Changes in the Labor Market Since India’s Economic Reforms

Woong Lee, Young Chul Song, Choongjea Cho and Yoonjung Choi

The momentum of the unexpected economic reform triggered by an external force led the Indian government to apply for the IMF bailout program, following the exhaustion of its foreign reserves at the end of 1991. India’s economic reform is an important example for the Korean economy because of its similarities to Korea’s 1997 foreign reserve crisis. The two countries have both experienced reform led by an IMF bailout.

This report examines changes in the Indian labor market since the economic reforms of 1991. Analyzed here is the direction toward which the labor market moved, as the economic reform has proceeded, with particular focus on the labor market change pre-and-post reform. For the distinction by period, four phases are defined as follows: the period of economic reform by external factors after the 1991 reform, the period of economic reform that reflected domestic demand, the period of booming economy and then the period after the global financial crisis. In industrial relation analysis, the time period under discussion is simply divided into two by 1991 economic reform as the divider because there has not been much change in labor market institutions, including industrial relations, compared to other sectors.

First, Chapter 1 highlights that this study covers a wide range of information regarding the labor market in detail and also attempts to estimate the aggregate matching function for India for the first time.

In Chapter 2, major contents of the reform by sector are organized in different phases after economic reform as follows: ① a period of general reform driven by external factors after adopting IMF stabilization policy (end of 1991 to 1997), ② gradual reform period reflecting the demands of various firms and industries (1998 to 2002), ③ high-growth period (2003 to 2008) and ④ the phase following the global economic recession (after 2009).

The achievements about economic growth, trade, investment and foreign exchange reserves after economic reform are then analyzed, mainly concentrated on the outstanding growth after the 2000s. Although the economy as a whole was impacted significantly by the global recession, the economic reform of the 1990s has turned potential negatives into positive achievements in each sector as India entered the 2000s.

Chapter 2 introduces the future tasks with respect to India’s economic reform. India has been successful in the reform of many sectors although challenges still remain in terms of improving the transparency of the economy and politics as demand for better infrastructure, consistent government policies, a less rigid labor market and the large gap between wage and labor productivity still await resolution.

Chapter 3 investigates several leading indicators of the Indian labor market after the economic reform in 1991 such as labor force participation rate, employment rate, unemployment rate, employment structure and wages.

Firstly, figures for labor force participation rate have appeared to show only minimal changes since the economic reform, though it begins to decline by the mid-2000s. The downward trend of youth population was steadily seen and has become clearer especially since the mid-2000s. The ratio of women in the labor force had quite increased but started to decline after 2005.

Even though the employment rate seemed to have experiences no major change after the economic reform, it tends to decline due to the global recession from 2010. This is attributed to the declining employment rate of the younger population in particular.

The unemployment rate of India has constantly decreased since the reform of 1991, except in 2005, and reached its lowest point since 1998 in 2010 due to the global recession. In the case of the unemployment rate, however, only the labor force population is considered so when the non-labor force such as those who gave up looking for jobs and students are included, the real number of the unemployed are not accurately reflected despite evident signs of a weakened labor market. This issue has been appearing also in the recent unemployment trend of India. Particularly in 2010, when the global economic crisis brought a recession to India’s shores, the unemployment rate actually declined. The unemployment rate of the younger population appeared higher as a proportion to the total employment rate, especially among urban youth and the unemployment rate of women was found to be higher than that of men.

Looking at the employment structure since the economic reforms of 1991, the employment rate in rural area showed a downward trend while the employment rate in manufacturing and services shows an upward trend. This most likely attributes to the enhancement of the Indian economy rather than economic reform. On the other hand, the economic reform may well explain the fact that employment in the public sector has experienced a significant decrease since the economic reform.

As employment elasticity, which measures the growth of employment caused by a unit of economic growth, is analyzed, India appears to have a low level of job creation in contrast to its rapid economic growth from the 2000s. Although the employment elasticity increased with the economic growth after 2000, only the elasticities in agriculture and mining appeared over 1 but the elasticities in services and manufacturing still stayed at 0.12 and 0.24 respectively. As opposed to the high growth of India, this is mainly due to the inability to create jobs in manufacturing and services, sectors that generated a significant portion of the growth. In addition, it also carries negative implications for job creation, meaning that the Indian economy has grown with focus on services rather than labor-concentrated manufacturing, and that India’s labor-related laws and institutions are not flexible. In addition, the wage inflation that exceeds the growth rate is another challenge that Indian economy faces at the moment.

Chapter 4 summarizes the labor market structure and institutions. This chapter then examines changes in India’s industrial relations by dividing the period into ‘before 1991 economic reform’ and ‘after 1991 economic reform.’ Then the industrial relations of Korean firms operating in India are listed and analyzed.

It is generally said that India’s labor market institutions have rarely saw any change since the start of the economic reform. The organized (formal) sector of which regular employees take up the major share accounts for less than 10 percent of all employees and since pro-employee labor laws only apply to them, consequently, the firms hire more and more irregular employees such as contractual and temporary employees. Furthermore the rapid decline of employment in the public sector since 1991, which used to represent three-fourths of the organized sector, could also be another factor that contributed to the growth without employment. During the same period, the private sector employment showed increasing trends in various aspects but it was not enough to compensate for the employment decline of public sector.

The power of employees and labor unions of India seem to move as the employment rate changes. At times of increasing employment, the number of labor unions, labor disputes and dispute participants increase and at time of decreasing employment, the number appears to decrease. Since the 1991 economic reform, the status of labor and labor union displayed a weakening trend. Especially the BJP government, with its pro-business character, ceased to create new employment in the public sector and began restructuring by voluntary retirement so employment fell and thus the influence of labor unions and laborers declined. In the 2000s, as a consequence of the increase in employment led by the private sector, the number of unions and laborers rapidly increased but the number of labor disputes decreased, leading to stable shape of industrial relations.

Weakening of labor unions could be the result of the special circumstances of India. Labor unions in India had been first organized primarily for political purposes. In the major union's case, it is affiliated with political parties especially if it is at the state level, it is nearly impossible for labor unions to form coalitions and led to segmentation of labor unions. This implies that first, the mutual solidarity among labor unions is weak and second, the weak labor unions are unable to support the increasing number of union members. Moreover the Indian government has weakened the power of labor unions by implementing pro-business policies and institutions. For example, the labor union law that was revised in 2001 had made it difficult to register a new labor union.

Strong response from firms was another contribution to the weakening of labor unions. The number of strikes by laborers has started to diminish recently but the number of lockouts is not decreasing accordingly. We could add to this the situation where strikes declined rapidly after the reform in the 1990s and that labor unions have a fear of employers imposing lockouts. Firms also have implemented a variety of institutions namely voluntary retirement, incentive systems, contractual employees and outsourcing.

New policies and institutions were implemented in many sectors after the economic reform in 1991, but there were still no significant changes in the labor market system. As for revision of policies and relevant law, labor happens tho be the sector where the least progress has been made. The main reason was that while the status of laborers and labor unions continued to weaken, it remained difficult for politicians to establish policies that displease laborers, who are also voters.

The Indian government has been trying to implement pro-business policies and institutions since the 1991 economic reform by such means as increasing labor market flexibility and improving the transparency of labor unions. All of these have not been fulfilled so far and as a matter of fact, revision of relevant laws was not made.

Korean firms operating in India have experienced amicable labor relations. Most Korean firms are operated without labor unions. Nevertheless, there certainly exist potential factors that can provoke labor disputes. Disputes may soon arise from demand for wage increases and large proportion of irregular employees. High rate of employee turnover is also pointed as one of the biggest troubles.

Chapter 5 approaches the economic reform from the perspective of trade liberalization and deregulation. This chapter provides extensive literature reviews on the influence of economic reform in the Indian labor market. Next, this chapter performed empirical analysis on aggregate matching function, a widely used macro-labor tool in economics, focusing particularly on the relationship between trade liberalization and new hires.

This study performed an empirical analysis of the impact that India’s trade liberalization on the process of job matching (the relationship between job search and new hires). The results of this research do not differ from the results of the past research (e.g., Hasan et al. 2012). In other words, we may infer that the impact of trade liberalization can vary by region, industry and type of profession since the relationship between trade liberalization and new hires appears negative with no statistical significance when the whole country is considered. On the other hand, from the analysis by period, it is shown that new job creation tended to decline when trade liberalization was slowed due to the industries’ demand. This implies the high probability that the gradual opening to protect domestic firms will actually lead to a decrease in new job creation and thus increase in unemployment.
Chapter 6 provides implications through previous chapters, labor market conditions, labor-related institutions, industrial relations, and empirical analysis of this research.

The institutions of labor market in India have not experienced much change since the economic reform of 1991. The main reason is that state governments possess strong authority regarding labor law-related matters. The pro-worker labor laws are limited only to regular employees and revisions of labor laws for enhancing market flexibility has been delayed or has not proceeded due to political reasons. This type of rigidity in the organized sector has produced a large number of irregular employees and has resulted in economic growth without increase in employment in India during the booming 2000s.

The pro-worker character of labor institutions only apply to regular employees, which firms attempt to balance by hiring irregular employees as contractual and temporary employees. Therefore it is a task of the Indian government to secure the flexibility of regular labor.

From a broader perspective, however, India’s growth without growth of employment is largely attributed to the declining employment in the public sector since the economic reforms began. Besides, the trend of increasing employment in the private sector is very clear, therefore the interpretation of India’s growth without growth of employment should not be exaggerated. The job-mismatch for highly educated workers of India could apply to the current situation of Korea as well. Thus, both governments should prepare systematic and long-term solutions to balance the workers with high-degree education.

The status of labor unions in India became progressively weaker since the 1991 economic reform. The fundamental structure of society takes away from the power of labor unions, since Indian labor unions carry strong political colors and are unable to ally with each other due to their affiliations with political parties, especially labor unions at national level. In addition, since the beginning of the 21st century, Indian government has helped the employers’ side by implementing the systems that make registration of new labor unions difficult. Moreover, because most of the Korean firms in India are operating without labor unions, we may predict that fortunately, Indian labor unions will not become a barrier to the entry of Korean firms to the Indian market.

However, there clearly remain factors with potential to cause labor disputes in India. First, labor disputes may arise during wage negotiations because continued inflation is leading to high demands for wage increase whereas the level of labor productivity stays low. Second, Korean firms in India have a large proportion of irregular employees and this may provoke labor disputes regarding hiring and firing of irregular employees. Third, problems could arise because the process of forcing retirement in the case of regular employees might become tumultuous. Fourth, the turnover rate of regular employees in India is very high thus trouble may occur from the lack of skilled employment. Fifth, in contrast with the continued weakening of labor unions’ status in India, labor disputes, especially in foreign firms about particular issues, are associated with a high level of violence. Korean firms in India should also be aware that there might be other factors in addition to the ones above, hence full attention should be made to establish amicable industrial/labor relations.

The gap between wage increase and labor productivity is also an important factor in the investment climate for Korean firms in India. They should pay more attention to this problem and formulate an adequate solution. To do so, Korean firms are required to either establish or facilitate the educational programs within the firm and prepare long-term solutions by cooperating among themselves and with the Korean Chamber of Commerce in India.

In particular, one of the most troublesome features of India’s changing investment environment is labor management. Therefore, the Korean government should provide assistance through supporting policies. A possible plan of support by the Korean government could be the establishment of a system for sharing of databases among Korean firms in the local market. Additionally it can also strengthen the role of KOTRA’s local branch or the Korean Chamber of Commerce in India to expand its support to include labor relations as well as labor management.

India’s economic reform, which began in earnest during the early 1990s, has transformed the labor market into one that aims to improve workers' living standards. This is well reflected in the previous literature, especially after the 2000s. According to earlier studies, the economic reform, which triggered trade liberalization in India, achieved decreases in poverty and wage increases. With respect to unemployment, victims and beneficiaries may coexist by different type of profession or industry but overall, economic reforms had little effect on unemployment in India. In sum, trade liberalization may contribute to the living standards of workers because it has only a limited impact on unemployment while lowering poverty as well as increasing wages.

According to the empirical results by the matching function analysis with the use of monthly data from 1988 to 2012, the relationship between trade liberalization and new employment appears negative with no statistical significance, a conclusion similar to previous works about the effect of trade liberalization on unemployment. However, when the period of 1998 to 2002, marked by limited trade liberalization from the demands of India’s domestic firms, is applied, new job creation rather diminished in response to trade liberalization. This implies that gradual opening of markets to protect domestic firms can cause a shrinkage in new hires and thus an increase in unemployment. The result suggests much regarding conditions of continuing globalization.

Since the impact of liberalization on unemployment is limited in India, expansion of trade works positively to ameliorate the labor market environment. Therefore, the Indian government should constantly carry forward the promotion of trade liberalization. Regarding this, Korea and India are required to cooperate actively in connection with the negotiation for the CEPA upgrade and accelerate the mutual opening for trade expansion together.

The Changes in China’s Bond and Foreign Exchange Market and Their Effects on Korea.

Ik Joon Moon et al.

Shanghai Pilot Free Trade Zone, announced in October 2013, has attracted attention from around the world. This is because the world has noticed the potential for growth in China’s financial industry, which has yet to attain maturity commensurate with its sheer scale, despite the fact that China has the largest manufacturing industry in the world. This study focuses on analyzing the changes in China’s bond and foreign exchange market and their effects on South Korea.

This paper consists of five chapters. Following the introduction, chapter 2 outlines the Chinese government’s bonds policy, status of the bond market, direction of future development and et cetera. Although the Chinese bond market has expanded rapidly, when we consider the scale of the Chinese economy, it can be said that the market has not fully opened up to overseas firms and that its development has been slow. By looking at cases from Japan, Germany, and Australia, we can expect that China will develop its bond market by promoting the offshore bond market, opening the internal bond market and issuing increased amount of corporate bonds. Initially, it is expected that China will try to increase the amount of non-resident bonds issued and promote the offshore RMB bond market. Also, in an effort to change the mode of economic growth, China is expected to increase the issuance of corporate bonds for private SMEs, which struggled with their financing under the existing system.

The third chapter examines the changes, status and outlook of the Chinese exchange rates system. The Chinese exchange rate system has been transformed alongside China’s reform and opening-up process and the transformation is still ongoing. By implementing the unified managed floating system from January 1994, China has been operating both the fixed exchange rate and managed floating systems that fix or adjust exchange rate bands according to the economy’s status and speed of development process. The process of capital account liberalization in China is expected to be gradual, since the Chinese government is being cautious about the side effects of the open capital market and because of the low development level of the Chinese financial market. Exchange rates system reform is also expected to be gradual alongside the capital account opening and interest rate liberalization.

Chapter 4 conducts an empirical analysis on the effects of the fluctuation of Chinese bond interest rates on South Korea’s bond interest rates, and on factors determining the won-RMB exchange rates. Firstly, the results show that the Chinese bond yield fluctuation does not have a direct impact on South Korea’s bond yield. However, there were statistically significant indirect effects through channels of synchronization of business cycle, prices and policies. Therefore, if China were to open up its financial market through the interest rate liberalization, the effects on the Korean bond market are likely to become larger, through various channels including the aforementioned synchronization of business cycle, prices and policies. Secondly, according to the analysis on factors determining the KRW-RMB exchange rates, the fluctuation of exchange rates between South Korea and China are affected by the difference between the two countries’ bond yield and the difference between the two countries’ benchmark rates. However, when won-dollar exchange rates are added, only the difference between the two countries’ benchmark rates affected KRW-RMB exchange rates. Ultimately, this study concludes that changes in won-dollar exchange rates system have statistically significant effect on won-RMB exchange rates.

Changes in the bond and foreign exchange markets that were examined in this paper reflect certain implications and possible countermeasures for South Korea. First, as the Chinese government is expected to promote the offshore bond market and, although gradually, open up the internal bond market, South Korea needs to take advantage of this opportunity. Korea should participate in both the offshore and internal RMB bond market, for example, and Korea can use RMB in financing through offshore RMB bond issue or reinvest RMB obtained from trade in offshore RMB bonds. Also, Korea needs to expand its investment in Chinese bonds, which are relatively profitable and stable, for diversification of its investment in foreign exchange reserves.

Second, Korea needs to seek policies that can utilize and gradually change Chinese investors’ investment in Korea, which are expected to increase, to stable, long-term investment. So far, majority of the investment have been led by the government, however, meaning the QDII investment overseas are expected to increase in the future. Thus, South Korea should seek ways to attract these investments and utilize them in the long-term.

Third, it is expected that the changes in China’s exchange rates system will be carried out cautiously and simultaneously with RMB internalization and interest rate liberalization. Accordingly, Korea should, in the long term, form and expand a market for direct trading of KRW and RMB. The market for direct trading of KRW and RMB will reduce the impact of won-dollar rates fluctuation and instead strengthen the role of trade and financial transactions between South Korea and China in determining won-RMB exchange rates. In addition, the Korean government should consider establishing an offshore RMB centre.

International Support for Climate Change Capacity Development and Policy Implications for Korea


Jione Jung and Jihei Song

From Paris Declaration to Busan Partnership, High Level discussions on aid effectiveness have emphasized the need to improve developing countries’ capacity. It was mentioned that self-reliant capacity of developing countries is a key condition for sustained growth, and that donor countries’ active support is essential in fostering such capacity.

Meanwhile, at the 16th session of the Conference of the Parties to the United Nations Framework Convention on Climate Change, the parties reached an agreement on two significant issues. Firstly, the parties agreed to scale up climate finance to 100 billion dollars annually by year 2020. In addition, the parties agreed to establish the Green Climate Fund, a specialized international fund on climate change mitigation and adaptation. Six countries, including Korea offered to host the secretariat. At the second meeting in November 2012, the GCF Board members decided that the secretariat would be hosted by Korea. The Conference of the Parties session, held the following month, acknowledged the Board’s decision. Thus, Korea officially became the host country of the Green Climate Fund Secretariat.

In order to expedite action against the adverse impacts of climate change and shift to a low-carbon development paradigm, the GCF will concentrate on building developing countries’ capacity against climate change in the initial stages of its operation. Korea has pledged to provide 40 million dollars to assist climate-related capacity building in developing countries. As a consequence, establishing climate capacity programs to foster country ownership and also to link the programs with the GCF’s own capacity support has now become an urgent task. The program must also be innovative and effective in order to differentiate itself from existing programs. This study seeks to examine the international consensus related to capacity in developing countries. By reviewing previous and current activities on climate capacity promoted by international organizations and donor countries, the paper seeks to serve as a fundamental reference for Korea’s support on climate capacity.

The study is structured in the following order. As mentioned above, international discussions and consensus on capacity and capacity development are outlined in Chapter Two. To clarify an abstract term like “capacity,” the study borrows definitions from the OECD Development Assistance Committee. In the second part of the chapter, a review is provided on the negotiations and decisions made under the UNFCCC on capacity building. Chapters Three and Four describe some notable climate capacity support activities pursued by the World Bank, UNDP, and three donor countries: Germany, Denmark, and Sweden. The World Bank with abundant experience in large-scale projects, recognizes the importance of the recipients’ capacity in order to maintain aid effectiveness. The UNDP, likewise, has sufficient experience in implementing capacity projects. Meanwhile, Germany has been long involved in technical assistance and it is now actively expanding the scope of activities to include various interrelated topics. On the other hand, although not substantial in size, Denmark and Sweden also provide sizable assistance and display extensive interest in capacity development on environment and climate change.

To conclude, Chapter Five seeks to provide suggestions for Korea in order to support climate capacity. First of all, stakeholders’ understanding in capacity and capacity development is a priority. Through its own experience, Korea genuinely recognizes the necessity of capacity and possesses the willpower to pursue capacity development. Building on its understanding and experience, Korea will be able to match suitable activities with countries in need. In addition, principle and process regarding capacity development need to be established. Korea International Cooperation Agency (KOICA) and the Ministry of Environment could consider cooperation in developing a framework for climate capacity development at the national level.

The next task is to develop distinctive and innovative ideas on climate capacity. For instance, Korea could consider launching an online platform on green growth policy, strategy, legal framework, and technology in close collaboration with the Global Green Growth Institute. Such platform could serve as a medium to match developing countries’ needs with donors’ expertise. Furthermore, integrating capacity development into general international development activities can produce positive added impact. As an example, Denmark promotes capacity development as an element in each stage of their program. Likewise, Korea could include capacity development in its overall climate change projects.

Finally, internal or domestic capacity on the topic of climate change in Korea must be developed sufficiently. Activities in that regard include, needs assessment, program structuring, as well as monitoring and evaluation. In the internal capacity improvement process, private experts should also be included along with public implementing agency stakeholders. Especially since climate change covers a wide range of topics, a large pool of capacity specialists from private and public sectors alike can create a positive impact and is highly desirable.

Prospects of China’s Political and Economic Changes and the Path Forward for Inter-Korean Economic Cooperation

Dongho Jo and Young-sook Nam

The main objectives of this study are to review the prospects for China’s political and economic changes and challenges under the new leadership and to propose directions for inter-Korean economic cooperation.

China has emerged as North Korea’s largest economic partner through increasingly active economic engagement in the context of shrinking inter-Korean economic relations. As North Korea’s economic dependence on China has surged over the years, China is expected to play an ever-increasing role in shaping the outlook for the North Korean economy and the Sino-North Korean economic relationship.

Chapter II of the study reviews the status and characteristics of Sino-North Korean economic cooperation and inter-Korean economic cooperation. It shows that the Sino-North Korean economic relationship has accelerated since 2009 and has expanded to include the joint development of border areas, which reflects China’s national economic interests in advancing the economic status of Northeastern provinces as well as in playing a leading role in the Northeast Asian region.

Chapter III then analyzes the prospects for China’s political and economic changes and challenges under the new leadership. China’s new leadership faces many domestic and international challenges in achieving the “Chinese Dream” put forth by President Xi. The new leadership has also been pressing hard for a U.S. commitment to a “new model of major country relationship.” Reflecting China’s new role as an emerging major power, China is expected to emphasize normal state-to-state relations with North Korea.

North Korea’s new leader, Kim Jong-un, announced the “Dual Policy for Nuclear and Economic Development (known as the “Byungjin Line”)” in March 2013. Chapter IV discusses the meaning of the “Byungjin Line” and implications for North Korea’s economic policy. It also provides an overview of the status of the North Korean economy and analyzes the direction and limitations of its economic policy.

Based on the analyses of previous chapters, Chapter V proposes a path forward for inter-Korean economic cooperation in view of the current government strategy for a “trust-building process on the Korean peninsula.” The policy implications emerging from this chapter include the following: first, the major task of trust-building process on the Korean peninsula is to induce North Korea’s transition from Byungjin 1.0 to Byungjin 2.0. While Byungin 1.0 is a dual policy for nuclear and economic development, Byungjin 2.0 represents a dual policy for non-nuclear and economic development; second, our thinking for inter-Korean economic cooperation needs to be reshaped so that we can utilize it to serve as a growth engine for our economy; third, we need to be proactive in promoting inter-Korean economic cooperation and taking advantage of North Korea’s keen interest in improving its economy; and lastly, fruitful paths might include pursuing projects in line with North Korea’s economic policies, developing multinational projects involving China, and utilizing the “package” method by linking inter-related projects to maximize synergy effects.

The Effect of Opening ICT industry and Cooperation by the KoreaㆍIndia CEPA

Hankyoung Sung, Sang-Joon Lee, Soon Cheul Lee, and Sung-Gul Hong

This study aims to identify development plans and to explore their application in the ICT industry related to utilization of the Korea-India CEPA. The Indian economy was under the danger of financial crisis during the recession but still has maintained its position as a major emerging market. After Korea-India CEPA entered into force in January 2010, trade between the two countries rapidly increased. However, bilateral trade has declined due to the recent global economic crisis. In addition, while Indian investment to Korea is being expanded, Korean investment to India among small and medium enterprises has been shrinking.

In terms of competitiveness, Korea has comparative strengths in the ICT manufacturing sectors, and also in banking and finance. Since the Ministry of Science, ICT and Future Planning was established, Korea views the ICT as a pivotal sectors in its quest for a creative economy. India’s policy goal on ICT involves making India a global hub and destinations for IT-ITeS. There are obstacles in this regard as Korea suffers from the shortage of ICT expertises and India is weighed down by potential IPR issues. The Korea-India CEPA could strengthen the complementary cooperation in ICT between Korea and India. According to the dynamic CGE model analysis, both economies would have benefit if the Korea-India CEPA succeeds in increasing the productivity of ICT manufacturing and ICT service sectors in both economies.

Korea has increased cooperation in ICT with the US., the EU, as well a inemerging markets through its FTAs. The expansion of the CEPA concession, enhancement of the CEPA utililization rate and the movement of ICT expertise would be implemented by regular job fairs, which not only provide information on Indian IT-related firms, universities and the market but also provide ‘practice’ projects on ICT for small and medium enterprises. In addition, it is necessary to figure out problems on a fundamental level regarding mismatches of HS codes and certification of the origin. Lastly, we should pursue long-term performance to bolster relations between the two countries by adopting a careful and gradual approach.

Production Networks and Economic Cooperation in the Asia Pacific Region

Chul Chung et al.

The new landscape of international trade negotiations in the Asia-Pacific can be summarized by the emergence of plurilateral regional trade agreements (RTAs), such as the Trans-Pacific Partnership (TPP) and the Regional Comprehensive Economic Partnership (RCEP). These two ongoing regional economic integration (REI) initiatives have shifted the focus of trade negotiations from bilateral free trade agreements (FTAs) to plurilateral RTAs in the region. Recent progress in these initiatives together with growing regionalism has drawn more attention to global production networks and regional supply chains.

This study examines whether and how production networks affect the regional economic integration of the Asia-Pacific region. By investigating the relationship and pattern of production networks and REI initiatives both theoretically and empirically, this study aims to provide policy implications for APEC and Korea's approach to the ongoing REI initiatives. Further, a desirable REI model is suggested in the study by conducting policy simulations based on scenarios of expansion of production networks in the region.

Global outsourcing and production sharing activities are most prominent in East Asia and the Asia-Pacific region. Economies in the Asia-Pacific are more deeply interconnected through trade than those in any other region. Statistics show that the share of intra-regional trade in parts and components for APEC increased from 68 percent in 1989 to 72 percent in 2012, while that for the EU decreased from 66 percent to 60 percent. In the case of NAFTA, the intra-regional trade share in parts and components stayed mostly the same at around 43 percent during the period.

The empirical results show that the stronger the existing production network between a pair of economies, the greater the probability of entering free trade agreements into effect between those economies. Furthermore, the correlation between production networks and regional economic integration measured by RTAs and FTAs among members is the highest in the APEC region. Thus, the empirical results imply that production networks are one of the most important determinants of regional economic integration and APEC is one of the most active region in that regard. On the other hand, results from the policy simulation analysis using the probit model and gravity equation suggest that the simplicity of the rules of origin (ROOs) and the efficiency of trade facilitation are the two most critical factors in improving the welfare of REI.

Based on the results of the empirical and policy simulation analysis, this study suggests the following policy implications for APEC in the context of expanding regional production networks and deepening economic integration in the region.

First, specific action plans and persistent efforts to attain Bogor Goals and trade and investment liberalization, including EGS (environmental goods and services) and ITA (Information Technology Agreement), should be made for the expansion of regional production networks. To this end, it is crucial for APEC to provide an environment within the region in which the formation of production networks can be achieved through properly functioning markets. As this study showed, production networks, which reduce production costs through production fragmentation, play an important role in regional economic integration. That is, the transition mechanism operates through the market and hence the focus of trade and investment liberalization should be on policies aimed at keeping markets free and properly functioning. Meanwhile, one of the specific action plans of this sort involves establishing measures to effectively implement the agreed liberalization of EGS in APEC. Special attention should also be paid to policy measures to create jobs and promote the competitiveness of small and medium enterprises (SMEs).

Second, APEC needs to set the priority on enhancing the competitiveness by promoting "open regionalism" from the early stage of REI. In order for APEC to effectively establish a regional production network under open regionalism, institutional cooperation is an integral part of reducing and eliminating tariffs and non-trade barriers, facilitating finance and services trade, increasing mobility of human capital and persons, establishing infrastructure for trade and investment facilitation, and consolidating regulations among member economies. In addition, it is necessary to establish concrete policy measures and institutional instruments that can put the concept of open regionalism into practice.

Third, the rules of origin should be simplified, as the policy simulation analysis of this study suggested, so that member economies can reduce the cost of building regional production networks and raise the utilization rate of existing FTAs/RTAs in the region. As a way of simplifying ROOs, APEC may adopt complementary instruments such as de minimis, diagonal cumulation, and self-certification so as to minimize costs and losses stemming from the complexity of ROOs, which will eventually contribute to enhancing productivity. In the case of diagonal cumulation, this study recommends APEC to introduce a Pan-Asia-Pacific Cumulation System (PAPCS).

Fourth, APEC-wide efforts to raise the effectiveness of trade facilitation should be made on a continuous basis. Increased effectiveness of trade facilitation is the key to bringing about a more pragmatic use of the regional supply chain in practice. To this end, APEC member economies need to work together painstakingly to lower potential costs associated with building the production network in the region. It is recommended for APEC to prioritize certain areas such as integration of cross-economy standards, bolstering electronic commerce, enhancing transparency of information and customs procedures, and alignment of domestic rules and regulations. In so doing, it will improve the supply chain connectivity among APEC economies along with regional economic integration.

Lastly, Korea can play a pivotal role as a middle power and founding member of APEC; expanding the production network in the region by actively engaging other member economies to find a way to facilitate ongoing regional trade negotiation initiatives towards the free trade area of the Asia Pacific (FTAAP); thus providing ways to enhance transparency. For instance, Korea has successfully led the capacity building needs initiative (CBNI) as a way forward on REI towards FTAAP in APEC for three years starting in 2012. Korea can contribute to expanding the APEC-wide production network and REI in the region by extending and upgrading the CBNI program to make it more comprehensive and promote intensive discussion for specific action plans.

Economic Impact of the Bali Packages of the Doha Round


Jin Kyo Suh et al.

The 9th WTO Ministerial Conference in Bali reached agreement in December 2013 on a package of measures that form a small component of the much wider Doha Development Round agenda. The study seeks to review the outcomes of the Conference in terms of their possible impact on the world economy, including Korean economy.

On the issue of trade facilitation, an extensive Ministerial decision was agreed in Bali committing member states to publication of a range of information relevant to import duties and procedures, including where possible through the internet; establishing inquiry points; advanced notification of new measures; timely and priority treatment of perishable goods; defined appeals and review procedures; freedom of transil; border agency and customs cooperation.

Under the S&D provisions, a commitment was made to providing assistance on a “best endeavor” basis, in line with the needs of developing and least developed country(LDC) WTO members. The timing of the implementation of the provisions of the trade facilitation agreement is also related to the implementation capacities of developing and LDC members. Implementation will not take place until the required capacity is in place. Nevertheless, LDCs will required to make commitments in line with their capacities.

At the Bali Ministerial meeting, agreement was reached on a range of simplification measures related to the administration of tariff-rate quotas (TRQs). Agreement was also reached on bringing TRQs under the Uruguay Round Agreement on Importing Licensing Procedures, with some specific modifications. Where cases of unjustified TRQ under fill are identified, the administrative authorities are required to establish transparent mechanisms for the reallocation of quotas to operators who can effectively utilize the quota, within a framework laid down in the agreement.

On export competition, the Bali agreement took the form of a Ministerial declaration rather than a decision. This declaration reiterated the recognition of the highly trade distorting and protectionist nature of various forms of export support and the importance of addressing this issues within the overall agricultural negotiations. However, regret was expressed that no agreement had been reached on how to eliminate export subsidies and equivalent measures in the run-up to the 2013 Ministerial Conference.

On the issue of duty-free, quota free access for LDCs, the Ministerial decision agreed in Bali commits “ developed country members that do not yet provide duty-free and quota-free market access for at least 975 of products originating from LDCs” to seek to improve their existing duty-free and quota-free coverage for such products, so as to provide increasingly greater market access to LDCs, prior to the next Ministerial Conference.

The Bali Ministerial decision commits WTO members to endeavor to develop or build on their individual rules of origin arrangements applicable to imports from LDCs in accordance with guidelines set out in the decision. These guidelines requires simplicity, objectivity and transparency in establishing the rules of origin applicable to LDCs.

Using computable general equilibrium model of the world economy (GTAP), we simulate the economic impacts of the 2013 Bali agreements.

The most important finding at the aggregate, global level is that Bali agreements will produce modest gains, in the world real GDP of $1,550 to $2,320 billion. Both developing and developed countries would be major beneficiaries of an agreement on trade facilitation. Global benefits are almost equally distributed to both economies. However, other agreements such agricultural TRQs, even duty-free and quota-free for LDCs has a little effect on the increase in world GDP. Trade facilitation can thus be described as critical in allowing both developing and developed countries to improve their economy, and thus we can recognize trade facilitation as a balanced interest of WTO members.

In conclusion contrary to a popular perception the Bali Ministerial Conference made progress on the Doha round of trade negotiations, adopting decisions on the ten texts regarding the three pillars of the Bali package: trade facilitation, some agricultural issues, and selected development-focused provisions including LDC issues.

Now more than 80 percent of the work of the Doha round is complete and for the rest, the WTO members will have to take a political call keeping in mind their developmental needs and overall balance of negotiations. This shows that members still have faith in the system. The key to unlocking the Doha impasse lies in pragmatically focusing on attainable outcomes, first in bali and then preferably before embarking into the post-2015 world of achieving larger development gains.

In these process, Korea needs to participate actively in the negotiations, particularly with a possible compromise on essential issues such as agriculture and NAMA.

Analysis on the Service and Investment Chapters of Korea’s FTAs: A Comparative Analysis of the Korea-US FTA vs. the Korea-EU FTA

Jong Duk Kim and Jun Hyun Eom


Since the late 2000s, Korea has actively engaged in FTA negotiations. As a result, Korea had already ratified nine FTAs, including the Korea-US FTA (the KORUS FTA) and the Korea-EU FTA. Nowadays, FTA negotiations have broadened their scope to include issues other than trade in goods such as service and investment. In addition, there is a distinct shift toward the so-called Mega-FTAs such as TPP, TTIP, and RCEP.

This study examines service and investment chapters of the Korea-US FTA and the Korea-EU FTA. Taking GATS as a starting point, the authors first compared the legal texts between GATS and the Korea-US FTA and between GATS and the Korea-EU FTA. Then, they proceeded to find explanations for the identified differences.

Regarding comparison of the Korea-US FTA and the Korea-EU FTA, there are two systematic differences: the existence of the investment chapter and the negative or positive list approach in liberalizing services and investment. First, only the Korea-US FTA has a separate chapter on investment. It is because the European Commission has not been empowered to negotiate on investment issues before the Korea-EU FTA negotiation was concluded. Second, the Korea-US FTA takes the negative list approach while the Korea-EU FTA takes the positive list approach.

When it comes to the detailed provisions of the service and investment chapters, the authors have found nine points as follows. First, the National Treatment (NT) provision of the Korea-US FTA contains a unique regulation on the “regional level of government,” taking into consideration the U.S. position. Second, the Most-Favored Nation (MFN) provision of the Korea-EU FTA stipulates a unique regulation on “the regional economic integration agreement,” taking into consideration the EU's position. Third, Market Access provisions of the two FTAs are similar. Fourth, the “Local Presence” (LP) provision of the Korea-US FTA is superior to that of the Korea-EU FTA in terms of coherence and cohesion. The Korea-EU FTA stipulates the LP provision, which is a qualitative restriction, as a form of footnote under other quantitative restrictions. Fifth, the “Senior Management and Boards of Directors” (SMBD) provision of the Korea-US FTA is also superior to the Korea-EU FTA in terms of coherence and cohesion. The Korea-EU FTA stipulates the SMBD provisions as a form of footnote under two different articles. Sixth, the “Domestic Regulations” (DR) provision of the Korea-EU FTA is similar to that of GATS. But the DR provision of the Korea-US FTA turns out to be much improved compared even to that of NAFTA in terms of clarity and logic. Other three points, which are the “performance requirement” (PR), “subrogation”, and the “investor-state dispute settlement” (ISDS) are found only in the Korea-US FTA.

With these findings, the authors offer some suggestions. First, the Korean government has to pay close attention to negative or positive list approach in service liberalizing talks in the so-called Mega-FTAs, such as TPP and TTIP. Second, the Korean government should be active in stipulating certain provisions including “performance requirement” (PR), “subrogation”, and the “investor-state dispute settlement” (ISDS) in future FTA negotiations. Third, the Korean government should pay special attention to the “regional level of government” issue when negotiating with China.

A Study on Japanese Fiscal Sustainability and Fiscal Discipline

Gyu Pan Kim et al.

This report analyzes Japanese government’s fiscal discipline mechanism, focusing on the fiscal sustainability of Japan which has re-ignited controversy after the Great East Japan Earthquake in 2011. The research scope covers the fiscal sustainability of central and local governments of Japan as well as that of social security funds. The main purpose of this report is to clarify how the fiscal discipline mechanism has failed in Japan, and to draw policy implications for Korean government’s fiscal management. It is highly probable that the economic and fiscal conditions in Korea will follow in the footsteps of Japan’s case, taking into account its rapid aging speed and onset of low growth rate.

Chapter two reviews fiscal sustainability issues of Japanese central government through key indicators, then introduces the studies dealing with Japanese fiscal sustainability from an economic perspective. We find that fiscal conditions in Japan has not been sustainable since the late 1990s. Nevertheless, Japan is free from fiscal crisis in virtue of its ‘zero-interest rates policy’. At the same time, foreign investors’ lower holding of Japanese government bonds contributes significantly to avoid fiscal crisis in Japan. Second half in chapter two exhibits the importance of tax reform to establish the future fiscal sustainability in Japan. We examine the background of Japanese government putting emphasis on consumption tax reform against individual income or corporate tax yet going through countless political impasses.

Chapter three shows that Japan’s cumulative government debt has derived from the relaxation of fiscal discipline in the government’s budget operation and the relationship between politics and bureaucrats. The relaxation of fiscal discipline in Japan has three major points. First, frequent issue of government bonds does not comply with the Golden Rule in Article four of the Public Finance Act. Second, a large part of various economic measures is organized in supplementary budget, which is free from the budgetary ceiling guidelines set by the Ministry of Finance Japan. Third, this budgetary ceiling guidelines also contributed to encourage budget planning with political considerations since 1990s, especially in public investment. It is apparent that the power game between politicians and bureaucrats limits the budget examination authority of the Ministry of Finance. Second half in chapter three analyzes three examples of how Japanese government intended to promote the establishment of fiscal discipline in the past; Hashimoto cabinet adopting Fiscal Structural Reform Law in 1997, Koizumi cabinet proposing Intergrate Expenditure and Revenue Reform in the early 2000s, and National Fiscal Management Strategies of the ruling Democratic Party of Japan(DPJ) in 2010. We point out the limits of expenditure cut priority and the lack of national consensus on the reform.

Chapter four covers fiscal sustainability and fiscal discipline issues of Japanese local governments. First, we examine the fiscal capacity of local governments through expenditure and revenue indicators. We confirm the main two factors threatening the local fiscal sustainability in Japan are the lack of resources on revenue side and the increase in social security spending on expenditure side. Then, we confirm that the Japanese government has put efforts on the reform of local revenue-sharing system and local tax system to promote the local fiscal sustainability. The reform of local revenue-sharing system is focused on reduction of reliance on temporary local bonds, adjustment of local subsidy through identifying local fiscal demand, pursuing decentralization of local power through the adoption of horizontal fiscal transfer system, and reinforcing accountability of local government’s fiscal management. On the other hand, the reform related to local tax system corrects the distribution of national and local revenue sources. Second half in chapter four examines whether local fiscal consolidation is valid for strengthening fiscal discipline, which was introduced in the wake of Yubari city’s fiscal crisis in 2007. We conclude that the recent improvement in financial indicators suggests positive correlation between the two factors. Finally, we review the local fiscal reform which Abe administration is pursuing and the new system change to mitigate regional tax revenue disparities.

Chapter five describes financial and structural problems threatening the sustainability of Japanese social security system. we find that it is necessary to eliminate disparities inter- and intra-generation in addition to the consumption tax increase and pay cut reform, so that the social security system function properly as a safety net. Next, we analyze the historical evolution of the Japanese social security system and arrive at the following three conclusions. First, the social security system has not been subject to the increase in premium, which resulted in increased fiscal burden. Second, the various reform measures took place until 1985 caused the increase in the fiscal burden and the imbalance between the existing public pension system. Third, the pension reform measures, so called the macroeconomic slide system introduced in 2004, does not function well in deflation, while the announcement of the consumption tax hike in 2012 is insufficient to secure fiscal sustainability in the low birth and aging era. Second half in chapter five identifies the effects and limitations of reform measures that the Japanese government has introduced in order to ensure sustainability of the social security system. Specifically, the public pension and medical insurance system, referred to as the two major axes of the social security system, are reviewed to identify the problems in fiscal management. Although the public pension system repeatedly implemented such measures as increasing insurance premium, cutting coverage, and raising the age of entitlement, it has failed in proactive response to the changes in the aging society. Also, in the public medical insurance system, fine-tuning approaches such as adjustment of finances between the insureds, and measures to reform senior medical insurance system can not guarantee the sustainability of the system.

The Russo-Sino-North Korea Triangle: The American Factor and Policy Implications for Korea

Jung Chul Lee, Jun-Kee Baek, Jae-Kwan Kim, and Nam-Ju Lee

The purpose of this work is to provide the Park Geun-hye administration with policy implications in response to the current diplomatic situation in the East Asia region: a rising China, the US “Pivot to Asia”, Japan’s reversion to conservatism under the Abe administration, and North Korea’s revisionist behavior. To this end, this research paper seeks to highlight the Russo-Sino-North Korean triangle that is the historical legacy of the region and how it affects the current state of affairs, through certain elements of path dependency and eliciting features of and prospects for a newly established trilateral relationship. We are entering the age in which the Northern trilateral relations are indispensible to the peaceful unification of the North and South Korea and the diplomacy of coexistence through trust, upon which Park’s administration places special emphasis.

The Russo-Sino-North Korea triangle which was established in the 2000’s has become less institutionalised and the interaction among three parties involved has also been declining in terms of frequency and intensity compared to the trilateral regime established in the 1950’s. The Russo-Sino-North Korea triangle once characterized as a military alliance has been considerably weakened by the elimination of the automatic-military intervention clause from the treaty involving those three nations; and the close association between the parties and governments regarding domestic and international affairs is no longer in place. Nevertheless, China-Russia and Russia-North Korea concluded treaties of friendship in the 2000’s which included a specific clause stipulating that the parties work closely with each other in case the other party is faced with immediate threat, and the Sino-North Korea treaty of friendship effectively maintained the clause for automatic military intervention. In other words, although there is no explicit treaty including all three nations, there is a probable mechanism among three parties which allows tripartite consultation or common action in case of a crisis arising in one party. In fact, it is an undeniable reality that the Russo-Sino-North Korean triangle has strategic significance in North East Asian geopolitics in light of the fact that they have been cooperating, albeit loosely, to deal with key issues such as the North Korean nuclear issue.

In this regard, the structure of the Russo-Sino-North Korean triangle identified by this research is as follows. Firstly, the triangle is not a systematisation or institutionalisation of the tripartite consultation but it comprises the total sum of the bilateral relations. There is, however, a dynamism as this triangular character is in operation with respect throughout the bilateral relations between the three countries, which can be seen in the interactions between Sino-North Korea and Russo-North Korea in particular. Nonetheless, the state of the Russo-Sino relationship also exerts a strong influence on the position of North Korea within the triangle. Secondly, each bilateral relationship has its own separate status within the triangle and it is the different interactions among those bilateral relations that create its dynamism. The Sino-Russian relations can be said to be the stabiliser of the triangle. Sino-Russian relationship provides a foundation as China is the most important actor within the triangle and Russia also happens to be a global power. Without the stabilizing force of the Sino-Russian relationship, the triangle would lose its unique strategic value. In view of the fact that China and Russia are reinforcing their strategic alliance, it seems that a Sino-Russian relationship is likely to serve as an impetus for the development of the triangle in the future as well.

The Sino-North Korea relationship takes the position of a conduit within the triangle. The Sino-North Korea relationship brings more strategic value to the triangle and shows greater variation in comparison to Russo-North Korea relations. Since 1992, when North Korea came into serious conflict with China, there have been three phases which led to the restoration of relations eventually, but this actually demonstrates the instability of the relationship. Increased cooperation between China and North Korea would amplify the impetus gained from Sino-Russia relations, and decreased cooperation would cause the opposite result. The Russo-North Korea relations plays a role of a balancer within the triangle. North Korea makes full use of the Russo-North Korea relation in order to achieve balance vis-a-vis the Sino-North Korea relationship while Russia endeavors to make the best use of its relationship with North Korea in order to prevent the triangle in Northeast Asia from being replaced entirely by the Sino-North Korea relationship.

With regard to future prospects for changes in the triangle, a number of possible scenarios can be predicted considering the roles of internal and external variables. The most important internal variable is the value of the triangle, which is complementary to national strategies. Higher level of cooperation within the triangle would lead to more complementarity and vice versa. The research result shows that the level of complementarity within the triangle is still not very high and quite a few factors remain for conflicts and competition in development and economic relations. Therefore, it would be unlikely that the internal impetus of trilateral cooperation will develop into something similar to the trilateral regime in the 1950’s based on ideological identity, given that the trilateral regime in the 1950’s was itself an exception. However, it is worth paying attention to the possibility of increased complementarity within the triangle economically since the economic benefits, not ideology as in the past, can raise the level of cooperation. Such a change is particularly noticeable in the China-Russia relationship. For example, bilateral trade volumes within the triangle is rising rapidly and energy cooperation is being pushed forward vigorously. Regarding Sino-North Korea relations, North Korea’s degree of dependence on trade with China is increasing but is far from complementary. Besides, the level of economic exchange between Russia and North Korea remains very low, which implies the possibility of rapid expansion of cooperation. Especially, the pace with which North Korea opens itself to the world will be the most decisive factor. Nonetheless, it should not be a matter of concern to us that the level of cooperation within the triangle is increasing under such circumstances because the three parties are in need of external capital and technology from South Korea, Japan, and the USA for economic cooperation within the triangle. Russia and China are seeking a policy which is compatible with national interests of South Korea, who has a positive perspective on open-door policy for regional cooperation activities. Therefore, as the triangle pivots around the possibility of North Korea’s opening to the world, other actors are given sufficient ‘space’ for cooperation and, by utilizing this space as a medium, South Korea can raise the level of regional cooperation in Northeast Asia. South Korea’s strategy should be to effect such a change in this direction.’’

Among other external variables, it seems that the US factor will have a huge impact on the triangle. From the standpoint of the dynamic inside the triangle, there is little likelihood of a Russo-Sino-North Korean triangle developing into exclusive cooperation. However, there is a possibility that the triangle might come into a conflict with other powers from outside, contingent on the way in which U.S. factor comes into play. Given the circumstances, this research pays special attention to US “Pivot to Asia” strategy and the reactions of Russia, China, and North Korea to the strategy. Since the USA expressed its intentions on the“Asia shift”, Russia, North Korea, and China have become more wary and, if this trend continues, it might lead to closer security cooperation within the triangle as a result. In particular, the closer cooperation in security among South Korea, the USA, and Japan will be a decisive factor affecting such circumstances. The USA will likely seek ways to avoid such a confrontation that might place a heavy strain strategically as it adjusts rebalancing policy while maintaining separate relationships with China and Russia. However, Russia and China will remain vigilant towards America’s Asian policy because it is clear that the USA’s intention is to make use of the ROK-USA alliance and Japan-USA alliance more effectively.

Given these circumstances, there is a high likelihood of competition between countries of the ‘triangle’ and the USA, and cooperation within the three countries relations will continue to increase unless the North Korean nuclear issue emerges as an obstacle within the triangle. It is necessary that we brace ourselves for such a situation where North Korea’s efforts to enhance its relationship within the triangle expedites exclusive cooperation.

In summary, it is highly likely that increased economic cooperation within the triangle might leave more room for South Korea to engage its constituent countries. On the other hand, it would be a highly undesirable scenario if the US “Pivot to Asia” strategy resulted in increased conflict between the USA and China; and leads to security cooperation within the triangle to counter the South Korea-America-Japan military cooperation. This would reduce the role of South Korea and confirm the exclusivity of tripartite relations as a result.

Based on the analysis above, the following policy responses are necessary if the Russia-North Korea-China relationship is to accord with South Korea’s interests.

1. Economic cooperation
It is recommended that Korea actively utilize economic means in dealing with the Russo-Sino-North Korea triangle, in line with South Korea’s national interests and strategy. The ROK should also take practical measures to take the initiative by making full use of favourable elements that are already present within the Russo-Sino-North Korea triangle; as the three nations are focusing on economic development as their main priorities and they have great interest in the Russia-North Korea-China joint development such as the Greater Tuman Initiative(GTI). To this end, they are looking forward to the participation of other actors who are capable of providing capital and technology, as well as relaxing competition among themselves. Thus it is possible for Korea to take the lead in encouraging cooperation from the nations involved by vigorously exploring elements that could promote cooperation. South Korea should play an active role to facilitate changes as an insider rather than passively responding as an outsider who could easily be ostracized as an outsider in that area. Korea should also be prepared to launch a project which can bring about changes and give impetus to development. Especially, it is vital that South Korea take the initiative in forming “the East Sea rim and the Pan Yellow Sea economic bloc” simultaneously, with the Korean Peninsula taking the centre stage.

2. Security cooperation
Recently, the security environment in Northeast Asia has deteriorated to its worst state since the Cold War. There is the possibility of military conflict between China and Japan, along with advances in North Korean nuclear capability and as well as unstable USA-China relationship since America’s “Asia Shift” strategy. At this point, it is important to note that creating an impetus for cooperation in Northeast Asia is possible only when current conflicts between China and Japan does not lead to actual military clashes. South Korea should vigorously speak out and criticize Japan’s rightward shift and distorted view of history, and strengthen diplomatic ties with Japan and USA in order to prevent Japan from turning further to the right. Under these delicate circumstances, Korea should remain prudent in its diplomatic responses since there is a high probability that strengthening South Korea-Japan military cooperation might exacerbate the rift in the region, thereby pitting the Russo-North Korea-China triangle against the South Korea-USA-Japan triangle. At the same time, we should also demand that China refrain from military posturing.

3. South Korea-North Korea-USA relationship
Given the current circumstances, it is necessary to prevent North Korea’s nuclear program from worsening, to maintain a stable East Asia. Simultaneously, South Korea needs to encourage USA to actively engage in efforts to keep the peace by emphasizing that the US show strategic patience in dealing with North Korea. It is very likely that, if inter-Korean relations continue to grow worse and consequently North Korea reverts to behavior which disrupts the status quo, USA-China relations will grow worse again and America’s diplomacy policy will shift from rebalancing to containment, which will cause conservative swing in the US in favor of acknowledging Japanese claims of its right to military action.

In this regard, managing stable North-South-USA relations will be an important element in ameliorating the ‘hardness’ of the Russo-Sino-North Korea triangle, as South Korea becomes an insider in the northern triangle while playing the role of a balancer. This would mean that South Korea-USA-Japan relations would not be in opposition against Russo-Sino-North Korea triangle. Therefore, it is important to realise that stable management of inter-Korean relations is the key to positioning South Korea at the centre of efforts to moderate between all parties in North-South Korea-USA, Russo-Sino-China, and South Korea-USA-Japan relations.