable engagement in FTAs. Since the Japanese government reached an agreement to start an Economic Partnership Agreement (EPA) negotiation with Singapore in October 2000, the Japanese government ratified EPAs with 13 trading partners as of 2012 such as Singapore in 2002, Mexico in 2005, Malaysia in 2006, Chile in 2007, Thailand in 2007, Indonesia in 2008, Brunei in 2008, ASEAN in 2008,

3 Korean exchange rate and FTAs Page 3 of 30 Philippines in 2008, Switzerland in 2009, Vietnam in 2009, India in 2011 and Peru in 2012(METI, 2013, pp ). Even though the Japanese government ratified more EPAs than the Korean government s FTAs in terms of the number, Japan s coverage of EPAs in its overall trade is only 18.9% as of 2012 because the Japanese government concluded and ratified EPAs with only small trading partners with a limited impact on Japan s overall trade (Yoshimatsu, 2012, p. 194; METI, 2013, p. 60). TheChinesegovernment signed FTAs/Close Economic Partnership Arrangements (CEPAs) with nine trading partners such as ASEAN in 2002, Hong Kong in 2003, Macau in 2003, Chile in 2005, Pakistan in 2006, New Zealand in 2008, Singapore in 2008, Peru in 2009, and Costa Rica in 2010 as of However, China s coverage of FTAs/CEPAs in its total trade limited to 25.6% (METI, 2013, p. 60). Accordingly, the Korean government s overall engagement in FTAs since the late 1990s has been enthusiastic. However, interestingly, the degree of each of the Korean administrations engagement in FTAs has shown discernible differences: While the Kim Dae-jung administration passively engaged in FTAs, the Roh Moo-hyun administration was proactive in that engagement. 1 The Kim administration, which started in February 1998, ambitiously initiated Korea s first FTA negotiation with Chile in February However, the Kim administration s subsequent engagement in FTAs was not so impressive. The Kim administration barely could conclude an FTA negotiation with a small trading partner, Chile in October 2002, just four months before the end of President Kim s term, taking almost three years. Furthermore, any new additional FTA negotiation was not initiated during the Kim administration. In contrast to the Kim administration s reactive and passive engagement in FTAs, the Roh administration, which started in February 2003, formulated a 1 Manger (2005) defines defensive FTAs as means by which the government tries to level the playing field, and proactive FTAs as instruments by which the government excludes outsiders (p. 812). However, in this article the government s passive engagement in FTAs means that the government s behavior aims at minimizing potential political costs rather than maximizing the benefits in FTA negotiations, and the government s proactive engagement means that the government s activism mainly targets maximization of the gains in FTA negotiations even at the cost of potential political losses (Park and Koo, 2007, p. 274).

4 Page 4 of 30 Koonsam Im comprehensive multi-track FTA policy. The Roh administration ratified the FTAs with Chile, Singapore, the EFTA, and ASEAN in 2004, 2005, 2006, and 2007, respectively. Even though President Roh Moo-hyun was dubbed a leftist and an anti-american president, the Roh administration started and concluded the most controversial FTA with world s most influential and Korea s third largest trading partner, the United States in 2007 (Park and Koo, 2007, p. 275). Additionally, the Roh administration began to negotiate an FTA with the EU, which was Korea s largest Foreign Direct Investment (FDI) source and second largest trading partner (Yoshimatsu, 2012, p. 205), in The diverging positions of the Kim and Roh administrations are puzzling when considering that different degrees of domestic constraints imposed on them. While the Kim administration benefited from a relatively favorable political environment for implementing trade liberalization because Korea s traditional protectionists such as agricultural groups and labor unions were temporarily disorganized due to the Kim administration and International Monetary Fund (IMF) s neoliberal reform after the Asian financial crisis (Koo, 2008, p. 2), the successive Roh administration could not enjoy a favorable environment like the Kim administration because the protectionist groups, which recovered from the disruption caused by the Asian financial crisis (Park and Koo, 2007, p. 275). What explains the shift from the Kim administration s passive FTA policy to the Roh administration s comprehensive multi-track FTA policy? This article argues that the appreciation of the Korean won since 2001 made Korean exporters, who account for more than 60% of Korea s GDP since the 2000s (Yoshimatsu, 2012, p. 196), lose their price competitiveness in the global market, thereby forcing the Roh administration to secure Korea s export markets and offset Korean exporters lost price competitiveness by formulating a comprehensive multi-track FTA policy, with huge side payments for politically sensitive import-competing sectors. The remainder of this article is structured as follows: Section 2 reviews existing explanations about the FTA proliferation in East Asia including Korea since the late 1990s; Section 3 shows how and to what extent the appreciation of the local currency motivates the government to engage in FTAs; Section 4 unfolds case studies of the Kim administration and the Roh administration s engagement in FTAs; Section 5 summarizes the main findings and draws prospect of thekorean government s engagement in FTAs.

5 Korean exchange rate and FTAs Page 5 of 30 2 Current explanations of the proliferation of FTAs in East Asia since the late 1990s Current explanations of main drivers of proliferation of FTAs in East Asia since the late 1990s can be classified into three categories: economic, political/strategic and institutional factors. Some scholars emphasize economic motivations for the proliferation of Preferential Trade Arrangements (PTAs) since the 1990s. Mansfield and Reinhardt (2003) argue, GATT/WTO has played a large role in stimulating the formation of PTAs (p. 830). They contend that GATT/WTO member countries form PTAs in order to enhance their bargaining power within GATT/WTO system, specifically, hedge against the appearance of disadvantageous conditions for their economies within the system, increase their negotiation power in periodic multilateral trade negotiations (MTNs), and prepare their countermeasures for possible stalemate of MTNs, and improve their market power, especially, when they are embroiled in GATT/WTO disputes (Mansfield and Reinhardt, 2003, p. 830). Similarly, Yoshimatsu and Ziltener (2010) explain Japan s EPA negotiation with Switzerland, which is one of the strong agricultural protectionist countries, with Japan s motivation for strengthening its bargaining power in the WTO agricultural talks. Lindberg and Alvstam (2012) also attribute the proliferation of FTAs in East Asia since the late 1990s to stalled progress in MTNs within the WTO, which prompted East Asian countries to pursue faster alternative options to implement trade liberalization ( p. 164). However, Mansfield and Reinhardt (2003) may not explain why East Asian countries with similar positions in the GATT/ WTO system did not join the proliferation of PTAs until the late 1990s. On the other hand, Baldwin (1993) posits, Recent regionalism is caused by two idiosyncratic events multiplied by a domino effect. The triggering events, the US-Mexico FTA and the EC s 1992 program, had nothing to do with GATT s health (abstract). According to Baldwin (1993), pronouncement of the US-Mexico FTA in 1990 stimulated American nations exporters, which are heavily dependent on the US market, to urge each of their governments to seek to form FTAs with the United States ( pp. 2 3). Similarly, the EC s 1992 project pressed non-ec exporters, which are heavily dependent on the EC market to call for their government to offset their expected loss by joining a trade bloc (Baldwin, 1993, pp.3 4). Urata (2008) also argues that a competitive and defensive motivation regarding trade

6 Page 6 of 30 Koonsam Im diversion from the proliferation of FTAs in other parts of the world prompted East Asian countries to join the bandwagon of the FTA wave. Moreover, some attribute the proliferation of the FTAs in East Asia to the FTA competition among East Asian countries. Koo (2008) argues that Japan and China s engagements in FTAs such as the 2001 Japan Singapore FTA and the 2003 ASEAN-China framework FTA have affected Korea s embrace of FTAs (p. 8). However, Baldwin s domino effect theory may not explain why East Asian countries, which are dependent on the United States and the EU market as their main export destinations (Ravenhill, 2010, p. 182), did not seek to form FTAs with the United States and the EU until the Korean government started FTA negotiations with the United States and the EU in 2006 and 2007, respectively. Moreover, Lee et al. (2008) argue that Japan and Korea s fear of discrimination and trade diversion from the trading blocs are empirically ungrounded, commenting that any trade diversion effect is not found for Japan and Korea in any of the major trading blocs (Lee et al., 2008, p. 857). Furthermore, given that there are few common FTA partners among Korea, Japan, and China, there may be little empirical evidence that Korean exporters have been under pressure due to the Japanese and Chinese firms discriminative market accesses from Japan and China s FTAs. Undoubtedly, the Korean government could be pressed to compete in the FTA races due to the FTA engagements of Japan and China even without any business involvement. However, the Korean government s pursuit of FTA negotiations with the United States may be attributed not to Korea s fear of trade diversion from the proliferation of China and Japan s FTAs, because neither Japan nor China had started any FTA negotiation with the United States, but to Korean exporters losing competitiveness vis-à-vis that of Chinese and Japanese counterparts in the global market. Some scholars emphasize societal groups interests and their lobbies for the formation of PTAs. Milner (1997) contends that firms, which are competitive not globally but regionally, may support PTAs. Specifically, firms call for their government to form PTAs with trading partners, which can establish regional markets where they can keep their competitive advantages over their counterparts in third parties. Criticizing that Milner (1997) may not explain larger countries motivations for formulating PTAs with smaller countries and emphasizing the increasing importance of FDI and internationalization of production networks, Manger (2005) argues that firms, which have international production networks in the host country,

7 Korean exchange rate and FTAs Page 7 of 30 emerge as key supporters of FTAs, when their profits are threatened by FTAs signed by rival countries. For example, Japanese firms, which had production plants in Mexico and were threatened by the NAFTA, pushed the Japanese government to engage in an FTA negotiation with Mexico (Manger, 2005). Some scholars emphasize business associations lobbies for the formation of PTAs. Moon and Cho (2009) point out that lobbies of the Federation of Korean Industries (FKI), which is one of the most influential business associations in Korea, played critical roles in the Korean government s initiation and conclusion of the Korea United States FTA (KORUS FTA). Kim (2011) also argues that the Korean business community, which has increased its influence on the Korean government s policy toward the United States, contributed to strengthen the domestic support base for KORUS FTA negotiation through building internal and external advocacy networks. Similarly, Yoshimatsu (2005) pays attention to the role of Keidanren, one of the Japanese business associations, as a pressure group and information provider in Japan s FTA negotiations with Singapore, Mexico, and Korea. However, Ravenhill (2010) argues that emergence of East Asian regionalism, since the late 1990s, has been driven by not an economic interdependence, an economic domino effect, or societal actors lobbies, but by a political domino effect, which is governments potential fear of being excluded from East Asian regional architecture. Specifically, according to Ravenhill (2010), East Asian countries economic interdependence has consistently decreased since 1955 ( p. 182). Trade diversion effects for nonmembers from EPAs were also minimal (Ravenhill, 2010, pp ). Moreover, societal actors lobbies for PTAs were likely to be offset by the activities of protectionists (Ravenhill, 2010, pp ). On the basis of the weak economic factors of proliferation of PTAs in East Asia, Ravenhill (2010) contends that East Asian regionalism is an economic instrument for achieving political goals ( p. 179). Pointing out that a feature of East Asian integration since the late 1990s is a formulation of PTAs with countries outside the region, namely, a cross-regionalism, Solís and Katada (2007) suggest East Asian countries leverage motivations for forming cross-regional PTAs. Specifically, East Asian countries form extra-regional FTAs in order to set domestic and international precedents, thereby mitigating resistance of protectionists and enhancing negotiation modalities for subsequent intra-regional FTA negotiations (Solís and Katada, 2007, p. 250). Although the Korean

8 Page 8 of 30 Koonsam Im government may form extra-regional FTAs such as the Korea Chile FTA in order to enhance the policy makers competence and confidence in successive intra-regional FTA negotiations and in handling the domestic oppositions to the FTAs, the Korean policy maker could not conclude Korea s first major intra-regional FTA negotiation with Japan due to the domestic oppositions from Korean manufacturers. Some scholars emphasize the roles of hegemon in the formation of regionalism (Mansfield and Milner, 1999, p. 608). Sohn and Koo (2011) argue that the United States and Korea s joint efforts to re-securitize their bilateral economic relations since the terrorist attacks of September 11, 2001 were main factors of the sudden start and successful conclusion of the KORUS FTA. The United States and Korea s security and strategic calculations, such as the United States need to check a rising of China, and Korea s need to accommodate China, tame assertive Japan, and keep a peace on the Korean peninsula, facilitated the launch and negotiations of the KORUS FTA (Sohn and Koo, 2011). Similarly, Rhyu (2011) contends that the successful conclusion of the KORUS FTA can be attributed to the Korean government s strong policy ideas and strong domestic trade institutions, and the United States re-empowering hegemon for East Asian regionalism. According to Rhyu (2011), President Roh Moo-hyun and Trade Minister Kim Hyon-chong shared a strong policy idea that the pursuit of an FTA with the United States was indispensable for survival of Korea s export-oriented economy, which were sandwiched by Japan s technologyintensive industries and China s labor-intensive industries in the global market. The shared policy idea between President Roh and Trade Minister Kim gave a strong mandate to the Ministry of Foreign Affairs and Trade (MOFAT) in negotiating FTA with the United States (Rhyu, 2011). Most importantly, the United States strategic intentions to take back its initiative in East Asian region made possible the conclusion of the KORUS FTA (Rhyu, 2011). Although economic and political/strategic factors can explain the proliferation of PTAs since the late 1990s, they may not explain the degree of each of East Asian countries engagement in FTAs. Accordingly, some scholars emphasize institutional factors to explain the extent to which East Asian countries engage in the PTAs since the late 1990s (Solís, 2010, 2013; Choi and Oh, 2011; Yoshimatsu, 2012). In their comparative study of Korea and Japan s agricultural liberalization policy since the late 1990s, Choi and Oh (2011) argue that, while Korea s cohesive trade governance the MOFAT as

9 Korean exchange rate and FTAs Page 9 of 30 a centralized trade negotiation authority and the Ministerial Meeting on External Economic Affairs as an inter-ministerial coordination mechanism, which were established in 1998 and 2001, respectively, effectively enabled the Korean government to liberalize politically sensitive agricultural sectors in FTA negotiations since the late 1990s, Japan s fragmented domestic trade governance four ministries system of Ministry of Economy, Trade and Industry (METI), Ministry of Foreign Affairs (MOFA), Ministry of Finance, and Ministry of Agriculture, Forestry and Fisheries (MAFF) allowed the MAFF to dominate the FTA agenda, thereby undermining agricultural liberalization. Solís (2013) also argues that the Korean government s proactive FTA policy was attributed to the centralized trade institution, which could concentrate FTA policy on the decisions of Korean presidents and elites of MOFAT, and Korea s effective inter-ministerial conflict coordination system of the Ministerial Meeting on External Economic Affairs ( p. 15). Solís (2010) suggests the need for the centralization of Japan s domestic policy-making system to implement market liberalization through FTAs as well. Institutions can constrain policy options. However, institutional reform pertains to the change of governments policy goals or preferences. Yoshimatsu (2012), in his comparative study of Korea and Japan s FTA/EPA policy, contends that Korean executive leaders policy preferences for trade liberalization and their solid actions to realize trade liberalization generated the Korean government proactive FTA policy ( p. 194). Especially, Yoshimatsu (2012) points out that Korean presidents who had strong preferences for enhancing growth of Korean economy through FTA strengthened trade institutions such as establishment of MOFAT and convinced the Korean people the indispensability of FTAs as survival strategies for Korea s export-dependent economy, thereby making the Korean government s proactive FTA policy possible ( p. 194). Institutional factors can explain different degrees of each of East Asian countries engagement in FTAs since the late 1990s. However, Although Yoshimatsu (2012) contends that different degrees of linkages to the external markets and pressure from interest groups affect the formation of the Korean and Japanese executive leaders policy preferences for FTA/EPA ( p. 197), he may not clearly suggest how they shape and change the executive leaders policy preferences. Current explanations of proliferation of PTAs in East Asia since the late 1990s can be categorized into three factors: economic, political/strategic, and institutional factors. Scholars, who emphasize economic factors of PTAs, suggest instrument of enhancing bargaining power in WTO,

10 Page 10 of 30 Koonsam Im countermeasures for stalled MTNs, and societal actors interest and lobbies. On the other hand, criticizing that economic factors of PTAs have weak empirical evidences, scholars, who, stress political/strategic factors of PTAs, propose political domino effect, leverage motivations for regionalism, and the United States security goals in East Asia. Even though economic factors and political/strategic factors can explain the proliferation of PTAs in East Asia, they may not explain why there are different degrees of each of East Asian countries engagements in FTAs since the late Some scholars explain the anomalies with institutional factors. They suggest that different trade institutions generate different degrees of each of East Asian countries engagements in FTAs. However, they may not focus on the institutional reforms pertain to the change of policy goals or policy preferences of governments. The next section suggests the level of the exchange rate of national currency as a factor, which affects the change of societal groups and governments preferences for PTAs. 3 The level of the exchange rate and the government s engagement in FTAs Milner (1997) contends, The preferences of societal groups depend on the distributional consequences of international agreements. The effect of cooperative agreements on societal actors incomes is the major determinant of their support or opposition to such agreements ( p. 60). Therefore, distributional consequences of the level of the exchange rate of the local currency in the foreign currency market generate the preferences of local societal actors. For example, a weaker exchange rate of the national currency invigorates local producers, which are import-competing industries and export-oriented industries at home and abroad (Frieden and Stein, 2001, p. 4). Specifically, a weaker exchange rate of the national currency provides import-competing sectors competitive advantages against foreign importers by raising the relative price of foreign goods in the domestic market and enhances the price competitiveness of local exporters by lowering the relative price of the export goods in the global market. Additionally, a weaker local currency directly increases exporters profits from foreign sales in terms of local currency value (Frieden and Stein, 2001, p. 4). However, a weaker currency deteriorates purchasing power of the national consumers. As a result, individuals in non-traded sectors favor a stronger currency (Frieden, 1994). Conversely, a stronger exchange rate of the national currency improves local

11 Korean exchange rate and FTAs Page 11 of 30 consumers purchasing power. However, a stronger currency weakens local producers price competitiveness vis-à-vis that of foreign rivals in the domestic and international market, thereby harming local producers interests. Therefore, individuals in the local import-competing industries and export-oriented industries prefer a weaker currency. Accordingly, as Hiscox (2008) points out, even in the floating exchange rate system, if the exchange rate of the national currency strongly continues to appreciate or depreciate, the level of the exchange rate of the national currency can be a politically salient issue (p. 104) because, as Frieden and Stein (2001) comment, The benefit of increasing the competitiveness of national producers comes at the cost of reducing the real income of national consumers, and vice versa (p. 4). Namely, the government can be forced by contradictory pressures from local producers and local consumers to intervene in the foreign currency market to lower or raise the exchange rate toward a new target. Specifically, if a stronger currency continues, the local import-competing industries and export-oriented industries, which are losing their price competitiveness, will force the government to lower the exchange rate, in order to recover their price competitiveness at home and abroad. However, national consumers may not support the depreciation of the national currency. On the other hand, if a weaker currency continues, local consumers, who are losing their purchasing power, will demand the government to raise the exchange rate of the national currency. However, the local producers, who are enjoying higher price competitiveness than that of the foreign competitors in the domestic and global market, will oppose the government s attempt to raise the exchange rate. On the other hand, trade liberalization also has distributional characteristics. Trade liberalization benefits export-oriented industries but harms import-competing sectors. Therefore, Milner (1997) points out, The argument is frequently made and empirically supported that industries (or firms) with international exports, and multinational operations are less protectionist than similar but domestically oriented industries. The former support trade liberalization, whereas the latter seek protection. This divide between internationally oriented and domestically oriented industries may be reproduced in international negotiations over trade policy. When the issue in those negotiations is trade liberalization versus protection, these two groups should be pitted against each other ( p. 63). In other words, while export-oriented industries support trade liberalization, import-competing industries are likely to oppose market liberalization.

12 Page 12 of 30 Koonsam Im Although Hiscox (2008) and Frieden and Stein (2001) suggest politics of the level of exchange rate of national currency and Milner (1997) proposes politics of trade liberalization separately, governments and societal groups are not in a separated tradeoff of the level of exchange rate or trade liberalization, but in multiple tradeoffs, between interests of local producers, which are export-oriented industries and import-competing sectors, and those of local consumers, regarding the level of the exchange rate, and between export-oriented industries interests and those of import-competing industries, in terms of trade liberalization at the same time. For example, as the exchange rate of the national currency strongly continues to appreciate, the local export-competing sectors, which are losing their price competitiveness in the global market, force a government to not only intervene in the foreign currency exchange market to lower the exchange rate of the national currency in order to recover local exporters price competitiveness but also implement trade liberalization for offsetting local exporters lost price competitiveness by lowering or eliminating tariffs of trading countries. However, if the government attempts to lower the exchange rate of the national currency, even though the government can obtain support from local importcompeting sectors, it can harm national consumers purchasing power. Moreover, lowering the exchange rate of the national currency means raising the exchange rate of foreign currencies and deteriorating the foreign countries trade balance and employment (Milner, 1997, p. 57). Therefore, the government s artificial manipulating of the exchange rate of local currency can attract the retaliation from foreign countries (Milner, 1997,p.57). On the other hand, if the government attempts to implement trade liberalization, although the government can obtain disorganized support from national consumers, import-competing sectors, which are already suffering from the stronger exchange rate of the local currency at home, will fiercely oppose the trade liberalization. Whereas societal actors preferences for the level of the exchange rate of national currency and trade liberalization depend on their profits, Milner (1997) posits, Political actors preferences for international cooperation are a function of electoral calculations ( p. 60). Grossman and Helpman (1995) also premise that the most important concern of political leaders is re-election. Therefore, for political actors, who need to attract the support of both import-competing industries and export-oriented industries (Mansfield and Milner, 1999, p. 602), and individuals in non-traded sectors for retaining their offices without economic retaliations from

13 Korean exchange rate and FTAs Page 13 of 30 foreign countries, PTAs can be one of the most attractive policy options. In other words, public officials can achieve, the two desirable goals, suggested by Frieden and Stein (2001), stimulating local manufacturing, agricultural and raw materials sectors, and increasing local purchasing power ( p. 4) without international conflicts by formulating PTAs under Article 24 of the GATT/WTO. First, the government can offset the export-oriented industries lost price competitiveness from the stronger national currency by lowering and eliminating tariffs of target PTA partners. According to Ravenhill (2010), In a world of floating exchange rates, any advantage provided by a PTA may be more than offset by currency realignments ( p. 195). Conversely, the government can compensate local exporters disadvantage from the stronger national currency by lowering and eliminating tariffs of PTA partners as well. Furthermore, PTAs can provide the regional markets where local exportoriented producers can achieve economy of scale, thereby making them to produce more competitive products beyond the regional markets (Milner, 1997). Moreover, the government can improve its trade balance without retaliations from foreign countries. Second, the government can improve purchasing power of domestic consumers by keeping a higher level of the exchange rate of the local currency and by lowering or eliminating national tariffs through PTAs. Specifically, lowering or eliminating national tariffs allows national consumers to purchase cheaper imported products. Moreover, PTA enhances relocation of importers production, thereby lowering their prices and benefiting national consumers (Manger, 2005, p. 811). Finally, and most importantly, as Grossman and Helpman (1995) point out, the government can appease resistance of the local import-competing industries, which are suffering from the stronger currency at home, by excluding the politically sensitive import-competing sectors in PTA negotiations. Practically, Article 24 of the GATT/WTO, which regulates the members of PTAs to liberalize substantially all trade, allows the exclusion of 10% of trade or more in formulation of PTAs (Manger, 2005, p. 811). Therefore, with the lax provision of the GATT/WTO, the government can exclude its politically sensitive import-competing sectors in the PTA negotiations in order to avoid the domestic political risks. Moreover, the government can pacify the strong resistance of the import-competing sectors regarding trade liberalization with huge side payments.

14 Page 14 of 30 Koonsam Im In the multiple tradeoffs, between local producers and national consumers of the level of the exchange rate of national currency, and between export-oriented industries and import-competing sectors of trade liberalization, especially, when local currency strongly continues to appreciate, PTAs can be one of the most attractive policy alternatives for political leaders who must attract support from exporters, import-competing sectors, and consumers for retaining their offices without international disputes because PTAs can enhance exporters price competitiveness in the global market, improve local consumers purchasing power, and exclude politically sensitive importcompeting sectors from trade liberalization with the lax provision of the GATT/WTO. The next section unfolds case studies of the Kim Dae-jung administration and the Roh Moo-hyun administration s engagement in FTAs in order to prove the main argument: the appreciation of the won since 2001 made Korean export-oriented industries lose their price competitiveness in the global market, thereby forcing the Roh administration to compensate Korean exporters lost price competitiveness by formulating a comprehensive multi-track FTA policy with exclusion of and huge side payments for politically sensitive import-competing sectors, especially agricultural sectors. 4 The Korean won exchange rate and the Korean government s engagement in FTAs since the late 1990s 4.1 A weaker won since the Asian financial crisis of 1997 The Kim Dae-jung administration ambitiously initiated Korea s first FTA negotiation with Chile in February However, the weak won against the US dollar and the yen since the 1997 Asian financial crisis allowed Korean exporters to enjoy their relatively higher price competitiveness than those of the United States and Japanese rivals in the global market, thereby demotivating the Kim administration to promptly conclude the Korea Chile FTA and initiate new additional FTA negotiations with Korea s trading partners, which would cause severe opposition from the import-competing sectors. Since its accession to the GATT in 1967, the Korean government has insisted on multilateralism under the GATT/WTO system as its main trade liberalization policy and had remained one of the very few WTO member

15 Korean exchange rate and FTAs Page 15 of 30 countries, which did not form PTAs under Article 24 of the GATT/WTO (Park and Koo, 2007, p. 261; Yoshimatsu, 2012, p. 193). However, against the background of the stalemated WTO s MTNs since the late 1990s and the adverse effect of the Asian financial crisis of 1997 on Korea s domestic economy, the Kim administration, which started in February 1998, dramatically shifted Korea s main trade liberalization policy from multilateral trade liberalization to bilateral/minilateral trade liberalization by formally announcing Korea s historic start of an FTA negotiation with Chile in November The Kim administration s initial start of FTA policy was so ambitious. First, in order to actively implement trade liberalization, the Kim administration reformed trade organization from fragmented organizations to a cohesive organization (Choi and Oh, 2011, p. 515). In the 1998 government organizational reform, the Kim administration established the MOFAT and the Office of the Minister for Trade (OMT) within MOFAT as a controlling tower of trade liberalization by combining trade functions, which were dispersed in each of the ministries, into the MOFA. Second, the Kim administration adopted FTAs as Korea s main trade liberalization policy by announcing an FTA negotiation with Chile in November Initially, the Kim administration proposed FTA negotiations to several trading partners and received positive responses from six trading partners, Turkey, South America, Thailand, New Zealand, Israel, and Chile (Park and Koo, 2007, p. 267). Among these countries, the Kim administration selected Chile as Korea s first FTA partner because of Chile s industrial structure and seasonal difference were expected to give less damage to Korea s industries, especially, agricultural sectors (Park and Koo, 2007, p. 267). Finally, President Kim Dae-jung was willing to use FTAs as instruments of building East Asian regionalism. President Kim announced his will of making Korea a hub of regions with FTAs in APEC 1998 (Park and Koo, 2007,p.267; Koo, 2008,p.11). However, as we can see in Fig. 1, although the real effective exchange rate (REER) of the won gradually appreciated in line with the US dollar, the yen, and the Chinese renminbi after the Asian financial crisis of 1997, the REER for the won stayed lower than those of the US dollar and the yen until The change of the REER of the won implies that Korean 2 Considering the influence of exchange rate changes on export performance, the REER, published by the Bank for International Settlement, provides a useful measurement of exporters price competitiveness in the global market (Sato et al., 2013, p. 2).

16 Page 16 of 30 Koonsam Im Figure 1. Real Effective Exchange rate of the US dollar, the Japanese yen, the Chinese renminbi, and the Korean won. Note: January 1994 through July 2013 (2010 = 100). An increase indicates exchange rate appreciation. Source: Bank for International Settlements effective rate indices (broad indices) comprising 61 economies ( eer/index.htm). exporters could enjoy their higher price competitiveness than those of the United States and Japanese counterparts in the global market until Actually, according to the reports of the FKI, the weak won against the US dollar and the yen increased sales and profits for Korea s mainexporters such as shipbuilders and automakers in the global market (The Korea Herald, 2001). Even in the Latin American markets, Korean exporters could extend their sales without FTAs with Latin American countries due to the weak won against the US dollar and the yen. For example, Korean car shipments to the Latin American markets had increased to around 90,000 units in 1999 and 140,000 units in 2000 (The Korea Times, 2002a). Accordingly, the relatively favorable exchange rate of the won in the global market discouraged Korean exporters and the Kim administration to promptly conclude the FTA negotiation with Chile and initiate new additional negotiations with Korea s trading partners, which would cause severe opposition from the import-competing sectors such as agricultural sectors. Even Park Yong-sung, president of the Korea Chamber of Commerce and Industry (KCCI), which is one of the most influential business associations in Korea, had opposed the FTA negotiation with Chile for fear that the accord was expected to deteriorate Korea s agricultural sectors (The Korea

17 Korean exchange rate and FTAs Page 17 of 30 Times, 2001b). Naturally, the Kim administration hesitated to include apples and pears, which were politically sensitive agricultural products for Korean farmers, into Korea s agricultural concession list during the FTA negotiations with Chile, thereby irritating the Chilean government and finally making the negotiation stall in July 2000 (Park and Koo, 2007, p. 269). 4.2 A stronger won since 2001 The appreciation of the won since 2001 made Korean manufacturers gradually lose their price competitiveness in the domestic and global market, thereby forcing the Kim administration to conclude the Korea Chile FTA and subsequently the Roh Moo-hyun administration to formulate a comprehensive multi-track FTA policy, with huge side payments for politically sensitive import-competing sectors, in order to offset Korean manufacturers lost price competitiveness. Since 2001, Korea s export-oriented sectors and import-competing sectors, which had kept their relatively higher price competitiveness than those of the United States and Japan since the Asian financial crisis of 1997, started to lose their price competitiveness in the global market and the domestic market, respectively. As we seen in Fig. 1, since 2001, the REER for the won started to move in opposite directions with those of Korea s competitors such as the United States, Japan, and China. Specifically, while the REER for the US dollar, the yen, and the renminbi started to depreciate, the REER for the won solely began to appreciate. Moreover, the difference between the REER for the won and those of Korea s competitors became much larger until the collapse of Lehman Brothers in September The change of the REER for the won clearly shows that Korea export-oriented and import-competing industries began to lose their price competitiveness in the global and domestic markets since The strong won against the yen since 2001 especially deteriorated Korean exporters price competitiveness in the global market. In February 3 The strong won was exogenously attributed to the weakened US dollar from the twin deficits of the US government and decreasing confidence in the US economy (The Korea Times, 2004e). The strong won also endogenously reflected the remembrance of the exchange rate adjustment after the Asian financial crisis in 1997 (The Korea Times, 2004e). Korea s nontradable sectors and Korean consumers could be beneficiaries of the strong won. However, the strong won could seriously injure Korea s extremely export-dependent economy. Therefore, the Korean government was forced to intervene in the currency market in order to stabilize the strong won or form FTAs in order to compensate for Korean exporters lost competitiveness in the global market.

18 Page 18 of 30 Koonsam Im 2002, the KCCI reported that the continued weak yen was expected to cause serious damage on Korea s main exporters such as shipbuilders and automakers (Yoo, 2002a). According to the report of the KCCI, the weak yen already forced Korean shipbuilders to cut export prices by % in the fourth quarter of 2001 and allowed Japanese competitors to expand overseas orders by 370% (Yoo, 2002a). The report also commented that, even though Korean automakers were barely maintaining price competitiveness of 10 15% over Japanese rivals, a 10% of the yen depreciation against the US dollar was expected to decrease Korean car exports by 2% in the global market (Yoo, 2002a). As Korean exporters lost their sales and profits in the global market due to the strong won, Korean manufacturers, which had yet mobilized political support for the Korea Chile FTA (Park and Koo, 2007, p. 269), started to force the Kim administration to urgently conclude the stalemated negotiation with Chile and expand FTA negotiations with other countries. For example, as Korean car shipments to the Latin American market, which were around 90,000 and 140,000 units in 1999 and 2000, decreased to 120,000 units in 2001 and 36,632 units in the early five months of 2002, down by 36% compared with the same period of 2001, the Korea Automobile Manufacturers Association urged the Ministry of Commerce, Industry and Energy to promptly conclude the FTA negotiation with Chile and launch new negotiations with other South American countries to level the battlefield with Japanese, European, and the US rivals (The Korea Times, 2002a). Moreover, Park Yong-sung, president of the KCCI, who had a passive position regarding the FTA negotiation with Chile (The Korea Times, 2001b), changed his stance and urged the Kim administration to speed up talks to finalize the Korea Chile FTA in March 2002 (Yoo, 2002b). On the other hand, as Frieden and Stein (2001) posit, the strong currency not only deteriorated exporters price competitiveness in the global market but also that of import-competitive sectors in the domestic market ( p. 4). Moreover, as Milner (1997) points out, market liberalization is likely to have a further immediate and harmful impact on import-competitive sectors. Accordingly, Korean farmers opposed the resumption of the FTA negotiation with Chile and tried to make their potential losses a highly political issue for the presidential election slated for December 2002 (Park and Koo, 2007, p. 269). Representatives of the state-funded National Agricultural Cooperative Federation issued a statement, demanding that FTA talks with Chile should be postponed until after the market liberalization talks at the

19 Korean exchange rate and FTAs Page 19 of 30 WTO are completed (The Korea Herald, 2002). In response to Korean farmers opposition, Minister of Agriculture and Forestry Kim Dong-tae said that the Korean government had to suspend the FTA negotiation with Chile until after the WTO finalized the new Doha round of global trade talksbytheendof2004(yoo, 2002c). The majority Grand National Party, the Millennium Democratic Party, and even the ruling party s presidential candidate Roh Moo-hyun demanded that the Kim administration deliver the Korea Chile FTA to the hands of the next administration (The Korea Times, 2002b). Despite the pressure from the import-competing sectors, the Kim administration decided to resume the stagnated FTA negotiation with Chile. In order to coordinate the inter-ministerial interests regarding negotiations, the Kim administration established the Ministerial Meeting on External Economic Affairs in 2001 (Choi and Oh, 2011, p. 516). Within the Ministerial Meeting on External Economic Affairs, which was chaired by Jin Nyum, the Deputy Prime Minister and concurrently Minister of Finance and Economy, the Kim administration could make a list of trade concessions which was more in line with Chile s request (Park and Koo, 2007, p. 269). Specifically, the Ministry of Finance and Economy decided not to request the Chilean government to open its financial market (The Korea Times, 2002c). More importantly, the Ministry of Agriculture and Forestry, which was reluctant to agricultural liberalization (Yoo, 2002c), allowed the OMT to lower off-season tariffs to Chilean grapes and negotiate liberalization of seasonings and dairy products with Chile after the Doha Development Round, which would commence in November 2001, would be completed (Park and Koo, 2007, p. 269). The Kim administration suggested the Chilean government to resume the negotiation with the revised list of trade concessions. In return for accepting the concession list of the Korean government, the Chilean government excluded sensitive manufactured items, such as refrigerators and washing machines, from its list of concessions in the negotiation (Park and Koo, 2007, p. 269). Finally, under the pressure from Korean exporters, the Kim administration barely managed to conclude the FTA negotiation with Chile in October 2002, which was about four months before the end of President Kim Dae-jung sterm. Although President Roh Moo-hyun had taken a relatively negative stance on the FTA negotiations with Chile during his presidential campaign (The Korea Times, 2002b), the increasingly strong won strongly

20 Page 20 of 30 Koonsam Im forced the Roh administration, which started in February 2003, to formulate a comprehensive multi-track FTA policy in order to secure Korea s export markets and compensate for the Korean exporters lost price competitiveness in the global market. In August 2003, the Roh administration outlined the FTA roadmap (MOFAT, 2006). According to the FTA roadmap, Korea s prospectivefta partners were classified into three groups: (i) immediate FTA partners such as Chile, Singapore, the EFTA, and Japan, (ii) medium-term FTA partners such as Mexico, Canada, ASEAN, and China, and (iii) long-term FTA partners such as the United States, the EU, and India (Lee and Moon, 2009, p. 51). In accordance with the FTA roadmap, the Roh administration started to negotiate with the immediate and medium-term FTA partners. Specifically, the Roh administration submitted the signed Korea Chile FTA treaty to the National Assembly for its ratification in July 2003 and simultaneously embarked on FTA negotiations with Korea s minor trading partners such as Singapore in January 2004 and the EFTA in January 2005, ASEAN in February 2005, and one of Korea s major trading partners, Japan, in December Meanwhile, the strong Korean won pushed Korean exporters to be exposed to increasingly severe competition with their counterparts in the Chilean market. For example, Korean exporters, which accounted for 3.34% of Chile s import market in 2001, dropped their share of the Chilean market to 2.81 and 2.98% in 2002 and 2003, respectively, while Japanese exporters extended their market shares from 3.48 in 2001 to 3.46 and 3.61 in 2002 and 2003, respectively (Myung, 2010, p. 13). To make matters worse, since 2003, the United States, Mexico, the EU, Brazil, and Argentina began to export automobiles to Chile, duty free, under their respective FTAs with Chile, thereby causing serious market loss for Korean automobile manufacturers. Specifically, the Korean automobile manufactures share of the Chilean market, which accounted for 26% in 2002, significantly dropped to under 18% of Chile simportmarketin2003(hyun, 2004). Accordingly, serious trade diversions in the Chilean market led Korean exporters, especially, automobile and electronic manufacturers, to intensify their lobbies for the ratification of the Korea Chile FTA against the Roh administration and the National Assembly (Park and Koo, 2007, p. 265). As the Roh administration submitted the Korea Chile FTA treaty to the National Assembly for ratification in July 2003, Korea s import-competing sectors, especially the agricultural and fishery sectors, and lawmakers