Effects of Trade and Investment Liberalization on Korea’s FDI

Jong Duk Kim, Seungrae Lee, Jungu Kang and Hyuk-Hwang Kim

After Korea-Chile FTA became effective since 2004, Korea has made multiple free trade agreements with 47 countries including United States and European Union, and is currently negotiating upcoming free trade agreements with other countries, such as Indonesia, China, Vietnam, Australia, and New Zealand. Along with the global spread of trade liberalization, it is necessary to evaluate the post-effects of FTA that came into effect and the strategies for the upcoming FTAs. However, prior reports and papers analyzing the effects of FTA were mainly focused on evaluating its economic effects on goods, while most of FTAs are influential not only on product sector but also on investment and service sectors. In particular, since foreign direct investment (FDI) is directly and indirectly related to goods trade, FTA is also associated with foreign direct investment sectors. This report analyzes the effects of FTA on outward and inward foreign direct investment (IFDI and OFDI) of Korea. Our report provides detailed analysis on the contents of FDI openness in the trade agreement and construct FDI openness indices by dividing investment sectors from the previous 8 free trade agreements that became effective into 5 sectors and 25 sub-sectors and quantifying FDI openness based on those sub-sectors. By adding our constructed FDI openness indices to the regression, we find that FTA significantly increases both IFDI and OFDI in the short run. Examining the effects of investment liberalization on IFDI and OFDI, the results indicate that investment liberalization from FTA increases IFDI. In particular, its magnitude becomes larger as investor-state dispute settlement is included in the chapter of agreement. On the other hand, the results imply that FTA has heterogeneous effects on OFDI from different industry sectors on the basis of investment related articles. For instance, OFDI from manufacturing sectors is likely to increase to FTA partner as agreement involves high FDI openness articles in general, while OFDI from wholesale and retail sectors is more likely to increase as agreement involves FDI openness articles on service related sectors. Furthermore, based on the relative GDP per capita difference between Korea and its FTA partner, we find that IFDI flow increases from FTA partners that have similar GDP per capita with Korea, while GDP per capita difference and FDI openness indices have interaction effects on OFDI flow from different industry sectors. For instance, we find that FDI openness indices have significant and positive effects on OFDI from manufacturing sectors to FTA partners that have higher income-level but small GDP per capita difference with Korea. Alternatively, OFDI from wholesale and retail sectors are likely to increase to FTA partner as a country has higher income-level and large GDP per capita difference with Korea, with high FDI openness on service sectors included in the agreement.
Based on the results, our report provides policy implications for expanding Korea's OFDI and IFDI. We find that Korea’s OFDI and IFDI have increased at the aggregate level and they are positively affected by trade and investment liberalization. As our results indicate that FTA significantly increases OFDI and IFDI, we should carry forward upcoming FTAs more aggressively. In particular, upcoming FTA negotiations should focus on including FDI openness in service sectors, FDI regulation and protection, and investor-state dispute settlement provision. Furthermore, as trade and investment liberalization are known to have different effects on OFDI and IFDI based on the GDP per capita difference between Korea and its FTA partner, upcoming negotiations should be proceed by considering country’ GDP per capita relative to Korea and the agreement should include investment related articles that could have positive effects on OFDI and IFDI from different industry sectors.

Expected Effects of Entrenching Financial Cooperation between Korea and the Middle-East and International Expansion Strategies of Korean Banks to the Middle-East Financial Markets

Oh Suk Yang

Throughout the Chapters 2, 3, 4, 5 in respective order, this paper examines the concentration ratio of bank market in GCC at status quo, competitiveness of Islamic bank in GCC, and competitive advantage and internationalization strategy of banks comprising GCC market, local commercial banks, and global commercial banks in GCC market.
In chapter 2, we examined the distribution of Islamic banks at status quo, the peer group analysis on 11 peer groups of the world’s largest (total asset) Islamic banks, and regional distribution of Islamic banks, along with careful observation on development and prospect of GCC bank market. The competition in bank market of GCC and MENA countries was analyzed through peer group analysis and PR H-statistics, together with thorough analysis on the consumption behavior for GCC bank at both individual and corporate level.
GCC region is the most concentrated area of Islamic banks and assets, where "troika" of Islamic bank industry is established among Bahrain, Malaysia, and Iran. Meanwhile, GCC occupies a great share, outweighing other regions among the Top 20 Islamic banks. The average of net interest margin (3.01%) of GCC Top 20 Islamic banks surpasses the average of the Islamic banks all over the world (2.35%).
The size of GCC bank market measured by total asset to bank equity ratio has grown by 17.4% during 2000~2011; domestic private credit (to GDP %) has grown by 63.7% during 1993~2011, which proves its outstanding financial development in light of bank market activity. In terms of asset size, UAE and Saudi Arabia are predominant, while Bahrain shows a steady rising tendency of GDP ratio. Furthermore, GCC bank industry, in general, presents rapid trend of recovery and development. The fall of bad debts and increase of bank profitability are expected to be consistent, and the saving ratio over 170% makes the prospect even brighter.
The peer group analysis substantiates the competitive status of GCC bank market. This is evident in the Gini’s coefficient measured by Lorenz curve: net income (0.24), total asset (0.38), operating revenue/turnover rate (0.01), market capitalization (0.38) and so on. However, for the purpose of methodological rigor, this paper applies PR-model to demonstrate the level of competitiveness in GCC bank market. As a result, it has been proven that GCC Islamic bank market is at balanced-competitive status (H-statistics 0.6386), which is a fairly equivalent level in comparison to bank’s H-statistics (0.60~0.80) over 50 different countries according to preceding research (Claessens and Laeven 2003). Meanwhile, GCC commercial bank market is also proven to be at balanced-competition level (H-statistics 0.6652).
In chapter 3, for escalation of practicality and holistic evaluation, an empirical analysis was conducted using pertinent firm specific variables, derived from internal factor such as financial structure and managerial attribute, and macro economic variables to analyze external factors affecting profitability of banks. As a result, the deviation in the determinants for each indicator between Islamic bank and commercial bank is verified: profitability, growth, efficiency, financial strength and stability.
In chapter 4, an empirical analysis was conducted to examine the correlation between corporate governance and firm values of Islamic bank and commercial bank.
The biggest distinction in corporate governance between Islamic bank and commercial bank is the presence of board of Sharia and Sharia executive department. Through ex ante and ex post supervision of bank business, Sharia board reinforces the compliance of Islamic law in their business. However, there are arguments purporting that multilateral supervision rather hinders efficiency, which abates the authority of Sharia board’s regulation. Furthermore, the original function of Sharia board may stand out in financial trade, but at work of bank management, the practical managerial skills of Sharia executive management is appraised to be more significant. The operation of Sharia board differs from country to country, mainly in two ways: The presence of internal Sharia board and the employment of external consultants.
In chapter 5, GCC bank market was investigated as to inquire the suitability for overseas expansion site of Korean banks. The examination encompassed the study of entrance and concentration of global bank’s GCC bank market, and the internationalization of participants in GCC bank market and Korean domestic banks. Competitive advantage of GCC bank market participants including Korean banks was also analyzed.
Concentration ratio of GCC commercial bank, executed with peer group analysis, delineated fairly low value. In measuring market concentration ratio using Lorenz curve, the Gini’s coefficient substantiated the GCC commercial bank at balanced-competition: net interest revenue (0.16), operating income (0.16), net income (0.32), savings & short-term fund (0.17) and so-on.
It can be proposed that a bank has sustainable competitive advantage when the bank’s resource for its competitive advantage is valuable(V), rare(R), immitable(I) for its competitors, and have organization(O) that can exploit such resource. Through VRIO internal analysis, domestic bank’s competitive advantage is based on its IT and consumer-on-demand service. Information, which is the pivotal source of competitive advantage for financial industry, is essential to realize economy of scale, and is expected to function as a resource that can overcome the ownership-specific advantage and location-specific advantages of Islamic bank and local commercial banks.
Meanwhile, result from quantitative analysis on performance suggests that Islamic bank has the highest competitive advantage on growth and financial strength, and competitive disadvantage on profitability, efficiency and stability. Global banks have displayed the highest competitive advantage on growth, but stopped at showing only fairly high competitive advantage on the rest of the indicators. Local commercial banks have shown the highest competitive advantage on profitability and growth, but fairly high competitive advantage on efficiency, stability and financial strength. Meanwhile, the Korean domestic banks appeared to have competitive disadvantage on growth, but they also appeared to be equipped with the highest competitive advantage on stability and financial strength, and fairly high competitive advantage on profitability and efficiency.
This study ultimately proposes Korean bank’s strategies for GCC bank market entrance. There are various strategic options for Korean domestic banks to penetrate into foreign bank market. First, collaborative entrance with another Korean bank already existing in the market would be the most favorable strategy. Second, collaboration with a local bank could be a safe choice in eluding the potential risks associated with foreign market entrance. The third option would be augmenting the risk-avoiding opportunities by joint overseas expansion with a manufacturing firm.
However, the following factors are required for Korean domestic banks to sustain its growth after its entry to GCC bank market. The first factor is the ability to incorporate various needs of local people in their financial products. Secondly, a pursuance of long-term orientation is a prerequisite for the acquisition of sustainable development, offsetting potential costs from internationalization at the same time.
Another strategy that drives GCC bank market entrance of Korean domestic banks to success is the optimization of internalization, which serves as a catalyst in reducing potential risks through experiential learning. At similar marginal cost-marginal benefit level, it is favorable for banks to reduce risks by maximizing the process of internalization.
However, entering GCC bank market is unachievable with sole effort of Korean domestic banks. Thus, in addition to persistent efforts of the Korean government through different policies, the following complementations are required to be processed. First, more active and practical moves regarding contracting agreements and treaties at government level are to be encouraged. Secondly, the government support to the bank's entry to GCC by training mid-east Islam experts are to be expanded and intensified. Third, a policy promoting GCC market penetration of domestic banks and firms is also a pressing matter.
Lastly, unlike the aforementioned optimistic expected effect from global business activities, foreign market entrance may become easier due to deregulation, which could result in excessive penetration on specific regions, arousing concerns about deterioration of profitability and financial accidents. In order to prevent such accidents, the supervisory authorities should strive to reinforce their superintendence on foreign branch, control over imprudent foreign market entry, stay vigilant on law compliance, and ameliorate internal control systems.

Development of Russian Far East and Baikal Region and Korea’s New Northern Economic Cooperation

Weon-Yong Sung et al.

Since the beginning of the third term of the Russian President Vladimir Putin, Russian foreign policy has given strategic priority to the economic and political integration of the entire Eurasian continent. In addition, Russia is unfolding plans to make Russia the central axis of a vast strategic belt between the EU and the Asia-Pacific region. Now Russia is carrying out its ‘New Eastern Policy’ in order to more actively expedite Russia’s integration into East Asia and the Asia-Pacific region.

Currently the Korean government and companies are trying to find appropriate investment methods under the banner of the so-called ‘New Northern Policy’, paying attention to a series of changes in the conditions regarding the development of the Russian Far East. However, it is not clear which are the actual components of ‘New Northern Policy’ and the what the policy has in common with Russia’s New Eastern Policy; and lastly, the role it can serve in strengthening the strategic partnership between Korea and Russia.

Therefore, it is important to examine the goals, tasks, and policy directions of the RFE development strategy and to analyze how we should manage the ‘New Northern Policy’ in response to Russia’s New Eastern Policy. The main challenge is to fully understand the real aspects of the ‘New Eastern Policy’ that Russia has proposed after the APEC summit in September, 2012 and to assess the manner in which the RFE development strategy and the Asia-Pacific regional integration will proceed. In this regard, we should pay attention to some of the programs under way in Russia. On March 29, 2013, the Russian government approved the national program “Socio-Economic Development of the Far East and the Baikal Region until 2025.” However, only a fragmentary description of this program was made known in Korea and comprehensive analysis of this program has not been done out until now.

Under these circumstances, the authors reviewed the policy directions and problems in RFE development, focusing on the national program “Socio-Economic Development of the Far East and the Baikal Region until 2025.” And we analyzed the sets of interests which Russia’s New Eastern Policy and Korea’s New Northern Policy might have in common.

This study consists of six chapters. In the first chapter we presented the background and purpose, the scope and methodological approach of this study, and provided an overview of previous studies on this issue. In the second chapter we analyzed the RFE development strategy and policy directions of the Russian government. The impact of the global economic crisis (2007~9 years) on the economy of the RFE was very great. The rate of economic growth decreased, investment activities shrank, the extraction industry’s share in industrial production rose considerably, and the preexisting problem of imbalance in the RFE economy became worse than before. The problem of outdated infrastructures and resulting limitations in capacity are serious. Also, there is also the continuing problem of a declining population.

The development of the RFE is marked by a combination of two driving forces. One is a program for regional development, initiated and financed by the Russian federal government. The other is foreign economic cooperation. The purpose of the national program “Socio-Economic Development of the Far East and the Baikal Region until 2025” is as follows: 1) formation of conditions for accelerating development of the RFE and the Baikal region, and the transformation of the RFE into a competitive macro-region with a diversified economy led by high value-added technology production; 2) achieve significant improvement of socio-demographic conditions in the RFE and the Baikal region with creation of conditions for stemming and reversing population loss with qualified specialists, and improvement of living standards of the population to levels above the average European standard.

In chapters three to five, this study made a comprehensive analysis of the current situation in terms of transportation, energy, and social infrastructure in the RFE and the Baikal region based on the analysis of the national program “Socio-Economic Development of the Far East and the Baikal Region until 2025”. The authors overviewed the goal, tasks, and policy directions represented in each sector subprogram and assessed the prospects for their development in the future. Lastly, in Chapter six, this study assessed the performance of economic cooperation between Korea and the RFE, and analyzed potential cooperation projects in transport, energy, and social infrastructure for Korean investment into the RFE.

Since the establishment of Korea-Russia diplomatic relations in 1990, the turnover of trade between Korea and the Russian Far East trade has increased rapidly due to their geographical proximity and complementary industrial structures. Trade relations now play a critical role. The Korea- Russian Far East trade turnover accounts for 41.2% of the total trade volume between Korea and Russia. But, on the other hand, Korea’s investment into the Far East is paltry, as it accounts for barely 0.7% of the total volume of FDI into this region. The Korea-Russian Far East economic relations has been locked in the frame of simple trade -the exchange of fuel, raw materials from the Far East for finished industrial products from Korea. In fact, Korean companies are reluctant to invest in the Russian Far East owing to poor investment conditions.

However, as Russia recently continues to drive the ‘New Eastern Policy’ forward and invests into Far East development projects, Korean companies are trying to make inroads into the Far East markets. Accordingly, investment cooperation between Korea and the Far East is expected to expand. Most of all, Korean companies can participate in projects in the field of transportation such as the construction of seaports and logistics facilities, including the realization of the ‘Rajin-Khasan Project’ as a pilot project for linking the TKR with the TSR. Additionally, Korea should strengthen policy coordination on tasks related to the activation of the Northern route including: 1) simplifying the process for using the Northern route, 2) reduction of the tariff for icebreaker use, 3) research on actual conditions for Northern route use, 4) build the information exchange system for safe navigation through the Northern route.

In the field of energy cooperation, it is expected to increase the import of coal for power generation from the Far East regions, and with the development of the gasification, the growth of investment in power generation will stimulate the regions’ import of electric power equipment and facilities from Korea. Supply of pipeline natural gas from Russia through North Korea to South Korea will be implemented only in a situation where Russian gas has an edge in price competitiveness and with enough quantity to satisfy market demand compared to shale gas from North America. In the future, in order to successfully implement the strategy for energy material exports to the Asia-Pacific region, Russia needs to gain the trust of regional countries by implementing sustainable and consistent FDI policy. And regional countries need to look for solutions such as establishing investment funds to secure a huge amount of investment money required for energy development projects.

Social infrastructure, a field into which Korea can invest, are divided into two parts. One part is the investment activities related to high-quality jobs to create sustainable additional value. For example, we can consider such activities as the management of universities such as MBA and hospitals, building industry-university R&D centers, and the operation of CNG stations for gasification. The other involves facilities that serve as a basis for a more comfortable and convenient life. For example, it would be possible to receive construction orders for housing and infrastructure, water and sewage system, a water purification plant, waste disposal facilities, and housing complexes.

Recently we have widely discussed the ‘New Northern Policy’ regarding Korea’s entry into the Russian Far East. There are clear strategic directions implied in the ‘New Northern Policy’. It means that Korea should extricate itself from its geographical handicap of being a virtual ‘island’ country and become an open country advancing into the continent and the sea. Also, the ‘New Northern Policy’ implies the building of trilateral cooperation belts in such forms as South-North Korea-China, or South-North Korea-Russia. In this regard, the ‘New Northern Policy’ is a kind of policy for unification of Korea. And South-North Korea economic cooperation is the starting point of ‘New Northern Policy.’

Considering the ‘New Northern Policy’ with Russia, it should be noted that it is directly linked to trilateral cooperation between South Korea, North Korea and Russia. That is the essence of the ‘New Northern Policy’ and it can become an indicator to measure whether the realization of that policy is possible.

For a more rapid progress in Korea-Russia economic cooperation, it is necessary to increase Korea’s FDI into Russia and implement the trilateral cooperation between South Korea, North Korea and Russia. In this respect, we need to overcome the physical and geographical distance between the two countries. This can be done through the three megaprojects including the Trans-Korean and Trans-Siberian Railway connection projects, supply of natural gas from Russia via pipelines through North Korea to South Korea, and supply of electric power from the Russian Far East to South Korea through North Korean territory within the framework of the NEAREST program. Therefore, in examining the economic feasibility of these projects, it is necessary to consider not only the economic benefit-cost analysis, but also geo-strategic, geo-economic interests. And because of the nature of the projects, mega-projects mentioned above are interconnected. Therefore, we require comprehensive and integrated approaches to deal with these projects.

Three mega-projects are closely interlinked with other tasks such as modernizing transport and energy sectors that Russia has given special meaning to in connection with the development of the Russian Far East. Therefore, we need to use these projects as a springboard to facilitate Korea’s entry into Russian Far East, Siberia, and the Eurasian Continent as a whole.

Development of China’s Northeast Region and Korea’s New Northern Economic Cooperation

Dong Wook Won, Seungho Kang, Hong Gyoo Lee, and Changdo Kim

Northeast China played a key role as China's major industrial base during PRC’s early years and planned economy period. Recent years, however, have seen Northeast China’s heavy-industry-based economy stagnate since the initiation of reform and open-up policies. To counter this problem, the Hu Jintao government established ‘Northeast Development Strategy’ in accordance with the concept of balanced national development. As a result, Northeast region has emerged as a new growth pole through the innovation of system and mechanism, adjustment of the functional relationship between market and the government, and the new plan for industrialization. In addition, the region has been growing as a major strategic base for economic integration in Northeast Asia, through active opening-up and cross-border cooperation.

With the succession of the 'fifth generation' of leadership, the Xi Jinping government seems determined to sustain pursuit of this strategy. This does not only provide us with bilateral and multilateral platforms for normalizing inter-Korean relations and promoting new northern economic cooperation, but also gives impetus to renewal of Sino-Korean relations which has regressed owing to political disagreements. We should take part in the cross-border cooperation which has been in Northeast China, not only to overcome the limitations in and instability of economic cooperation between two Koreas, but also to bring about change in inter-Korean relations through building multilateral cooperative platforms with China and Russia, which retained a fair amount of influence over North Korea. In conclusion, we can operate new growth engines of national economy through revitalization of the northern economy, based on development and enhancement of industrial structures in Northeast China.

China has already put its visions of a Northeast Asian economic community into practice through the ‘Northeast Development Strategy’ and cross-border development. In this regard, we now stand at a crossroads where we should propose our own New Northern Economic Cooperation plan that accords with China’s plan. A corresponding strategy for the future does not only take into account the negative aspects of a China-led cross-border cooperation, but also constitutes wise preemptive response by anticipating geoeconomic change in this region. In other words, we should seek closer cooperative relations with Russia which expresses concern over ‘sinicization of the Far Eastern Region’ and restore economic relations with North Korea. We must take part in China-led cross-border cooperation with North Korea for the short term, yet thereafter secure a balance in the Northeast Asian economic community by gradual transition from a China-led bilateral cooperation system to a trilateral or multilateral cooperation system including Mongolia, Russia, Japan, and the US in the medium and long term.

China’s Green Growth Strategy and Implications for Trade between Korea and China

IkJoon Moon, Jihyun Jung, Su Yeob Na, HyunJung Park and Hyo Jin Lee

When the Chinese capital of Beijing was enveloped by unusually heavy smog in 2013, alarms were raised at home and abroad concerning environmental problems facing China. In response, the Chinese government decided on a policy change, making the switch from quantitative to sustainable development, while promoting green growth. This report reviewed Chinese green growth policy overall; and also analyzed trade policy, trade disputes, and Korea-China trade.

This report consists of six chapters. Following the introduction, Chapters 2 examine China's green growth strategy. China's promotion of green growth was studied in both domestic and international terms, and accordingly, some features related to green growth were identified. A key point in understanding China's green growth is that it represents a transition in the mode of economic development. China's green growth strategy began with reflections on past mode of economic development. However, it is still in the early stage, as transition to resource-saving or environment-friendly models of development is a comprehensive and time-consuming process. Hence, green growth in China would require more time and appropriate economic reform policy.

Chapter 3 discusses Chinese green growth policy and its relation to trade policy, including a review of Chinese environmental regulations and an outline of related trade prohibitions, restriction policies and TBT. Recently, China has deemed free trade to be one of the causes of pollution and restricted trade somewhat to decrease environment pollution. This implies that the number of on trade prohibitions related to environmental pollution increased. Empirical analysis reveals that the export industry of China is still labor-intensive rather than capital-intensive. It is also empirically proven that improvement of environment - the result of environmental regulation policies - actually provide positive impact on export increases.

Chapter 4 examines trade disputes related to China’s green growth policy. As case studies for Chinese green industry subsidies, countervailing duty of US and EU, along with wind power equipment subsidy case of the WTO, were analyzed. According to the analysis, grants, preferential policy loan and price under the production element were the main types of subsidies that US and EU protested against in applying countervailing duties. On the other hand, wind power equipment subsidy case of WTO showed the nonfulfillment of subsidy notification can bring about lawsuits. Recent countervailing duty towards polysilicon of US and EU is an expression of the Chinese government's strong willingness to respond to countervailing duties utilized by developed countries.

Chapter 5 includes analysis of environmental products in Korea-China trade. Import statistics data from China Customs was utilized in order to understand environmental products imported for domestic use. In 2012, the import market for environmental products was 18.17 billion USD and domestic use accounted for 34.3% of the total, or 6.25 billion USD. According to analysis of collaborative cases, it is suggested that Korean companies engage in joint venture with local companies to learn the Chinese system before switching to become an independent entity at a later date.

Implications of the Chinese green growth strategy to Korea and Korean policies in response are as follows. First, Chinese adoption of green growth strategies is inevitable but would involve a long, drawn-out process. Hence, Korean companies should strengthen competitiveness and simultaneously prepare for further environmental restrictions in the long term. In addition, during FTA negotiations, the Korean government should push for diversification of bidding, and also discussion on methods for sharing green funds and appeals.

Second, the Korean government should prepare for green industry disputes Korea might become involved in. Factors that can cause disputes should be identified ahead of time to avoid the disputes between major trading counters. Multilateral action at the WTO level must be considered to ensure that China its obligations for subsidy notification, in order to raise awareness on Chinese subsidies in the green industry. In case Korea is targeted with excessive countervailing duties, Korea should actively utilize the WTO disputes settlement system.

Third, the Korean government should provide support for the Korean environmental industry to develop a niche market where it has comparatively high competitiveness. This should include financial and management support, and matching service with outstanding local companies. Moreover, the government needs to negotiate issues such as simplification of customs procedures, customs and duty-free imports with the Chinese government.

Last, cooperation channel among environmental experts and trade professionals should be created at the government level to share information and establish a specific mechanism to resolve environment and trade conflicts.