Global Business 3rd Edition by Mike Peng

Exercise 38

The EU embarks upon its most ambitious free trade agreement (FTA). For South Korea, the FTA is part of building a free trade network around the world that will allow over 70% of its exports to achieve duty-free access by 2014. But, bilateral agreements have been criticized for undermining the multilateral process (WTO) by allowing preferential treatments. Will this bilateral deal deliver what it promises?
After more than two years of negotiating, the European Union (EU) and the Republic of Korea officially signed the EU-Korea Free Trade Agreement (EU-Korea FTA) on October 6, 2010, during the EU- Korea summit in Brussels. The agreement provisionally became effective on July 1, 2011. It is not only the most comprehensive FTA ever negotiated by the EU, it is also the first in Asia and the largest FTA by market size entered into by South Korea (hereafter "Korea"). The EU-Korea FTA reduces and eliminates tariffs and other trade barriers in manufactured goods, agricultural products, and services. Import duties into the EU are to be eliminated on nearly all Korean products (99% on duties within the next five years) and there will be liberalization of trade in services, including telecommunications, environmental services, shipping, and financial and legal services. The agreement also covers trade-related activities such as government procurement, intellectual property rights, labor rights, and environmental issues. In addition, the FTA also addresses nontariff barriers, specifically in the automotive, pharmaceutical, medical devices, and electronics industries.
Regional and Bilateral Trade Agreements in the Context of Multilateral Trade
An Economist article noted that bilateral and regional trade agreements had increased significantly from 49 in 2001 to 167 in 2009. The increase was attributed to frustration in the progress of the World Trade Organization's (WTO) Doha Development Agenda- more commonly referred to as the Doha Round, which had not achieved much of what it had promised. The article contrasted the criticisms and benefits of regional and bilateral FTAs. Two broad criticisms are (1) that these deals are overly complex, and (2) that they do not serve as a stepping-stone to multilateral deals but instead distract governments from the multilateral process. Complexity is evidenced by the large amount of paperwork and bureaucracy resulting in few countries using many of the provisions in the agreement. In addition, the Economist article notes, FTAs contribute to a confusing set of rules rather than the predictability that multilateralism promises. Finally, regional and bilateral deals are criticized because they give advantages (through lower tariffs) to less efficient companies and hence hurt the more efficient ones. What are the advantages? The main advantage is that some deal is better than no deal at all. If little or no progress is being made in the Doha Round, regional or bilateral deals are better than nothing.
Consider these criticisms in light of certain proposed benefits of the EU-Korea FTA: The FTA purports to strengthen existing WTO agreements. In addition, the proponents of the FTA argue that certain aspects of trade are better addressed in a bilateral rather than a multilateral agreement. Thus, the FTA both has aspects very similar to those found in the WTO agreement and the added benefits of fine-tuning to better meet the specific needs of the EU and Korea.
The EU-Korea FTA and the WTO
The EU-Korea FTA represents a shift from an emphasis on multilateral trade (WTO) to an accelerated negotiation of bilateral FTAs. The EU has been more aggressive in developing FTAs. Korea has recently moved towards developing several FTAs in Asia, Latin America, and Oceania. The EU-Korea FTA is part of a broad EU strategy called "Global Europe in a Competing World," which called for renewed engagement with Asia. "Global Europe" was a response to increasing globalization with the goal of reducing tariff and nontariff barriers and to opening markets for foreign investment.
Interestingly, the EU believes that the EU-Korea FTA is more effective than the WTO at addressing issues of competition policy, regulatory issues, government procurement, and stronger intellectual property protection. EU-Korea accepts much of the existing WTO commitments (for example, on antidumping and antisubsidy remedies) while making modifications to some aspects of WTO agreements. EU-Korea fits into South Korea's broad strategy of creating a free trade network to offset competitive pressures from Japanese and Chinese firms. The Korean government has sought FTAs with both large advanced economies such as the EU and the United States as well as natural resource-rich developing countries such as Chile and Association of Southeast Asian Nations (ASEAN).
The agreement comprises 15 chapters, several annexes and appendices, three protocols, and four understandings. What follows is not a detailed discussion of each chapter, annex, or protocol, but rather the key provisions.
Trade in Manufactured Goods
A major aspect of EU-Korea is the removal of duties and nontariff barriers (NTBs) on the trading of goods. Virtually all (98.7%) customs duties on manufactured goods will be removed within the first five years of the FTA. Several agricultural and fisheries products will have longer transitional periods, and rice and a few other agricultural products are excluded from the agreement. While NTBs are generally addressed in the FTA, NTBs relating to consumer electronics, motor vehicles, pharmaceutical products, and chemicals are addressed in separate annexes. The annexes represent a more detailed treatment of NTBs in these industries over what currently exists under the WTO agreement. These NTBs are essentially regulatory and other barriers that in some cases reflect the pursuit of legitimate quality and safety goals. The FTA broadly seeks to have the EU and Korea accept each other's standards with an emphasis on conformity with international standards and practices. For example, in consumer electronics, the agreement removes duplicate testing and certification (for example, where a Korean product would have to go through testing and certification in the EU before it may be sold there). Similarly, for automobiles, tests conducted in the EU to show compliance with EU standards will be accepted in Korea. In the case of pharmaceutical products, transparency in pricing and reimbursement rules are key aspects of the agreement since health authorities set drug prices in both the EU and Korea.
The Duty Drawback and Rule of Origin Concessions by the EU
A "duty drawback" is a provision in trade rules where the government refunds the import tariff paid by a company (thus reducing production costs) if the imported parts are used in a product that is then re-exported (such as a car). The EU generally does not allow duty drawbacks once the tariff on the finished product is removed as would be the case in the EU-Korea FTA. The EU has, however, allowed the duty drawback to continue for Korean producers (for the first time in any bilateral deal), much to the dismay of the EU automobile industry. The duty drawback would give Korean manufacturers a competitive advantage because they could purchase inexpensive components from China duty free. In contrast, European firms still have to pay duty on imports of foreign components. The agreement includes a provision that will allow a cap of 5% on that duty drawback should there be a significant increase in foreign sourcing by Korean manufacturers.
The "rule-of-origin" concession also offers advantages to the Korean manufacturers because it allows them to reduce the cost of the exported product by importing more inexpensive components from China rather than using more expensive Korean components. This will occur where the rule-of-origin content was reduced from 60% to 55% in the case of automobiles.
Trade in Services
EU-Korea is the most extensive FTA in services agreed on by the EU. In general, Korea's services market is more restricted than the EU's. The agreement significantly opens the Korean market to a wide variety of service sectors. EU firms will have increased access to Korean markets in telecommunications, environmental services, shipping, construction services, financial services, express delivery, air transport, and legal services. Korea obtained increased access to EU markets for architecture, engineering, urban planning, landscaping, printing and publishing, telecommunications, construction, finance, and transportation services. The FTA uses the "positive list" approach whereby the EU and Korea must specifically identify the kinds of services for which market access will apply. The agreement also includes liberalization of investment in both services and nonservices sectors. For example, in telecommunications, Korea would allow EU firms to own 100% of the shares of Korean-based providers (with some exceptions where the share of ownership is limited to 49%).
Trade Remedies
The EU-Korea FTA includes a chapter addressing the use of antidumping and antisubsidy remedies by the two parties. The FTA recognizes the right of each party to use these remedies, but it attempts to limit use to situations of real injury to one of the partners. The agreement stipulates that the amount of the antidumping or antisubsidy duty should be lower than the amount of the dumping or subsidy to the extent that it is adequate to remedy the injury. The FTA also provides for increased transparency in the investigation of dumping or subsidy cases and establishes a working group to facilitate cooperation in the use of trade remedies.
A safeguard action is taken when there is a surge of imports that causes or threatens serious material injury to a domestic industry. The FTA allows either party to use safeguard actions (i.e., to impose temporary tariffs) in the event that a surge in imports threatens serious injury.
Technical Barriers to Trade
Technical barriers to trade are regulations, standards, and testing and certification procedures that may create an obstacle to trade. WTO policy recognizes the need for such regulations to achieve safety, health, and environmental objectives, but seeks to avoid such regulations being used for protectionist reasons. The EU- Korea chapter on technical barriers to trade commits to the spirit of the WTO policy. The EU-Korea FTA, however, tries to improve on the WTO policy by agreeing to cooperate on standards and regulations and to establish dialogues between regulators with the intention of simplifying and standardizing the regulations. In addition, EU-Korea incorporates transparency in making rules, encourages use of international standards, and allows either party to discuss the rules before they are implemented.
Sanitary and Phytosanitary Measures
Under existing WTO agreements, member countries are allowed to enact procedures to protect human, animal, and plant health, as long as those measures are not intended for protectionism. EU-Korea builds on existing rules by making specific commitments on transparency, and emphasizing the use of international standards in determining these rules. EU-Korea also provides a mechanism for cooperation between the parties and provides a forum for discussion of problems arising from the implementation of any sanitary and phytosanitary measures.
Government Procurement
Within the WTO, the agreement on government procurement is known as a "plurilateral agreement" because not all members are signatories to that agreement (the EU and Korea are signatories). The purpose of EU-Korea is to make laws, regulations, procedures, and practices governing government procurement transparent and to ensure that they do not become instruments of protectionism or discriminate against foreign products or suppliers. EU-Korea will extend the existing WTO agreement to include public works concessions and build-operate-transfer (BOT) contracts that are not covered under the existing WTO agreement. This aspect of government procurement is of particular interest to European suppliers that are global leaders in this area. Essentially, this agreement would provide opportunities for BOT contracts in cities, counties, and provinces in Korea.
Intellectual Property
The EU-Korea FTA builds on the existing WTO Trade-Related Aspects of Intellectual Property Rights (TRIPS) to fill certain gaps in TRIPS. Within the WTO framework, TRIPS is a minimal agreement and members are permitted to have more stringent standards. EU-Korea complements and updates the existing TRIPS rules for three areas: copyrights, industrial designs, and geographical indications. Enforcement of intellectual property rights is based on EU standards. Copyright provisions are in line with the latest international developments and include music and other artistic works. Enforcement of industrial designs fills some gaps in TRIPS and includes provisions for unregistered designs. Finally, EU-Korea will provide a high level of protection for geographical indications important to the EU such as wines (e.g., champagne), spirits (e.g., Scotch or Irish whisky), and cheeses (e.g., manchego). Competition Policy
Within the WTO, competition policy is a relatively new area that addresses how policy instruments such as antitrust or competition laws interact with international trade. The WTO working group assigned to look at competition policy issues is currently inactive. As such, EU-Korea has developed a more concrete competition policy. The FTA prohibits actions by firms that are intended to reduce competition. Examples of prohibited practices are cartels, mergers that have the effect of reducing competition, and abusive behavior by market leaders. Both the EU and Korea have agreed to maintain competition laws and an authority to enforce those laws. In addition, both parties agree to prohibit certain kinds of subsidies that distort competition, such as subsidies covering debts or liabilities of an enterprise without any limitation to the duration or subsidies to ailing enterprises without a plan to restructure that enterprise and remove the subsidy.
Dispute Settlement
EU-Korea has a dispute settlement mechanism based on the WTO dispute settlement model, but with the improvement of being faster. The first step of the mechanism is a consultation between the parties with the goal of reaching a solution. If no solution is reached, the dispute goes to an arbitration panel consisting of three experts chosen by the disputing parties or selected from a list agreed upon in advance. The panel then holds a public hearing where interested parties and companies may submit their views. The panel's ruling, which is binding on both parties, must be delivered within 120 days of the panel being formed. The party found in breech of the FTA rules has a period in which to bring itself into compliance. At the end of that period, if the complainant believes that the other party has not complied and the panel agrees, the complainant is allowed to impose sanctions in the form of tariffs. For urgent situations, the time limits for arbitration may be reduced.
Expected Benefits
Most studies estimate that the agreement will have a small but positive benefit to both economies but that the larger relative benefit will accrue to Korea. The smaller Korean economy (relative to the EU), greater dependence on the EU's market, and higher trade barriers explain this larger relative benefit. The overall positive effect is small because of the larger role played by other countries in EU and Korean trade. For example, the EU's trade with South Korea represents 2%-2.5% of total extra-EU trade.
EU service providers in retail and wholesale trade, transportation services, financial services, and business services will be expected to gain from the FTA. Also benefitting from the agreement will be EU goods exporters, especially in pharmaceuticals, auto parts, industrial machinery, electronics parts, and some agricultural and processed foods. The FTA will give Korea access to the largest market in the world. Korean producers of cars, ships, wireless communication devises, chemical products, and imaging equipment will be expected to increase their exports to the EU.
Winners and Losers of the EU-Korea FTA Free Enterprise (a publication of the US Chamber of Commerce) published an article in July 2011 entitled "Winners and Losers of the EU-Korea FTA." According to the article, the winners were EU and Korean companies and consumers. The losers were Americans. Why? Failure to ratify the US-Korea FTA (which was signed by both governments) resulted in lost opportunities to exports and to create more jobs in America. Since that time, much has changed. On March 15, 2012, the US- Korea FTA came into force amid much fanfare. The US International Trade Commission estimated that the FTA will add $10 billion to $12 billion to annual US GDP and around $10 billion to annual merchandise exports to Korea. EU-Korea and US-Korea are good examples of the recent surge in bilateral signing of FTAs noted at the beginning of the case. A question is worth considering is: Is the WTO becoming less important and are regional and bilateral agreements the wave of the future?
Case Discussion Questions
While trade theories generally support free trade, political realities ensure that trade barriers still exist. How does the EU-Korea FTA address the realities of international trade?