Korea China Challenge

Korea’s Response to the China Challenge: Implications for Latin America

October 2003

Won-Ho Kim

Korea Institute for International Economic Policy

The rate of economic growth in major countries (Adapted from ADB, IMF, The statistics Yearbook of China) 0.0 0.1 0.1 0.4 2.8 0.1 -1.1 Japan 2.0 1.4 2.4 0.3 3.8 4.1 4.3 U.S.A 1.6 3.2 3.5 -2.2 5.9 5.4 4.6 Taiwan 1.9 3.7 6.3 3.1 9.3 10.9 -6.7 Korea 7.0 9.9 8.0 8.1 8.0 7.1 7.8 China April - June January – March 2003 2002 2001 2000 1999 1998

Korean economy’s recovery from the financial crisis

Source: Bank of Korea

Korea’s Trade with China

Determinants

Contrasting factor endowments

Gap in the level of economic development

Cultural and geographical proximities

China’s rapid economic growth in the 1990s

Limited trade before diplomatic relations

February 1992, China bestowed MFN status upon Korea by a trade agreement

Korean exports increased dramatically in 1992 (160%), and in 1993 (94%)

Korean exports increased 27.4% annually

Korea’s Trade with China (2)

Recently, more industrial goods (75% in 2000) imported

Electric/electronic industry is the core of bilateral intra-industry trade -> Horizontal division of labor

Attributable to Korean investments, who import Korea equipments and intermediate goods and export processed products to Korea

More than 10% of Korea’s total exports (2 nd ); 7-8% of total imports (4 th )

4.5% of China’s total exports; 10.3% of total imports (4 th )

Export products from Korea to China - 1 18.0 55.0 90.3 40.9 7.7 23.1 31.2 41.2 17.4 22.0 17.2 2003 (Jan – July) 481.0 64.9 33.2 -0.2 123.6 50.8 17.0 89.2 136.1 69.5 47.0 2003 (Jan – July) Rate of increase (%) 4.8 2.2 0.7 Automobile parts 28.4 2.5 1.8 Petrochemistry intermediate raw material 40.7 3.3 1.5 Synthetic fiber raw material 15.7 3.5 3.3 Electron tube 0.9 4.2 1.3 Semiconductors 22.7 5.3 8.3 Chemical products 34.6 6.0 11.7 Synthetic resin 15.4 7.2 6.4 Steel manufactures 5.5 9.3 1.2 Wireless communication tool 2.6 9.6 1.1 Computer 9.0 100 100 TOTAL 1998 2003 (Jan – July) 1998 Exports to China / Total exports (%) Each item / total exports to China (%) ITEMS

Export products from Korea to China - 2 2.9 25.6 49.2 19.4 25.3 33.7 17.2 2003 (Jan – July) 175.8 -3.5 -17.9 15.8 6.1 116.0 47.0 2003 (Jan – July) Rate of increase 0.8 1.6 0.7 Automobiles 10.9 1.6 1.4 Sound facilities 51.3 1.7 5.0 Leather 18.0 1.7 2.9 Backing cloth 20.4 1.8 3.4 Other textile products 6.8 2.0 0.6 Construction & mining machinery 9.0 100 100 TOTAL 1998 2003 (Jan – July) 1998 Exports to China / Total exports Each item / total exports to China ITEMS

Trend of Korea’s Trade with China

Changes in the shares as destinations for Korean exports

Changes in the shares as sources for Korean imports

Recent Trends in Korea’s Investment

Korea’s overseas investment has steadily increased until mid-1990s

Main destinations of Korea’s overseas investment are the US and the Asian regions (in particular, China)

FDI into Korea was sluggish until mid-1990s

however FDI into Korea started to increase quite rapidly after the financial crisis

Main source of FDI to Korea are the US, EU, Japan and the Asian regions including China

Korean Investments in China

Before 1992, thru intermediaries in HK…

With diplomatic relations, an investment protection treaty was signed

Remarkable in 1992-96, more than 50% of Korea’s ODI went to China

Stalemate during the Asian financial crisis

But rebounding fast since 1999 and China’s accession to WTO because of abundant cheap labor supply and huge market potential

Chinese statistics: $18.7 billion by the end of 2000 (contracted), $10.3 billion (invested)

Korean Investments in China (2)

Korea is the 3 rd largest investor in China after U.S. and Japan

Concentrated on Shandong, Tianjin, Jiangsu, Liaoning, Shanghai

Constrasted with Guangdong, Long River Delta by other FDIs

90% in manufacturing projects

Electronics and telecommunication equipment, textile and apparel, petrochemical, and machinery and equipment sectors

75% of Korean investments (35% in amount) concentrated on labor-intensive, SMEs, exporting to Korea or a third country

Trend of Korea’s Investments in China US$ million

Chinese Investments in Korea

Recent trend

US$150 million by 2000

60% concentrate on service sectors, engaging in trade and restaurant businesses

Among the manufacturing investments, the electric/electronic sector takes a dominant share

Opportunities since China’s WTO Accession

Lowered tariff barriers

Limited

China eliminates NTBs

CRT, polyester filament, plastic molding,…

MFA quotas phase out

China import more textile yarn and fabric for more textile and clothing exports

WTO ITA participation

IT products

Foreign firms allowed to import, distribute and retail foreign products

Consumer goods, including mobile phones, automoviles, clothing…

Lowering of tariff on export products to China 5 – 6% 8 – 9 (%) Steel 10 – 16 % 20 – 32 (%) Textile & clothing 6 – 8% 8 – 18 (%) Chemical industry & Chemistry 25 % 10 % 80 – 100 (%) 35 – 50 (%) Automobile Parts Reduction within narrow limit 8 – 12 (%) Electrical & electronic industry Duty free for Semiconductors, computers, communication appliances by 2005 13.3 (%) Information & communication appliances Probably reduction by 1/2 30 – 35 (%) Electric appliances Reduction by 5 or 6% on the average 15.3 (%) Manufacturing industry Particulars Actual tariff Items

Plan for the opening of the Chinese market - 1 Reduction to 25% (Actual rate: 80-100%) Automobiles Gradual reduction of customs duties by 2001 (from 15.3% to 9.4%) Dutyfree for Information & Technology products by 2005 Customs duties Mobile & Wired communication products: up to 49% Value added communication products: Permission of joint venture (up to 50%) in two years Information & Communication Reduction by 17% on the average until 2004 (All agricultural products) Reduction by 14.5% for Several U.S products Abolition of the import prohibition of U.S wheat, citrus fruits, flesh and meat Abolition of export subsidies Gradual abolition of export subsidies for corn and rice product by 2005 Establishment of scientific standards of SPS Agriculture Particulars Industry

Plan for the opening of the Chinese market - 2 S E R V I C E

( Financing)

Insurance: Increase in foreign capital quota (51%)

Banking: Permits foreign capital banks to transact with Chinese currency

Securities: Permission of Joint venture company

(Distribution)

Opening of the transportation business, wholesale and retail within 3 years

Abolition of the domestic selling quota within 3 years after joining WTO

(Tourism)

Permission of 100% foreign investment in hotels within 3 years after joining WTO

China Challenge since WTO Accession

China emerges as the global production base for wide range of products

FDIs by MNCs and the growth speed of domestic industries make China compete in most of Korea’s major industries, in more favorable position

3 Links: The combination of Taiwanese capital and production technology with the cheap mainland labor

Create highly competitive industries once Taiwanese industries compete with Korea

China’s market share in the U.S. increases while Korea’s decreases

Danger in other world markets and Chinese market

1995 1996 1997 1998 1999 2000 0 1 2 3 4 5 6 7 8 9 Korea’s & China’s Market Share in U.S 3.3 2.9 2.7 2.6 2.4 2.3 KOREA 6.1 6.5 7.2 7.8 8.0 8.2 CHINA

China as a member of WTO & Korean economy (CHINA) (KOREA) Joining WTO (CHINA) Liberalization of trade Liberalization of Foreign investment & improvement of investment environment Increase in competitiveness Increase in economic growth rate Increase in exports to China Increase in investment in China Increase in imports from China Shrinkage of Foreign Direct Investment Increasing competition in Chinese market Decrease in exports to China & the 3 rd countries Opportunity for restructuring

China’s WTO Accession & its influence on Korean economy Increase in exports due to the lowering of tariff and increase in demand Chemical industry Increase in exports due to the lowering of tariff Good opportunity for domestic automobile industry due to the increase in small size car demands Automobile Less risky industry due to the different type of ship construction In the long run highly risky industry due to the enlargement of investment Shipbuilding More competitive Loss of competitiveness of electric appliances with low price Increase in export of luxury electric appliances Electric appliances Equal competitiveness Loss of price competitiveness Loss of possession in U.S market Footwear Toys Increase in import of natural fiber Loss of possession in U.S market Textile & Clothing Increase in import of agricultural products at a lower price Agriculture Less competitive Particulars Industry

China’s WTO Accession & its influence on Korean economy (2) Increase in communication tools export to China Information & Communication Probable increase in exports when China demands more electric appliances Semiconductors Chance of enlargement Less competitiveness Financing / Distribution Increase in steel demand in China Chance of solving excessive supply problem in Korea Steel More competitive

Rising China and Korean economy Rising China

<Industry>

Competes with Korea in most of the main industries

Challenges the newest industries like I.T

<Market>

Vast domestic market

Keen competition between the top class products

<Policies>

Advantageous business conditions

Flexible labor market

Active inducement of Foreign capital investment

<International economy>

Offset actions by U.S.A & Japan

Trade disputes

Decrease in competition

May provoke an industrial secession from Korea (Doughnut)

May delay the industrial progress

Too small size of domestic market compared to China

Continuous invasion of Chinese products into the Korean market

Ambiguous government policies

Restriction of enterprise operation

Shrinking foreign capital investment

Frequent trade disputes

Increasing competition with rival countries

May reduce Korean competitiveness

May lose the competitiveness unless coping with the situation

Should switchover the crisis to an opportunity

Korean situation Korea’s response

Korea’s Responses?

Short-term relief from the dynamic trade surplus from China’s expanded markets

Restructuring, open-economy, complementary relations with the Chinese economy, higher-level technology, more efficient management know-how, knowledge-based industries emphasized

FTA and Northeast Asian Business Hub concept has been developed

Vision for Korea as a Business Hub in Northeast Asia 1) Korea’s geo-economic location between “continental economy” and “ocean economy” is proving to have increasing economic and social value in the newly emerging geo-political, economic order. 2) Regionally an “inward globalization” strategy to make Korea the regional center for trade, finance and MNC’s. (regional hub of three pillars) 3) Logistics becomes a strategic sector as high value-added export sector (supply chain management). 4) Container shipments on Korea-China route and Korea-Japan route -- air passengers and air cargo are on the rapid rise.

Vision for Korea as a Business Hub in Northeast Asia (2) 5) Incheon International Airport and surrounding areas are to be developed as a transport hub and value-adding logistic hub for finished and semi-finished products. 6) As an intermediate step, “special economic zones” are to be designated with a set of incentives. 7) Korea’s role as an effective intermediary between two regional hegemonic powers, Japan and China. 8) Korea’s hub idea should contribute to the “Northeast Asian Economic Community,” and then North Korea will have no choice but to join the regional growth bandwagon. 9) In the medium term, Korea needs to turn the entire nation in a special economic zone.

Implications for Latin America