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Congressional Leaders Break New Ground With Proposed Korea FTA Fixes
Alan Tonelson
Friday, June 29, 2007
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Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press). has been pretty hard on the Congressional Democrats’ trade policy record recently.  In particular, we’ve called the labor and environment compromise reached by the House Democratic leaders and the Bush administration almost completely irrelevant to the main trade concerns of America’s domestic manufacturing sector. We’ve also chided the new House and Senate leadership for dallying on passing an effective bill to combat currency manipulation.

How encouraging, then, to report that the Democrats’ performance has been much better on another critical trade policy front – the Korea-U.S. Free Trade Agreement.  More specifically, the  Democrats –  along with some Republicans from the industrial Midwest –  have recognized the special challenges and outright dangers posed by industrialized U.S. trade partners like Korea.  Even better, they have proposed some genuinely intelligent and innovative responses.  And although their recommendations for changing the agreement can still be improved, they could put much of U.S. trade policy on a much smarter and more realistic footing.

Not that the Korea FTA is such a sacred cow.  To the contrary, it’s been under fire for months from numerous quarters.  American ranchers and their influential champions in Congress (notably Max Baucus of Montana, Democratic Chairman of the Senate Finance Committee) have accused Korea of using bogus health and safety concerns to continue keeping out American beef.  The usually outsourcing-happy U.S.-owned auto makers charge that Seoul will still be able to keep its passenger car markets hermetically sealed.

Korea’s unions are independent and effective.  But their U.S. counterparts (along with many American national security stalwarts and others) have legitimate labor rights concerns over Korea’s ardent desire to bring under the FTA’s purview the new southern-financed Kaesong industrial complex located in dictatorial and belligerent North Korea.

Just as important, the Korea FTA has “Rush Job” written all over it.  A final agreement needed to be signed by March 30, or else it couldn’t be fast-tracked by Congress until trade promotion authority was renewed.  Clearly, both Seoul and Washington were anxious to avoid lengthy debate in and extensive amendments by Congress.  

Yet with Korea’s market obviously much more closed than America’s, and the Bush administration plainly in the role of demandeur, there’s every reason to believe that, on numerous specifics, the United States settled for a bad deal rather than no deal at all.  In fact, as revealed by comments written from the U.S. government’s official Industry Trade Advisory Committees, dozens of critical details still need to be clarified or actually agreed on.  More bizarrely, U.S. and Korean negotiators are still frantically working to produce a second “final” text before a second fast track-related deadline expires this Saturday night.  

And then there’s the VAT issue.  Most sector-specific manufacturing groups heartily congratulated the Bush administration for negotiating an immediate end to tariffs on 95 percent of industrial and consumer products traded by the two countries and for securing reciprocal phase-outs for most remaining levies within ten years.  

What they (except for the steel industry) forgot is that Korea is one of nearly 140 U.S. trade partners imposing value-added taxes on every product consumed within the country (including imports), and rebating these taxes on all of its exports.  As a result, even the total and immediate elimination of all U.S. and Korean tariffs would still leave U.S. companies at a double-digit percent price disadvantage (depending on the product and the VAT rate in third-country markets) when competing with their Korean counterparts anywhere in the world.

The biggest problem with the Korea FTA, however, concerns the Bush administration’s reluctance to acknowledge the real nature of the Korean economy.  It’s best seen not as a system shielded by hundreds or thousands of discrete tariff and even non-tariff barriers that, however vexing, can be meaningfully opened by canny American diplomats.  Instead, the Korean system is best seen as one gigantic, all-embracing trade barrier whose fundamental purpose is to disadvantage foreign competitors, and whose specific forms at any given time are limited only by the human imagination

After all, Korea is a country that, like most developing countries, needed to rely heavily on export-led growth to promote industrialization, and that is fully aware that its domestic market is way too small to support its ambitious – and hugely successful – technology development plans. This orientation has meant not only promoting exports, but nurturing national champions in heavily traded industries like steel, shipbuilding, autos, and electronics by (a) curbing imports and (b) providing extensive subsidies.  

According to the Office of the U.S. Trade Representative, Korea is a country whose government openly mounted anti-import public relations campaigns until the very recent past, and retains numerous more subtle means of stigmatizing foreign products.  It’s a country whose government agencies require prior approval to import an unusually wide range of products.  It’s a country with a state-owned Development Bank charged with providing favored sectors with low-cost loans and loan guarantees.  It’s a country that also provides major industries with special tax breaks and government-supervised sales of debt obligations.  It’s a country that keeps most of its regulations, rules, and policies secret, and gives unaccountable bureaucrats wide-latitude in applying them.  It’s a country whose drug approval process requires foreign pharmaceutical companies to submit proprietary data to the government, which then often shares it with Korean competitors.  It’s a country that currently imposes five types of engine taxes plus a Special Consumption Tax to discriminate against foreign auto sales.  And it’s a country that has kept out foreign motorcycles by banning the heavy models made competitively by Harley-Davidson and other non-Korean producers from being driven on expressways and certain bridges – exactly where they would perform best.

The effectiveness of Korea’s manifold trade barriers shows up in the country’s trade with the United States.  It’s bad enough that from 1997 to 2006, the U.S. trade balance with Korea shifted from a $1.35 billion surplus to a $13.92 billion deficit.  And that the manufacturing trade deficit during this period rose more than ten-fold, to $16.48 billion.  

Even more revealing, Korea’s imports from the United States are highly concentrated in a handful of industrial sectors.  Certain products like aircraft and, more recently, semiconductors, tend to dominate U.S. global trade flows.  But the Korean pattern is glaringly distinctive.  America’s top five goods exports to the world in 1997, for example, represented 19.19 percent of total U.S. goods exports. (In order, they were aircraft, semiconductors, a catch-all category known as special classification goods, autos and light trucks, and basic inorganic chemicals.)  By 2006, this total had dipped to 18.53 percent  (with the top five exports being identical).  

The top five U.S. goods exports to South Korea in 1997, however, represented a much higher 27.71 percent of total U.S. goods exports that year.  The list’s makeup was distinctive, too – in order, the Korea top five were semiconductors, aircraft, non-poultry meat products, semiconductor production equipment, and computer parts.  In 2006, this degree of concentration increased to more than 36 percent (with the list changing to semiconductors, aircraft, semiconductor production equipment, basic inorganic chemicals, and aircraft parts).

In fact, the only major U.S. trade partner with a profile like Korea’s is China, where the top five’s share of total U.S. goods exports rose from 33.19 percent in 1997 all the way to 39.67 percent in 2006.  The implications are pretty clear: to a great extent, Korea (along with China) buys from the United States products it doesn’t yet make at all itself, or in which it remains hopelessly uncompetitive.

Even the Bush administration has conceded that Korea is a special trade policy case.  Thus it has trumpeted  how systematically it has won Korean promises to eliminate or greatly reduce various non-tariff barriers, and how many Korean commitments it has won to improve regulatory transparency.  Mindful of Seoul’s failure to carry out previous pledges to open the auto market, the White House has also boasted of crafting “an innovative process for settling disputes” in this sector “within six months” that will “serve as a powerful deterrent against violations of FTA commitments.”  The secret weapon?  The right to restore pre-FTA auto duties whenever a bilateral dispute resolution panel finds a violation – a practice known as “snapping back” tariffs.

Unfortunately, these proposals do little more than establish a WTO-like dispute resolution system for U.S.-Korea trade.  True, the United States won’t have to deal, as in the WTO, with some 150 countries determined to keep its market much more open than theirs.  But nothing in the agreement recognizes the special trade law problems posed by secretive systems of government that extensively use intrinsically difficult-to-identify non-tariff barriers.  As is also the case with the WTO, the appeals process can drag on much longer than most hard-pressed U.S. industries and companies (especially smaller companies) can tolerate.  Finally, since U.S. auto tariffs are so low (2.5 percent), snap-backs can easily be negated by a country like Korea, which can pay for offsetting subsidies with its domestic wealth or with its huge ($240 billion) stockpile of  foreign exchange reserves.

The bipartisan group of Congressional Korea FTA critics address these problems much more effectively.  On autos, they would recognize the huge inequities created by Korea’s longstanding protectionism and increase America’s leverage by abolishing Korea’s auto tariffs immediately and by keeping America’s for at least 15 years.  (The much higher and genuinely effective 25 percent U.S. tariff on light trucks would stay in place indefinitely.)  

In addition, they would give Korea concrete incentives to open its auto market by allowing Seoul to ship as many cars to the United States duty-free as U.S.-based producers can sell in Korea above an agreed baseline figure on a one-for-one basis.  And they would permit the auto tariff snap-back to be applied as a safeguard measure, which would enable Washington to impose it unilaterally and maintain it “until the United States determines that imports are no longer increasing significantly.”

The broader significance of the one-for-one proposal must not be underestimated.  It means that results-oriented trade approaches to trade – once widely denounced even in liberal circles as unconscionable efforts to “manage” trade and slip protectionism in through the back door – have now been endorsed by powerful mainstream Congressional Democrats like House Ways and Means Chairman Charles Rangel (D.-NY), Ways and Means Trade Subcommittee Chairman Sandy Levin (D.-Mich.), and New Democrat Coalition Chair Ellen Tauscher (D.-Cal.), along with key Republicans like Ohio Senator George Voinovich, and Michigan Representatives Joe Knollenberg, Vernon Ehlers, and Fred Upton  

But the Congressional critics don’t stop with autos.  They would require Korea to eliminate whatever non-tariff barriers U.S. industries identify as impeding market access.  And recognizing the limits of conventional trade diplomacy and dispute resolution in combating these practices, they would authorize Washington to take “immediate, unilateral compensatory action to counter any future barrier (or any current barrier not specifically identified in the agreement)” based on a relatively low and realistic threshold of “reasonable evidence” of its existence.  

Best of all, it would be up to the Koreans to “establish conclusively “ that the measure either no longer existed or was not serving to protect Korean industries.  In other words, no longer would U.S. trade treaties naively assume “moral equivalence” between the wide open American economy and the tightly closed economies with which Washington often negotiates.  As a result, no longer would the U.S. government or private U.S. companies be forced to expend enormous amounts of time and money struggling to prove the often unprovable – in the rigidly legalistic sense usually required by U.S. trade policy and trade law.  Thanks to this unmistakably unilateralist proposal, countries like Korea would be forced to pay a price for serial protectionism.  

This Congressional proposal, however, still needs some toughening.  Just as the 2.5 percent U.S. auto tariff is way too low to deter Korea from violating the FTA’s auto provisions, it’s way too low to give Korea much incentive to open its auto market as envisioned in Congress’ baseline proposal.  Korea’s terrible auto trade record and string of broken promises more than justifies a higher, punitive tariff level.  

Ditto for the safeguard proposal – why would the Koreans be worried by an extra 2.5 percent burden? Hiking it to 25 percent, just like the light truck tariffs, is the best guarantor that Korean export surges become a bad memory.  Further, given Korea’s terrible overall trade record, why not extend both of these auto provisions to the entire range of goods exported by Seoul?  

Nonetheless, the Korea plan’s authors and supporters deserve considerable praise.  In fact, they’ve done such a good job, that they have unavoidably raised the question, “Why stop with Korea?”  As closed as Korea remains to imports, it’s hardly the only problem trader America deals with.  And autos and steel aren’t the only U.S.-made products competing against heavily protected and subsidized foreign counterparts (although they are among the few major U.S. industries that will complain regularly about these practices).

Street smarts and unilateralism are what make Congress’s Korea plan so unusual and so exciting. Legislators should now move vigorously to apply these principals to the rest of America’s wrongheaded trade policies.

Alan Tonelson is a Research Fellow at the U.S. Business & Industry Educational Foundation and the author of The Race to the Bottom: Why a Worldwide Worker Surplus and Uncontrolled Free Trade are Sinking American Living Standards (Westview Press).