## Abstract

When signing their bilateral free trade agreement (FTA) in February 2015, South Korea (Korea, hereafter) and China called the deal a historic milestone in deepening their strategic cooperative partnership and expected it to bring about practical benefits for both countries. The China–Korea FTA seems to generate low impact, however, because of its narrow coverage and tenuous commitments. Korea has taken a passive position regarding the FTA in response to the strong objections from its agricultural sector, and China has promoted the FTA in light of political considerations, then hurried to conclude negotiations for inclusion in the Beijing 2014 Asia-Pacific Economic Cooperation Leaders’ Meeting. This study is the first academic assessment of the China–Korea FTA based on the Chapters and Appendices that both countries have signed. Major elements of the FTA, including its narrow coverage, are analyzed qualitatively. We also provide a quantitative assessment based on tariff liberalization commitments. Finally, the study discusses the policy implications of the China–Korea FTA for economic integration in East Asia and the Asia-Pacific region.

## 1.  Introduction

The governments of China and South Korea (Korea, hereafter) signed a bilateral free trade agreement (FTA) on 25 February 2015 and implemented the agreement ten months later on 20 December. The China–Korea FTA has several implications for both signatory countries as well as East Asia: Because this agreement involves the largest and third largest economies in the region, its provisions are expected to provide reference points for future development of a region-wide FTA (Ahn 2012).

The agreement is comprehensive—the 22 chapters cover goods, services, investment, trade rules, and intellectual property rights—and is expected to bring about substantial economic gains for both signatory countries. Nonetheless, the content of the FTA does not contain basic elements that are characteristic of a high-quality FTA. For example, the China–Korea FTA lacks wide and speedy tariff elimination, liberalization measures in the services sector, commitments for the improvement of the business environment, and the protection of intellectual property rights. Against this background, this study evaluates the FTA qualitatively and quantitatively, assessing its basic elements and comparing its elements with other FTAs in which Korea and China have participated. In addition, this study delineates the implications of the FTA for regional economic integration in East Asia and the Asia-Pacific region in promoting mega-FTAs such as the Regional Comprehensive Economic Partnership (RCEP) under negotiation or forming a new trading bloc in the future.

Although many studies have sought to assess the potential impact of a China–Korea FTA, those projects were conducted prior to the conclusion of the agreement's negotiations. Thus, this study provides the first academic assessment of the FTA's elements based on the details of the chapters and appendices in the agreement as it was signed. To this end, qualitative assessments are carried out for many elements of the FTA along with the quantitative analysis of the effects of tariff reductions. Further, whereas most researchers have analyzed the potential effects tied to a complete tariff liberalization, this study considers the actual schedule of the tariff cuts implementation schedule, which will phase out tariffs in the FTA over 20 years.

## 2.  The path to bilateral economic cooperation

China and Korea have served as important trading partners since the two countries established diplomatic relations in 1992, and both countries have promoted closer economic relationships. The China–Korea FTA has been regarded as one of the key drivers of the two countries’ bilateral economic cooperation, because it is expected to bring about substantial economic gains and has political implications for both countries as well as the landscape of East Asian regionalism. China became Korea's largest trading partner a decade ago, and Korea expects large gains from its FTA with China that will be comparable to the gains it has achieved through its FTAs with its other partners. Similarly, China views this FTA as its largest trade deal, and considers this FTA to be a policy mechanism to help it grow and adapt to the ever-present and various forms of regionalism in East Asia and the Pacific region, which are being led by the United States and Japan.

Developing the FTA was not smooth, however, and it took 12 years to implement. When Korea adopted its national roadmap for FTA policy,1 the FTA with China was categorized as a long-term target. Because of economic and political issues related to agricultural liberalization, eight years (2004–12) were spent by both countries for (1) conducting joint research with research institutes; (2) additional study in the title of trilateral research by academics, industry, and the government; and (3) joint evaluation by trade authorities of the two countries before launching official negotiations for a bilateral FTA. Table 1 describes the history of the China–Korea FTA.

Table 1.
Abbreviated history of the key dates for the China–Korea FTA
DateProgress
September 2004 Agree to launch a joint feasibility study on a possible China–Korea FTA
2005–06 Joint feasibility study
November 2006 Launch of a Joint Study Group of governments, businesses, and academic scholars
March 2007 First round of the Joint Study Meeting (Beijing)
September 2010 First joint evaluation meeting by trade authorities
April 2011 China–Korea Trade Ministers’ Meeting (Beijing)
February 2012 Korea's public hearing on the China–Korea FTA
May 2012 Agree to launch the China–Korea FTA negotiations
May 2012 First round of the FTA negotiation (Beijing)
November 2014 Conclusion of the 14th round of negotiations (Beijing)
February 2015 Official agreement signed
December 2015 Implementation of the FTA
DateProgress
September 2004 Agree to launch a joint feasibility study on a possible China–Korea FTA
2005–06 Joint feasibility study
November 2006 Launch of a Joint Study Group of governments, businesses, and academic scholars
March 2007 First round of the Joint Study Meeting (Beijing)
September 2010 First joint evaluation meeting by trade authorities
April 2011 China–Korea Trade Ministers’ Meeting (Beijing)
February 2012 Korea's public hearing on the China–Korea FTA
May 2012 Agree to launch the China–Korea FTA negotiations
May 2012 First round of the FTA negotiation (Beijing)
November 2014 Conclusion of the 14th round of negotiations (Beijing)
February 2015 Official agreement signed
December 2015 Implementation of the FTA

Source: Summary based on information on Korea's official Web site (www.fta.go.kr).

During the negotiating period beginning in May 2012, Eichengreen, Park, and Wyplosz (2008, 108) stated that “a China–South Korea FTA will certainly elevate China's status as a regional hub in East Asia. However, it will take many years for the two countries to initiate and conclude negotiations for a bilateral FTA, even if South Korea gives priority to a China–Korea FTA over a Japan–Korea FTA. This means that for the foreseeable future, East Asia will remain a thick web of bilateral FTAs.” The negotiation was concluded in a shorter period of time than the preparation period, indicating the economic and political difficulties of the FTA. China and Korea concluded bilateral FTA negotiations in 2.5 years, yet they spent 8 years in three stages of feasibility studies. This process stands in contrast with the U.S.–Korea FTA, which required 1.5 years (from May 2005 to November 2007) of negotiations following a short discussion/study period of about one year. Further, negotiations in the last six months were critical in concluding the China–Korea FTA. Indeed, although the countries discussed many issues in the first two years, neither country was active in the negotiation.

The biggest hurdle to Korea's engagement in official negotiations was domestic objections to agricultural liberalization. The Korean agricultural sector stalwartly demanded the exception of agricultural liberalization, and Korean authorities promised to minimize agricultural sector losses through a two-stage negotiation process. The first stage was to agree on market access in the agricultural sector by Korea, with negotiation on other issues following in the second stage. Though this two-stage process had not been used in any previous negotiations across the world, China accepted Korea's negotiation proposal because of the political usefulness China saw flowing from a FTA with Korea. This agreement represented an important turning point for the China–Korea FTA, and this expedited the negotiations and defined the agreement's content. Traditionally, Korean farmers have objected to FTAs, and the FTA with China was regarded as the one to bring most devastating effects to the Korean agricultural sector. During the negotiation period, the United States and Japan actively promoted the Trans-Pacific Partnership (TPP), and China needed to expand its FTA network with its major trading partners: “From its inception, the TPP has been considered by many as a strategic instrument to isolate or contain China” (Fortune 2015). China decided to complete the negotiation soon by accepting poor market access for Korean agricultural market.

The most critical factor that spurred the conclusion of the China–Korea FTA negotiation was China's political drive to announce the agreement at the November 2014 Asia-Pacific Economic Cooperation (APEC) Leaders’ meeting in Beijing. Observers at the time noted that “[t]he reason why China declared the conclusion of the China–Korea FTA at the Beijing APEC Leaders’ Meeting while inviting political leaders such as U.S. President Barack Obama into its capital city is not just based on economic estimates. … China did not hurry for more exports of its cheap manufactures into Korea. … China's political considerations can be found in [China's national strategy against the U.S.'s ‘Pivot to Asia’ strategy and the progress of the TPP]” (Business Watch 2014). It can be inferred from this that China wanted to demonstrate its own way of coping against the TPP by actively promoting the FTA with Korea (its first import partner and fourth export partner) and proposing an APEC FTA, which is called the FTA in Asia Pacific. In addition to this, China began to promote the “One Belt One Road” strategy in 2014 for closed economic/political cooperation with Central Asia and European countries.

## 3.  Structure of the China–Korea FTA

In general, advanced economies tend to conclude comprehensive FTAs with a wide liberalization package. In contrast, developing countries tend to conclude narrowly defined FTAs that are mainly focused on trade liberalization in goods, though they often mention and aim to conclude a comprehensive FTA such as the Korea–U.S. FTA (KORUS FTA). As Table 2 shows, the overall structure of the China–Korea FTA is similar to the FTAs that Korea has concluded with advanced countries such as the EU–Korea FTA and the KORUS FTA. The China–Korea FTA encompasses more issues than Korea's bilateral FTAs with ASEAN and India. The coverage noted in Table 2 shows that the China–Korea FTA is the most comprehensive agreement China has concluded thus far. Critical elements such as government procurement (GP), labor, intellectual property rights, the environment, and transparency are either not included in the FTA or they lack a strong implementation mechanism. Therefore, the China–Korea FTA does not stand out as a model for developing future FTAs within East Asia and the Asia-Pacific region. The less ambitious ASEAN–China FTA is regarded as a typical south–south FTA, and China's FTA with New Zealand does not cover GP, competition, labor, the environment, or e-commerce.

Table 2.
Provisions included in China's and Korea's FTAs
KoreaChina
FTA partnerEUUnited StatesASEANIndiaVietnamChina–Korea FTANew ZealandASEAN
Sanitary and phytosanitary measures O
Investment O
Intellectual property protection O
Government procurement X
Dispute settlement O
Transparency O
Competition O
Labor X
Environment O
E-commerce O
Cooperation O
KoreaChina
FTA partnerEUUnited StatesASEANIndiaVietnamChina–Korea FTANew ZealandASEAN
Sanitary and phytosanitary measures O
Investment O
Intellectual property protection O
Government procurement X
Dispute settlement O
Transparency O
Competition O
Labor X
Environment O
E-commerce O
Cooperation O

Source: Based on the chapters of the FTAs assessed in the table.

Note: O = covered in the agreement; X = not included in the agreement.

China has not included chapters on GP or labor in any of its FTAs to date. As a result, these issues, along with intellectual property rights, the environment, and transparency represent critical barriers to China's potential for participation in the TPP. Although China adopted a market economic system and joined the WTO in 2001, a substantial share of its economy still remains in the communist system. China has privatized many of its state-owned enterprises (SOEs), but the total number of state-holding and collective-holding enterprises in China as of 2012 was 549,774, accounting for 7.74 percent of all enterprises in the country. More importantly, the share of China's state-owned and controlled enterprises, taking a broad definition including SOEs and state-holding enterprises as well as the visible state sector such as urban collectives and public government-owned township and village enterprises, produce roughly 50 percent of China's GDP according to the report by the U.S.–China Economic and Security Review Commission (2011) (see Table 3). China has a high share of SOEs in its economy, and this makes it difficult for China to liberalize its GP.

Table 3.
Number of corporate enterprises in China by region and holding status (2012)
Private holdingState holdingCollective holdingTotal
Number of enterprises 278,479 271,295 6,552,049 7,101,823
Private holdingState holdingCollective holdingTotal
Number of enterprises 278,479 271,295 6,552,049 7,101,823

Source: National Bureau of Statistics of China (2013)China Statistical Yearbook 2013.

FTA labor chapters define FTA member obligations regarding the adoption and maintenance of its statutes, regulations, and practices based on the core principles of the International Labor Organization's Declaration (ILO Declaration).2 For example, the KORUS FTA encourages member countries to guarantee worker core rights such as the freedom of association. As Table 2 shows, however, the inclusion of labor provisions is not common in Korea's FTAs. Because labor issues are politically sensitive for most countries, both countries easily agreed to the exclusion of a labor chapter in the FTA.

Although the China–Korea FTA lacks in some issues, its overall structure can be said to be comprehensive, in fact the most comprehensive among China's FTAs, since it is more broadly defined than China's FTAs with ASEAN and New Zealand.

## 4.  Evaluation of the China–Korea FTA

### 4.1.  General assessment

The China–Korea FTA is comprehensive in that it has 22 chapters embracing not only goods, services, investment, and intellectual property rights but also trade facilitation, trade remedies, e-commerce, labor mobility, competition policy, the environment, and dispute settlement. Moreover, the China–Korea FTA includes a separate chapter on economic cooperation, which is absent from Korea's previous FTAs with major partners such as the United States and EU.3 Although the governments of China and Korea have openly stated that the FTA meets high standards, its content lags other FTAs in quality. Prior to negotiation, it was expected that the level of trade and services liberalization should exceed each country's WTO commitments. Following Kim (2013), the level of ambition and coverage of an FTA should appropriately address the issues related to bilateral services/investment flows. Services liberalization is closely linked with the flow of investment, because the former allows new business opportunities for investors. The China–Korea FTA falls short of initial expectation, however, in services liberalization. Table 4 shows that China's services sector protection is high compared with other countries. This is a barrier arrangement for Korea as one of its main purposes in negotiating the FTA with China was to expand Korean firm access to China's services market.

Table 4.
Service sector barriers, tariff equivalents (%)
United States 70.72 35.46 33.9 8.9
United Kingdom 105.98 72.72 60.35 19.91
Germany 25.77 47.62 40.91 11.45
Japan 46.02 78.89 42.97 66.34
Korea 95.34 102.31 70.78 86.62
China 200.54 187.04 197.58 170.2
World average 111.18 102.43 91.43 47.47
United States 70.72 35.46 33.9 8.9
United Kingdom 105.98 72.72 60.35 19.91
Germany 25.77 47.62 40.91 11.45
Japan 46.02 78.89 42.97 66.34
Korea 95.34 102.31 70.78 86.62
China 200.54 187.04 197.58 170.2
World average 111.18 102.43 91.43 47.47

Source: Seo et al.(2014).

Tourism may be the Korean services sector that benefits most from the FTA, because China allowed Korean companies to open local offices in China, and soften the regulations for tourism. Nevertheless, the FTA failed to liberalize access to most of China's services sector to the extent envisioned. For example, the chapters on financial services (Chapter 9) and telecommunication (Chapter 10) were included in China's FTAs for the first time. Yet the increases in market access provided by the China–Korea FTA is limited because the liberalization measures only apply to the China (Shanghai) Pilot Free-Trade Zone and the services concession in the Doha Development Agenda (DDA, revised package). These measures are already implemented or announced by China, and additional net liberalization is hardly apparent. A similar result can be said for Korea, in that it did not offer more than its DDA package.

Chapter 5 of the China–Korea FTA defines sanitary and phytosanitary (SPS) measures, which have been one of the major non-tariff barriers for Korean businesses in China. The chapter heavily relies on the WTO SPS agreement, and has just six Articles. Although the objective of the chapter is to “minimize the negative effects of SPS measures on trade between the Parties while protecting human, animal or plant life or health in the Parties’ territories” and to “enhance transparency in and mutual understanding of the application of each Party's SPS measures,” Article 5.6 (Non-Application of Dispute Settlement) states that “neither Party shall have recourse to Chapter 20 (Dispute Settlement) for any matter arising under this chapter.” This implies that the two countries are encouraged to ensure that their own SPS laws and regulations are not deterrents to bilateral trade, although the chapter lacks any enforcement or implementation mechanism. Further, in the absence of recourse to dispute settlement procedures, the reform or removal of arbitrary SPS measures seems unlikely. The reform or removal of arbitrary technical trade barriers is also unlikely because of the absence of an implementation and enforcement mechanism.

The most disappointing part of the agreement is the level of goods market access, which is regarded as the basic indicator of the quality of FTAs, as the EU FTA Manual states that “[t]he ‘free movement of goods’ (also termed ‘goods market access’) remains the core element within EU Free Trade Agreements.”4 Broad coverage of the goods market is helpful for gaining agreement on the other issues, and is especially relevant for FTAs involving developing countries. Unless progress is made in market access to goods in the early stage of negotiations, the number of negotiation rounds rises and the negotiation for goods tends to be concluded in the last round. As evidence, the China–Korea FTA was concluded with a 71.1 percent liberalization ratio (10th year of implementation, by partner country) after 14 rounds of official negotiations, which contrasts with the KORUS FTA (concluded with 100 percent in the sixth round) and the EU–Korea FTA (98.1 percent in the eighth round).

### 4.2.  Analysis of tariff liberalization

Chia (2015), Cheong (2014a), and Cheong and Kwon (2006) discuss how to evaluate FTA quality under the current implementation processes. The quality of a FTA depends on coverage and commitments. Broad coverage and firm commitments are the markers of a high-quality FTA, which will bring larger economic gains than a low-quality FTA with narrow coverage and shaky commitments. According to the latter approach, the China–Korea FTA has the lowest quality of Korea's FTAs concluded to date. Indeed, it is rated as having lower quality than Korea's FTAs with ASEAN and India (see Figure 1).5

Figure 1.

Quality assessment of Korea's FTAs

Figure 1.

Quality assessment of Korea's FTAs

As Table 5 shows, the China–Korea FTA led to immediate tariff elimination in 49.9 percent of all Korea's tariff lines and 20.1 percent of China's tariff lines. These tariff reductions applied to 51.8 percent of Korea's trade (as measured by import value) and 44.0 percent of China's import value. The share of import value benefitting from trade liberalization when the FTA reaches its tenth year of implementation will be 66.2 percent for China and 77.1 percent for Korea. These ratios will rise to 85.0 percent for China and 91.2 percent for Korea after 20 years of the FTA's implementation. This slow tariff liberalization in the China–Korea FTA appears to be contrary with regulation in Article 24 of the GATT, which governs exceptions from the Most Favored Nation principle.

Table 5.
Tariff liberalization phase-in in the China–Korea FTA (unit: number of tariff lines, %)
KoreaChina
Tariff linesaShareImport valuebShareTariff linesaShareImport valuebShare
Immediate 6,108 49.9 41,854 51.8 1,649 20.1 73.372 44.0
10 years 9,690 79.2 62,281 77.1 5,846 71.1 110,453 66.2
20 years 11,272 92.2 73,638 91.2 7,428 90.7 141,746 85.0
Total 12,232 100 80,769 100 8,194 100 166,754 100
KoreaChina
Tariff linesaShareImport valuebShareTariff linesaShareImport valuebShare
Immediate 6,108 49.9 41,854 51.8 1,649 20.1 73.372 44.0
10 years 9,690 79.2 62,281 77.1 5,846 71.1 110,453 66.2
20 years 11,272 92.2 73,638 91.2 7,428 90.7 141,746 85.0
Total 12,232 100 80,769 100 8,194 100 166,754 100

Source: Author's calculation.

Note: a. Calculated based on the numbers of tariff lines applicable. b The number of imports affected by tariff liberalization are counted.

These liberalization ratios are far below Korea's FTAs with the United States and EU: The liberalization ratio for Korea was about 68–80 percent when the FTAs were implemented and 95 percent in the tenth year of implementation (see Figure 2). Although Korea took a more liberal position in the FTA with China than its FTAs with the United States and EU when the country started FTA negotiation with China, the country's net liberalization ratio was just 10 percent, considering that 41.9 percent of imports are free of any charges.6

Figure 2.

Immediate liberalization ratios in Korea's FTAs with China, the United States, and the EU (unit: %)

Figure 2.

Immediate liberalization ratios in Korea's FTAs with China, the United States, and the EU (unit: %)

Because GATT Article 24 is interpreted to require substantial liberalization in preferential trade agreements within ten years of implementation, it is worth comparing the tariff liberalization ratios for Korea's FTAs by the tenth year of implementation (see Figure 3). Indeed, this approach was taken by the WTO Committee on Regional Trading Agreement, which compared the tariff liberalization ratios for FTAs based on the tenth year of implementation, and found that the liberalization ratio in the China–Korea FTA was lowest for Korea.

Figure 3.

Tariff elimination ratios in Korea's major FTAs (ten years after implementation)

Figure 3.

Tariff elimination ratios in Korea's major FTAs (ten years after implementation)

Because of the difference in industrial development in the two countries, Korea liberalizes its tariffs more quickly than China. Nevertheless, the overall speed of liberalization is slow for both countries and not all tariffs are eliminated by the end of the implementation period (Figure 4).

Figure 4.

Average tariff rates during the implementation of the China-Korea FTA (unit: %)

Figure 4.

Average tariff rates during the implementation of the China-Korea FTA (unit: %)

As displayed in Figure 5, the FTA provisions imply that China and Korea will reduce average tariff rates gradually, with slow liberalization continuing even after the tenth year of implementation. For comparison purposes, Korea reduced its tariffs in the first year of implementation in the KORUS FTA and almost fully liberalized its tariffs by the 15th year. The more serious problem is that Korea's tariffs on major agricultural products remain unchanged in its FTA with China, whereas large proportions of manufacturing goods are liberalized.

Figure 5.

Average tariff rates during the implementation of the China–Korea and KORUS FTAs (unit: average tariff, %)

Figure 5.

Average tariff rates during the implementation of the China–Korea and KORUS FTAs (unit: average tariff, %)

The most sensitive agricultural item in the liberalization process has been rice and related products. Korea achieved almost the full liberalization of agricultural sectors in its FTAs with the United States, the EU, and Australia, with agricultural liberalization ratios of 78.1 percent (tariff lines) and 89.0 percent (import value) in its first ten FTAs (see Table 6). The agricultural liberalization ratio dropped to 40 percent (import values) in the China–Korea FTA, although it rises to 70 percent if measured by tariff lines. Although Korea's trade authority is proud of the fact that the tariffs on 60 percent of the imported agricultural products from China were unaffected by the FTA, it is reasonable to say that this became one of the major reasons for China's active protection of its industrial sector. Korea liberalized 93.5 percent (imports) of manufacturing tariffs, but China's liberalization ratio of manufacturing was agreed to be 85.1 percent, which is the lowest in China's FTAs.

Table 6.
Agricultural liberalization ratios in Korea's FTAs (unit: %)
FTA partnerUnited StatesEUAustraliaAverageaChina
Tariff lines 98.9 97.2 88.6 78.1 70
Import value 99.1 99.8 98.6 89.0 40
FTA partnerUnited StatesEUAustraliaAverageaChina
Tariff lines 98.9 97.2 88.6 78.1 70
Import value 99.1 99.8 98.6 89.0 40

Source: Korea's Ministry of Trade, Industry and Energy (2015).

Note: a. These ratios are the averages of tariff liberalization in Korea's first FTAs from its first FTA with Chile (implemented in April 2004) to its tenth FTA with Australia (December 2014). The FTAs with the U.S. and EU are Korea's 6th FTAs and 8th FTA, respectively.

### 4.3.  Estimation of the economic effects of the China–Korea FTA

Many researchers have studied the economic effects of the China–Korea FTA prior to its implementation based on hypothetical assumptions, not on the contents of the FTA signed. Reports include those of the Development Research Center of the State Council of China (DRC) and the Feasibility Study for the China–Korea FTA by the Korea Institute for International Economic Policy (KIEP 2007) as well as the Joint Study Committee for a China–Korea FTA (2010). Examples of existing studies include Lee et al. (2005), Sung (2009), Cheong and Cho (2008), Lee, Noh, and Seo (2011), Samsung Economic Research Institute (SERI 2011), Kim (2012), the Korea Institute of Finance (2012), and Cheong (2014b).

The DRC and KIEP (2007) research, which utilizes a static computational general equilibrium model, predicts that the China–Korea FTA will increase the GDPs of Korea and China by 2.443 percent and 0.395 percent, respectively, over next ten years. Alternatively, the predictions from a capital accumulation model imply that Korea and China's GDP will increase by 3.313 percent and 0.584 percent, respectively. Although the predictions vary somewhat across studies, the conclusions are qualitatively similar: Most studies predict that the FTA will lead to increases of real GDP, which range from 0.4–0.6 percent for China and 2.4–3.1 percent for Korea.

In the past decade, the volume of China–Korea trade has expanded at a 22.3 percent annual growth rate, rising from US$90 billion in 2004 to US$ 300 billion in 2014. The two countries are also important investment partners. Korean investment in China rose above US$70 billion in 2014, and Chinese investment in Korea amounted to US$1.8 billion dollars. Industrial cooperation between the two countries has also advanced thanks to the benefits of complementarity and geographical adjacency. These close economic relations imply the qualification of good FTA partners, which will produce substantial economic gains for both countries when a high-quality FTA is implemented. Assuming a high-quality FTA between two countries, the KIEP predicted that the China–Korea FTA is expected to increase Korea's real GDP by 0.95–1.25 percent in five years and 2.28–3.04 percent in ten years (Choi 2012).

Even after the conclusion of the FTA, Beijing and Seoul continued to expect high economic gains, as if the FTA was of high quality. New work by KIEP researchers, however, presented in the report of the Ministry of Trade, Industry and Energy (2015) revises their estimates of economic gains arising from the FTA with China from 2.28–3.04 percent to 0.3 percent (accumulation, five years after the implementation) and 0.96 percent (ten years). These figures are much lower than the FTA with the United States. A similar study conducted by Cheong (2014b), is summarized in Table 7. Cheong (2014b) introduced the tariff concession schedules of the China–Korea FTA in a dynamic computable general equilibrium simulation.7 Because the FTA is narrow in its commitments and the improvement of non-tariff barriers is limited, the study does not adopt exogenous shocks for efficiency gains, as was done in the evaluation study for the KORUS FTA. Instead, the method of Ianchovichina and Walmsley (2012) is used to account for the internalization of investment. Regional investment is allocated based on the expected rate of return (ROR), and the model assumes perfect competition in all markets. In the absence of barriers to the movement of capital, investment is allocated such that the ROR on investment is the same in all regions. The estimates in Table 7, which report the sum of the effects arising from trade liberalization and internalized investment, note that the predicted gains from the China–Korea FTA are much smaller than those predicted for the KORUS FTA.

Table 7.
Comparison of the economic gains under the KORUS FTA and China–Korea FTA (unit: % of GDP)
2015202020252030
KORUS FTA 1.76 2.64 3.62 4.61
China–Korea FTA 0.42 0.61 0.81 1.00
2015202020252030
KORUS FTA 1.76 2.64 3.62 4.61
China–Korea FTA 0.42 0.61 0.81 1.00

Source: Cheong (2014b).

### 4.4.  Background to the low quality of the China–Korea FTA

When entering into the China–Korea FTA negotiations, China sought to gain access to Korea's agricultural markets, and Korea sought access to China's manufacturing markets. The poor quality of the China–Korea FTA, as shown in Figure 1, may have occurred because of several constraints, including structural differences in economic output and labor structure between China and Korea, the division of political power between central and local governments, and the prevalence of SOEs in industrial production. Korea could not be aggressive in liberalizing its agriculture sector because of the strong political power of its local governments, and the high share of SOEs in China, which were particularly inefficient and uncompetitive in service sectors such as telecommunication and financial services, impeded China's ability to offer a broader liberalization scheme to Korea.8 The two countries compromised to choose the second-best option, since the benefits of a China–Korea FTA must exceed its costs, despite its low quality. Given the constraints faced by the two countries, the second-best outcome will eventually increase welfare of the two countries, although they could have gained more if they had managed to lower protection in their most sensitive sectors. Nonetheless, this second-best outcome is better than the absence of an agreement. That is, both parties agreed to proceed with a low-quality FTA.

Several issues can be raised regarding the low impact of the China–Korea FTA from institutional factors to negotiation strategy. As Korean President Park Geun-hye took office, she reshuffled the government structure. In particular, the trade authority was transferred from the Ministry of Foreign Affairs and Trade to the newly organized Ministry of Trade, Industry and Energy (MoTIE), underlining the linkage between trade and industrial policy. This sounds reasonable in that trade policy should be designed in favor of industrial interests. During this process of governmental restructuring, the agricultural authority (Ministry of Agriculture, Food and Rural Affairs: MAFRA) was tasked with managing agricultural trade issues, with the MoTIE having a smaller range of coordinating issues along with the important task of leading the whole negotiation team.

When China asked to begin official negotiations for a bilateral FTA, MAFRA and agricultural circles openly argued that the Korean agricultural sector should not be hurt by the FTA. This resulted in the two-stage negotiation mentioned earlier, in which both parties agreed on the coverage of agricultural liberalization in the first stage and other sectors/issues in the second stage. In agreeing to this choice of sequencing, China agreed to minimize Korean agricultural liberalization, but at the cost of excluding Korea's major export items to China.9 China wanted to open the agricultural/fisheries, textile, and apparel markets in Korea and exclude manufacturing from the concession list for Korea. Korea did not have enough political leadership in persuading sensitive sectors for higher economic gains, and China wanted to complete negotiation before the November 2014 APEC Leaders’ meeting in Beijing. As a result, the deal eventually concluded by packaging items/issues of modest priority rather than those of utmost priority (Korea Investment & Securities 2014).

The other FTAs in which both China and Korea participate has made Korean authorities reluctant to engage in active negotiations with China. When negotiations for the China–Korea FTA began, those for the China–Japan–Korea (CJK) FTA and RCEP (ASEAN+6 FTA) were also scheduled. Note that China and Korea will liberalize their bilateral trade if either of these FTAs is concluded. Because these FTAs are linked with the China–Korea FTA, the trade authorities of the two countries took a defensive position in that wide liberalization in the China–Korea FTA will adversely affect their negotiation leverage in the larger FTAs.

Limited staffing also had an adverse effect on the FTA negotiations. Prior to MoTIE's launch, roughly 100 full-time trade officials were available to support the advancement of Korea's FTA policy. Most were well-trained for FTA negotiations, from information gathering to face-to-face negotiation. Many of these trained negotiators were transferred to MoTIE, however, and this slowed the negotiation process.

Finally, China's internal factors disturbed the progress of negotiations. Although China has concluded several FTAs, it lacks experience in negotiating a high-quality FTA. The gap between the central and local governments in China impedes the recognition of the central government's policy authority, which results in a more limited liberalization and the weakening of enforcement mechanisms. Moreover, the non-market characteristics of China's economic system, and the small number of trade officials, complicated the give-and-take process. Finally, because of the high share of SOEs in China's economy, China was not open to the inclusion of government procurement in the FTA chapters, even though this topic is the core element in modern FTAs.

## 5.  Conclusion and implications for East Asian economic integration

China's President Xi Jinping called the Korea–China FTA a “monumental event” that will “not only lead to a new leap in trade relations between the two countries but also bring practical benefits to the people of both countries,” and Korea's President Park Geun-hye called the deal a “historic milestone in the countries’ efforts to deepen their strategic cooperative partnership” (The Diplomat 2015). Unfortunately, the China–Korea FTA is neither monumental nor historic, due to its slow liberalization mechanism. The tariff elimination ratio at the implementation of the agreement was as low as 9.2 percent for Korea and 4.0 percent for China when measured by imports, which compares unfavorably with ratios in the range of 50–60 percent for Korea's FTAs with the United States and EU. In spite of the official announcements regarding Korea's motivations for entering the negotiations with China,10 the completed FTA provides Korean companies with only limited market access to the Chinese service sector. For example, some sectors that were fully committed to be open for Korean business partners, such as construction and distribution, were already bound to be open through commitments China extended when it joined the WTO. Overall, services sectors with WTO plus treatment in the FTA are limited. Moreover, China's commitments for the audiovisual services sector fail to meet the level that was provided in the China–New Zealand FTA, and the FTA lacks any measures to handle issues related to government procurement.

As discussed in Section 2, China promoted the FTA with Korea for political considerations and hurried to conclude negotiations in advance of the Beijing APEC Leaders’ Meeting. The speed was motivated by China's desire to undertake a strategy of strengthening its capacity in leading the discussion of economic integration in East Asia and the Asia-Pacific region. As Japan turned its priority from the RCEP to the TPP along with the United States, China became jittery about being left out from a mega FTA in the Asia-Pacific region, and needed an alternative proposal for the TPP. Recently, a report by the Peterson Institute for International Economics in Washington, DC, states that “Simply put, the Korea–China FTA disappointed both business leaders and trade experts, who had expected the deal to both bolster commercial ties and set a new standard for Chinese trade liberalization. But political interests trumped economic objectives, and the negotiated outcome cut too many corners to achieve such a comprehensive result” (Schott, Jung, and Isaacs 2015, 1).

Though China could accumulate experience and know-how as a byproduct of the FTA negotiation, its economic system remains to be improved and globalized.11 In the end it is unclear whether the China–Korea FTA will be a stepping stone for East Asian economic integration, or whether China should have prioritized its quality rather than pushing the conclusion of the negotiation in order to build a model FTA for East Asian countries. If China had pursued a region-wide FTA, it would have shown leadership in the negotiation of the RCEP and CJK FTA.

China, Japan, and Korea have not made progress in the negotiations of the CJK FTA in 2015, despite the signing of the China–Korea FTA. Although the three countries announced their aim to pursue a comprehensive and high quality FTA, they have not yet reached any agreement regarding market access for goods. The prospect of the Korean Federation of Industries (2013) was too optimistic, and it needs to be balanced based on the progress of major FTAs in East Asia.12 Although the outcome of market access in the China–Korea FTA will provide many guidelines for dealing with sensitive items when negotiating FTAs, it is unlikely to be a base for the CJK FTA because of the poor provisions for market access in goods and services. Absent other political considerations, such an FTA would be unacceptable.

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## Notes

*

The author thanks Bhanupong Nidhiprabha of Thammasat University for valuable comments on an early draft of the paper. Any remaining errors are the author’s.

1

The FTA roadmap, which was adopted in August 2003, prescribed the FTA promotion strategy for Korea's major trading partners such as the United States, EU, Japan, China, India, ASEAN, and others.

2

The full title of the ILO Declaration is the ILO Declaration on Fundamental Principles and Rights at Work and its Follow-Up (1998).

3

Refer to Ministry of Trade, Industry and Energy (2015) about the Korean government's evaluation of the China–Korea FTA.

5

The FTAs in the right upper quadrant of Figure 1 have wide elements (chapters), as given in Table 2, and near 100 percent tariff elimination ratios, shown in Figure 3, whereas the FTAs in the left lower quadrant have opposite characteristics.

6

Ten percent net tariff liberalization is calculated by calculating the difference between immediate liberalization ratio (51.8 percent in Table 1) and the ration of free tariffs (41.9 percent).

7

The model assumes perfect competition in all markets, and is described in Cheong and Tongzon (2013).

8

This was presented by Bhanupong Nidhiprabha of Thammasat University at the Fall 2015 AEP conference.

9

Korea's major export items are automobile, home appliances, mobile phones, chemicals, and machinery.

10

Regarding Korea's motivations for the FTA with China, refer to Kim (2013).

11

Refer to Chia (2013), regarding the linkage of FTAs in East Asia.

12

The institute predicted that the China–Korea FTA will bring about a synergy effect to the conclusion of the CJK FTA and RCEP.