Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

Policy Brief on Mega-Regional Free Trade

Agreements;

Prepared for the Ministry of Trade, Industry

and Energy of the Republic of Korea

Author: Ramón Lohmar

Student No.: s1418521

Word Count: 4720

22.10.2014

Course: International Political Economy

Lecturer: Dr. Adam William Chalmers

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

The Republic of Korea: Caught between the TPP and RCEP?

Executive Summary: Two mega-regional free trade agreements (FTAs) are

currently under negotiation: the US-led Trans-Pacific Partnership (TPP)

and the China-led the Regional Comprehensive Economic Partnership (RCEP).

Both negotiations have set the completion date for late 2015, taking on

the character of a “race to the finish”. They have the potential to

decisively shape the future of regional economic integration, trade

liberalization and diplomatic relations in the Asia-Pacific. The Republic

of Korea (ROK) has shown interest in joining the TPP, but has so far

adopted a “wait and see” approach, avoiding a definitive choice. However,

the recent accession of Japan to the TPP has altered the equation by

adding a major market to the TPP with which the ROK does not yet

entertain a bilateral FTA. Also, recent concessions by Japan to China

over their territorial disputes may pave the way for RCEP. With both

negotiations going into their decisive phase and limited resources at our

disposal, the ROK can no longer afford to sit idly by and must prioritize

on of the two FTA projects. This policy brief recommends to push for the

conclusion of a China-Japan-South Korea trilateral FTA (CJKFTA) in order

to facilitate RCEP. TPP may be joined after the finalization of

negotiations.

This Policy Brief is prepared for the Ministry of Trade, Industry and Energy of the Republic of Korea.

1. The “Noodle Bowl” of FTAs in the Asia-Pacific

The regional financial crisis of 1997-1998 sparked the proliferation of

FTAs in Asia to advance trade liberalisation and regional economic

integration (Dent 2013: 970-971). FTAs are “bilateral agreements that go

beyond WTO rules to preferentially reduce barriers to trade between

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

signatory countries” (Wilson 2014: 2). With just one such FTA in place in

the Pacific and none in East Asia prior to the crisis, there are now 75

active FTAs in the Asia-Pacific (Dent 2013: 973). However, the

proliferation of FTAs has caused several problems. As FTAs grant

preferential market access, countries without FTAs stand to be

outcompeted by those unburdened by tariffs. It thus becomes necessary to

sign an FTA in order to avoid exclusion. The regional FTA-game is one

with winners and losers. Second, not only are there many FTAs, but they

are also “notably heterogeneous, varying greatly in terms of their

technical policy content, ideational conception and other factors”

(ibid.). The proliferation of FTAs has created a highly complex web of

rules and provisions that difficult compliance and increase the

transaction costs for businesses (Capling and Ravenhill 2011: 556-557).

This is known as the “noodle bowl problem” (ibid.: 554). Thirdly, most

countries in East Asia are small markets. They are mostly developing

countries that seek to protect themselves from excessive intrusion and

competition to their most vulnerable industries. Furthermore, FTAs

sometimes follow less an economic, but a strategic rationale. They serve

to strengthen diplomatic ties and increase geopolitical influence (Wilson

2014: 2). As a result, FTAs in East Asia tend to be of low quality and

narrow coverage (Dent 2013: 974), lowering the potential costs, but also

the potential benefits of FTAs especially for developed countries.

The TPP and the RCEP are the culmination of this regional FTA game. They

aim to bring the different bilateral FTAs under one umbrella. However,

each has different implications on the issues of market access, FTA

quality, FTA harmonization and regional integration in the Asia-Pacific.

They can thus be regarded as standing in competition with each other.

Both negotiations have set the completion date for late 2015, taking on

the character of a competitive “race to the finish” (Wilson 2014: 6).

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

The ROK is a participant of RCEP. However, the US has been heabily

courting Korea to join the talks and President Park has recently

expressed interest in joining the TPP (Meltzer 2014).

Japan's recent accession to the TPP could be a game changer for Korea. A

TPP without the ROK could divert trade to Japan and thus “take away

Korea's market share in TPP member countries” (Park 2014: 13). With

Japan's accession, the opportunity costs of missing out have increased

substantially. When it comes to RCEP, active involvement could prove

vital to solve the impasse between China, Japan and Korea. However, this

would necessitate a heavy diplomatic initiative on two fronts and thus

the bulk of our Department's resources.

With the negotiations of both FTAs nearing the finish line, the ROK must

decide behind which mega-regional FTA it wants to throw its weight

behind. Negotiations of this calibre would bind the majority of the

resources of our Office of FTA Negotiations, making a prioritization

unavoidable. The geopolitical and economic implications of TPP and RCEP

make this an issue of paramount importance to the ROK. Should Korea

prioritize solving the “quality problem” over the “noodle bowl problem”?

Are close ties with China or the US more important under current

circumstances? What about the prospects for regional integration? While

we might continue to“wait and see” for future developments, recent events

have raised the stakes and opened new windows of opportunity.

Furthermore, this is also a chance for the Ministry of Trade, Industry

and Energy to allay concerns about its ability to proactively handle

trade negotiations after trade negotiation authority was transferred to

it in late 2013 from the Ministry of Foreign Affairs (Solis 2013: ii).

2. The Differing Approaches of TPP and RCEP

The TPP is the economic backbone of the US' “pivot to Asia” (Song 2014).

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

Based on the Economic Partnership between Brunei, Chile, New Zealand and

Peru, the US regards it as a chance to advance trade and financial

liberalization in the Asia-Pacific (Wilson 2014: 4). As of today,

Singapore, Australia, Peru, Vietnam, Canada, Malaysia, Mexico and Japan

have joined the negotiations, covering 8.6% of world trade and 40% of

global GDP (Hess 2013). The TPPs three principal objectives are to

“increase markets for exports, provide a basis for broad Asia-Pacific

regional economic integration, and increasing the competitiveness of the

participating states” (Backer 2014: 54). To do so, the TPP aims to set

high, comprehensive standards covering all trade (ibid.: 54-55). It will

include “WTO Plus” issues addressing intellectual property rights,

technical barriers to trade, and investment, which are absent from many

FTAs in the region (Wilson 2014: 3). With this highly ambitious agenda,

the US lauds it as a landmark and standard-setting agreement for global

trade in the 21st century (Backer 2014: 54) that might come to define

“the parameters of trade within the Pacific basin” (ibid.: 66).

This last remark indicates that US interest in establishing a TPP is not

purely economic. Seeing that China is increasingly becoming an FTA hub in

the region and persisting differences between the two countries on issues

such as constraints on foreign direct investment (FDI) and intellectual

property rights (Chen 2014: 58), the US is worried that China's rise

might come “at the expense of U.S. global economic interests” (ibid.: 62-

63). With the TPP, the US seeks to redress “the trend in the Asia-Pacific

region toward regional economic integration that excludes the United

States” (Meltzer 2012). Although it would be theoretically possible for

China to join TPP talks, its current make-up of the makes it very

difficult for China to join (Drysdale 2011). It thus effectively excludes

China. By setting hight standards of free trade and including major

trading partners for other countries in the region, the TPP would create

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

pressure on other states in the region to conform their behaviour to TPP

standards (Backer 2014: 68). “The great hope [of the TPP] is [it] will

trigger a domino effect which draws in all APEC members [...]” and thus

provides a basis for a Free trade Area of the Asia-Pacific, under US-set

rules (Cheong 2013a: 22).

China has legitimate reason to regard the TPP as a tool to strengthen US

partnerships in the region and eventually incorporate China into a US-led

system. It seeks to evade containment by concluding its own FTAs.

Officially launched on November 2012 (Su 2012), RCEP is centred around

ASEAN and the six countries that already entertain bilateral FTAs with

it: China, Japan, Korea, India, Australia and New Zealand (Wilson 2014:

5). It would cover 50% of the world’s population and 27% of global GDP

(Hess 2013). Contrary to the TPP, it is focused squarely on Asia. Itsmain aim is thus to address the “noodle bowl” problem by harmonizing the

existing FTAs under one single umbrella. With China as part of the

agreement and based around ASEAN, RCEP would bind the region closer

together and “its completion would cement the bloc’s status at the centre

of the regional economic architecture” and future regional integration

(Wilson 2014: 5). On the other hand, RCEP's liberalization ambitions are

much lower than those of the TPP. Its key focus is trade on goods and it

does not address “WTO Plus” issues (ibid.). Contrary to the TPP, which

follows a Western approach of gaining market access for its companies,

RCEP is conceived more as an a tool to foster economic partnerships and

regional cooperation (Dent 2013: 974). The lower quality of RCEP

guarantees lower costs for ASEAN's developing countries, while the main

incentive for the developed countries is gaining market access to China.

Additionally, China is pursuing a trilateral FTA between China, Japan and

Korea (CJKFTA). This agreement would bind together the three major

economies of the region and balance a possible participation in the TPP

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by Japan and the ROK.

3. The Economic and Geopolitical Implications of TPP and RCEP for the

ROK

The ROK is the world's 15th economy and its 7th largest exporter (Solis

2013: 3). Its export-oriented growth model has proved extremely

successful in the past decades. One of the least developed countries in

1960, in 2011 it became the world's ninth country to exceed $1 trillion

in trade (Ministry of Economic Affairs of Taiwan). It has come from

exporting primary commodities to being one of the main exporters of

intermediate goods, cars, LCD TVs and mobile phones (Solis 2013: 3). In

order to secure and expand its markets, the ROK has aggressively pursued

FTAs in the past decades with its neighbours and main economies in the

world. This has required the ROK to evolve from a low-key approach, aimed

at minimizing negative effects, to one that meant the progressive

liberalisation of our economy. Today, the ROK's FTAs are deep and

comprehensive and boast liberalisation ratios in the 96-99 percent range

(ibid: 4). It has even begun to liberalise our previously heavily

protected agricultural sector. Today, the ROK is the only Asian country

next to Singapore to have an FTA with the US (KORUS), and is is the only

country in the world to have an FTA with the US, the EU, ASEAN and India

(Minjeong and Kim 2014: 9). Through FTA's, Korea is a standard setter for

trade in the region. It is Korea's goal to become the region's main FTA

and business hub (Cheong 2013a: 21).

TPP and RCEP are crucial in this regard. The TPP would help solve the

“quality problem” in the region. It would be a chance to upgrade and

deepen some of Korea's existing FTAs with other TPP partners and be in

line with its role as a standard setter in the region. RCEP on the other

hand would mainly work to harmonize FTAs in Asia and solve the “noodle

bowl problem”.Most importantly, it would bring with it an FTA with ROK's

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

No. 1 trading partner: China.

However, there are also geopolitical implications to consider. The TPP is

often cast as part of a large geopolitical game for regional influence

between China and the US. A good relationship with both countries is

indispensable for the ROK. However, by choosing between the TPP and RCEP,

the ROK might risk upsetting the relationship with one of them. Korea is

a close friend and ally of the US. This close relationship is underpinned

by a military alliance as established under the Mutual Defense Treaty

more than 60 years ago (Minjeong and Kim2014, 6). This friendship is

strengthened by our common values and, since 2012 (Ministry of Foreign

Affairs of the Republic of Korea), a strong economic bond through the

KORUS FTA.

South Korea must balance its military dependence with the United States

with its economic dependence with China (Kelly 2014). China is the ROK's

No. 1 trading partner. Good relations with China are crucial for another

reason: North Korea. China being North Korea's main ally, good relations

with China serve us to gain leverage over North Korea. As of today,

relations with China have seldom been better (Minjeong and Kim 2014: 6).

Special mention has to be made of Japan. Due to its claim on the Korean

Dokdo Islands and intransigence over the “comfort women” issue,

diplomatic relations with Japan are difficult at best. Furthermore,

Japan's recent revisionism and nationalism is regarded with deep mistrust

by the Korean public (Kelly 2014). Nevertheless, Japan-ROK trade is worth

over $103 billion and and we are each others fourth and second largest

trading partner respectively (Tiezzi 2014). Japan joining the TPP means

it is effectively prioritizing its conclusion over RCEP.

4. “Wait and See”

Although the ROK has officially expressed interest in joining the TPP, it

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has so far followed a “wait and see” approach. This is because the

economic value of the TPP for the ROK depends on the final form it will

take. Should it become a wide-ranging, comprehensive and high-quality

agreement that substantially improves upon existing bilateral FTAs, then

its value for the ROK rises because it addresses the “quality problem”

(Cheong 2013b: 7). However, so far it seems that the outcome will be “a

matrix of new separate bilateral deals packaged within a very generic TPP

agreement [...]” (Dent 2013: 978). This would decrease the value of the

TPP for the ROK because it already has bilateral FTAs with most TPP

countries.

The ROK is able to “wait and see” this position because TPP negotiations

are heavily based on KORUS. It is named by US officials as the blueprint

to follow for TPP (Cheong 2013a: 6). Thus, participation in the

negotiations is of less importance for the ROK because it has already

some of the provisions that will in all likelihood be in the final

agreement. Furthermore, recent conclusion of FTAs with Australia and New

Zealand have removed further potential stumbling blocks to TPP accession

(Department of Foreign Affairs and Trade of the Australian Government).

Still, the TPP will provide provisions for areas not contained in KORUS

(Hess 2013). The accession of Japan to the negotiations has added a large

market with which the ROK does not have an FTA and thus increase the

potential gains of joining the TPP.

The announcement of interest in joining the TPP shows Korean

dissatisfaction over the progress of RCEP. Due to the high number of

developing countries involved in the negotiations, the standards set will

be low and thus not of much gain to Korea (Minjeong and Kim2014: 9). The

main incentive to the ROK is the lowering of trade barriers with China.

However, RCEP talks have been stalled because of the diplomatic freeze

between China-Japan due to their territorial disputes (Dent 2013: 980).

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As a result, China and the ROK have been pushing for the finalization of

a bilateral FTA (Song 2014). However, Japan has recently indicated that

it is willing acknowledge the existence of a territorial dispute over the

Senkaku/Diaoyu islands, opening the way for a resumption of CJKFTA

negotiations (Keck 2014).

5. Policy Options

In light of these developments, the following policy options point a way

forward:

(1) Continue “wait and see”

There are several arguments in favour of continuing the status quo. The

economic value of the TPP for Korea depends to some extent on the quality

the final agreement will take. Furthermore, the TPP will not be a closed

agreement, but accession will still be possible after the conclusion of

the negotiations. Due to the fact that the TPP will be heavily based on

KORUS, and the recent conclusion of FTAs with New Zealand and Australia,

there are no main obstacles to late TPP accession. Our resources may thus

not be adequately employed by getting involved in this complex

negotiation process. Yet the accession of Japan to the talks has added a

major market to TPP. Due to difficult bilateral relationship, this

multilateral setting might provide the FTA which is currently out of

reach bilaterally.

(2) Join TPP

Joining TPP, with 2015 set as the time-line for its conclusion, would

mean its prioritization, not least in the eyes of China. The TPP would

solve the “quality problem” of FTAs in Asia. Based on KORUS, the final

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agreement will be of higher quality than RCEP and thus more in line with

our ambitious trade policy. It would also mean a chance to upgrade the

quality of some of our current FTAs of lower quality, for example that

with Malaysia. Furthermore, the TPP could through its high standards

“pressure other states to conform their behavior to TPP standards”

(Backer 2014: 68). South Korea could start a domino effect and cause

other countries with which has strong trade relations to follow suit.

Last but not least, the TPP would be of great promotional value to the

Korean Ministry of Trade and outshine the FTA performance of the Ministry

of Foreign Affairs by participating in the creation of a 21st century,

mega-regional “gold standard” agreement.

However, the direct economic gains would be rather minimal since the ROK

already has FTAs with most TPP countries. The only major economy missing

is Japan. Estimates of the economic gain for the ROK vary greatly. While

Minjeong and Kim (2014: 9) expect and increase in real GDP of 2.5-.26%

after 10 years, this would only be the case if the TPP involves

“immediate elimination of tariffs of all products, investment

liberalization, and elimination of all the non-tariffs”. This could be

overly optimistic due to the heterogeneity of countries involved. Taking

a much more negative estimate, Cheong (2013a: 20) sees the economic value

of joining TPP equal to an FTA with New Zealand. In the end, joining the

TPP could be more about avoiding trade diversion than achieving large

economic gains.

The main drawbacks would be geopolitical in nature. For one, the TPP

might not advance regional economic integration, but in fact hinder it.

By effectively excluding China, the TPP could drive the “region apart

with the systematic exclusion of non-members, including [the PRC]. This

wedge through the middle of the Pacific will be political as well as

economic”. The TPP has already split the ASEAN countries and excludes

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China. Asian regionalization cannot occur without China and an ASEAN bloc

to balance its rise. As a positive relationship with China is of very

high importance to the ROK due to North Korea and as our primary trading

partner, we would risk damaging it by acceding to the TPP.

(3) Prioritize RCEP

RCEP would alleviate the “noodle bowl” problem by multilateralising the

ASEAN FTAs (Wilson 2014: 6). This would increase the efficiency of

regional production networks and thus be very beneficial to the ROK's

intermediate goods economy. Economic gains would be more substantive than

under the TPP. Compared to the 2.5% of GDP growth estimated under the

TPP, using the same model RCEP would bring about an increase of GDP

growth of about 4.1% in ten years time (Solis 2013: 16). “The larger

gains [...] reflect the opening of the Chinese market, with which there

is no pre-existing FTA, and the benefits of eliminating the larger

external barriers of many Asian countries” (ibid.). For these reasons the

Korean business community, while relative muted over TPP, has publicly

endorsed participation in RCEP (Park 2014: 14).

RCEP could also prove a greater contribution to regional integration than

TPP. Contrary to the latter, RCEP is likely to include specific

provisions to enhance economic cooperation and constitute a broader

economic partnership (Dent 2013: 981). Thus, “by emphasizing a proactive

integration approach rather than just the passive integration of a market

access deal, the RCEP is more likely to engage East Asian states

especially in building a stronger, more inclusive regional economic

community” (ibid.).

Drawbacks include deepening our dependence on the Chinese market and the

low quality of the agreement. Also, it is in our interest to have a

strong US in the region. Just as we would risk upsetting China by

choosing the TPP, we could hurt our relationship with the US by choosing

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

to stay out of TPP. Most importantly, can RCEP move forward with the

current difficult diplomatic relations between China-Japan and ROK-Japan

impeding any progress?

(4) Revitalise CJKFTA

Economic interdependence between CJK is very deep. Yearly trade between

China and Japan is valued at $332 billion, while Chinese-ROK trade is

valued at $257 billion. Our trade with Japan is worth over $103 billion

(Tiezzi 2014). With the regard to these numbers and in the absence of

bilateral FTAs between our countries, the economic benefits of a

trilateral agreement would be very large. China and the ROK are currently

involved in negotiating a bilateral FTA. While negotiations are well on

track, the levels of liberalization will not be as high as the ROK would

like (Newsworld 2013). Adding Japan, which has similar economic

interests, would increase pressure on China in negotiations. But most

importantly, RCEP is unlikely to happen without a CJKFTA. Healthy

relations between CJK is the precondition for a successful conclusion of

RCEP and future regional economic integration. A CJKFTA would also in all

likelihood serve as the standard-setter for RCEP, the same purpose KORUS

serves for TPP.

What speaks against this are the geopolitical tensions between China-

Japan and difficult diplomatic relations between Japan-ROK. However,

ahead of next month's APEC meeting in Beijing, the Japanese Government is

showing a renewed sense of urgency “to reset relations by coordinating

bilateral summits with his Chinese and Korean counterparts, Xi Jinping

and Park Geun-hye”. Only last month, deputy foreign ministers from all

three sides met in Seoul with the intention of reigniting the stalled

[CJKFTA ]process” (Miller 2014). Abe's acknowledgement of the existence

of a territorial dispute over the Senkaku/Diaoyu should allay tensions

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Ramón Lohmar 24.10.2014International Political EconomyDr. Adam William Chalmers

and provide a unique window of opportunity to further CJKFTA

negotiations. This trilateral forum would be the opportunity for all

three to save face while move on their substantial economic interests.

6. Policy Recommendation: CJKFTA to facilitate RCEP

The choice for the ROK is not whether to choose either RCEP or TPP. The

choice is about which one's immediate termination brings more benefits

and thus necessitates our closer attention. What our current “wait and

see” policy was based on is the relative lack of urgency to join TPP

negotiations now. Due to KORUS, it would relatively easy to join the TPP

after its conclusion. Korea's addition to the TPP would still be welcome

to the US. Its alliance with the US is strong and institutionalized and

thus unlikely to be negatively affected if we choose not to participate

in negotiations now. It is still in the ROK's interest to participate in

the TPP. However, as its benefits could still be reaped at a later stage,

the immediate use of Korea's resources is better applied elsewhere.

It is because of this that this paper recommends the Ministry of Trade

prioritize the reignition of CJKFTA negotiations, as a precondition to a

conclusion of RCEP. The potential benefits are too large, and Korea's

interest in not damaging relations with China too strong, to pass up the

window of opportunity provided by Abe's recent concession on the

Senkaku/Diaoyu. The CJKFTA is in the interest of all three parties, which

is why there is a real possibility for it to succeed. For China, it

provides a chance to balance against the TPP and against Japan's

participation in it. It would also make for a more China-centric and less

ASEAN-centric RCEP. For Japan, it would improve market access to its

first trading partner China, whose importance as a consumer base will

only increase in the future. As Japan participates in the TPP, it can use

that in negotiations as leverage over China. Also, it would gain

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preferential market access to the Korean market.

Finally, the ROK would be able to reap the benefits of preferential

market access to China and Japan. While it would also grant Japan access

to our market, the ROK has no reason to shy away from increased

competition. While the quality of CJKFTA and RCEP will certainly be lower

than the TPP, the ROK could still push for higher levels of

liberalization by prioritizing the RCEP negotiations. However, the

conclusion of the CJKFTA is only part of a larger endgame: gaining market

access to China and Japan through CJKFTA, advancing Asian regionalization

through RCEP, while balancing China and lessening Korea's economic

dependence on them through participation in the TPP. This strategy would

make the ROK “a linchpin that links the integrated market of East Asia

centred around China and the pan-Pacific market led by the United States”

(Solis 2013: 9).

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