Executive Summary

1. Introduction

2.  A Retrospective Analysis of the Processes of Regional Economic Integration in CA

3. Dynamics of Foreign Trade of CA Countries
3-1. General Foreign Trade
3-2. Mutual Trade

4. The Role of CA Countries in International Organizations

5. Conclusion

Appendix

References 

  At the current stage of globalization, Central Asia (CA) is becoming a focal point for the political and economic interests of global forces because of its rich natural resources and critical strategic position. From this point of view, the CA countries need to form a joint development strategy for solving regional problems and a strong mechanism for countering the main political and economic conflicts in the region. At the same time, the countries of the region need to choose the path of joint development in order to increase the efficiency of their internal capacities and resources, adapt the domestic social and economic infrastructure to modern requirements and improve the living standards of the population.
  This is directly related to the progress of regional economic integration in CA. Through this integration, the economies of the countries in the region could complement each other and ensure a high level of development in mutual trade and industrial development.
  However, there are some obstacles and problems hindering the development of economic integration in the region. Most particularly, the weak infrastructure in the region, its economic-geographical isolation from world markets, administrative barriers and political instability hinder trade between the countries of CA.
  From this point of view, this study focuses on the problems of general and cross-border trade in CA countries, and the opportunities for economic integration in the region.

Keywords:  Foreign Trade, Export, Import, Central Asia, Mutual Trade, Economic Integration

JEL Classification:  F50, F63, R11 

Executive Summary

1. Introduction

2. The Model
2-1. Consumer
2-2. Firm
2-3. Labor market and production
2-4. International trade

3. Equilibrium
3-1. On the equilibrium
3-2. Changes in equilibrium
3-3. Solution algorithm

4. Counterfactual Analysis Based on the Model
4-1. A revisit to Caliendo and Parro (2015)
4-2. The welfare effect of China’s tariff reductions

5. Conclusion

References

Appendix 

  Over the last decade, quantifying the welfare effects from tariff changes has become one of the main challenges among international trade economists. There are a number of quantitative trade models with micro-foundations which emphasize demand-side (Anderson and Van Wincoop 2003), supply-side (Eaton and Kortum 2002), Bertrand competition (Bernard et al. 2003), extensive and intensive margin (Chaney 2008), etc, and conclude that trade liberalization with tariff reductions leads an economy to reach a higher level of welfare compared to pre-liberalization (Costinot and Rodriguez-Clare 2014). While elegant, these models inducing gravity equations share the common assumption, a perfect labor market. Quantitative trade models with full-employment developed so far have not taken account of labor market frictions when evaluating the welfare effects from tariff changes. This paper aims to fill the gap in the trade literature by explicitly considering labor market frictions.
  I employ search-and-matching to a multi-country and multi-sector Ricardian model with input-output linkages, trade in intermediate goods, and sectoral heterogeneity, in order to quantify the welfare effects from tariff changes. The paper shows that labor market frictions can be a source of comparative advantage in the sense that better labor market conditions contribute to lower cost in production. Labor market frictions play a critical role in determining the probability of exporting goods to trading partners, and interact with bilateral trade share, price, expenditures, etc. Unemployment and changes in unemployment rates due to tariff reductions contribute welfare changes across countries, implying that welfare effects based on quantitative trade models with full-employment are likely to be biased. I confirm the biased welfare effects by revisiting Caliendo and Parro (2015), who conduct an analysis of the welfare effects from the NAFTA from 1993 to 2005. I show that the welfare gap between theirs and mine has a positive correlation with changes in observed unemployment rates across countries. With the constructed model, I further conduct counterfactual exercises by asking what would happen if China’s tariffs remain unchanged from 2006 to 2015. It turns out that there are mild welfare effects to trading partners in the world trading system.

Keywords: Quantitative Trade Model, Unemployment, Welfare
JEL Classification: F10, F17, F60 

ⅠIntroductionⅠ

Political Changes on the Korean Peninsula and the Significance of Trilateral Cooperation between South Korea, North Korea, Russia
Lee Jae-Young
President, Korea Institute for International Economic Policy (KIEP)

❙Korean and Russian Perspectives on Trilateral Cooperation between South Korea, North Korea, Russia❙

Korean Perspectives ❚

01 New Opportunities for and Approaches to the Trilateral Cooperation between the ROK, DPRK and the Russian Federation

Kim Seok Hwan
Visiting Research Fellow, KIEP

Park Joungho
Director General, New Northern Policy Department, KIEP

02 Key Challenges of the Trilateral Cooperation and its Action Plan

Kim Seok Hwan
Visiting Research Fellow, KIEP

Park Joungho
Director General, New Northern Policy Department, KIEP

Russian Perspectives ❚

03 North Korea-Russia Relations and Overview of the Prospect of Trilateral Cooperation by Areas

Pavel A. Minakir
Director emeritus, Economic Research Institute, Far Eastern Branch of the Russian Academy of Sciences

04 Interrelation between the North Korea-Russia Cooperation and the Trilateral Cooperation

Vasily V. Mikheev
Vice President, Institute of World Economy and International Relations (IMEMO)

05 New Developments in the North Korean Nuclear Issue and the Trilateral Cooperation between the ROK, DPRK and the Russian Federation

Sergey A. Karaganov
Dean, Faculty of World Economics and International Relations, National
Research University-Higher School of Economics

Natalia Kim
Associate Professor, School of Asian Studies, National Research
University-Higher School of Economics

ⅠConclusionⅠ

Policy Recommendations to Promote TrilateralCooperation between the Two Koreas and Russia
Lee Jae-Young
President, Korea Institute for International Economic Policy (KIEP)

ⅠReferencesⅠ

ⅠAppendixⅠ 
Developments related to Trilateral Cooperation between the Two Koreas and Russia 

  North Korea’s nuclear development plans and missile tests led to a state of acute tension in 2017, escalating the risk of war. The tense situation took a sharp turn following the 2018 Pyeongchang Winter Olympic Games, followed by two inter-Korean summit meetings and the first in history meeting between the leaders of North Korea and the United States. These developments have improved relations between the two Koreas and are leading to substantial talks toward the denuclearization of North Korea.
  On April 27, 2018, the leaders of the two Koreas met for the first summit talks in 11 years, culminating in the Panmunjom Declaration in which they agreed on the dramatic improvement and development of inter-Korean relations, elimination of military tension and mutual non-aggression, and complete denuclearization and establishment of a peace regime on the Korean Peninsula. In the second inter-Korean summit of the year held on May 27, 2018, the two leaders reached a consensus to work closely toward denuclearization of the Korean Peninsula and the establishment of a permanent peace regime. he South and North held inter-Korean high-level talks on June 1, in which it was agreed to establish a joint liaison office in Gaeseong, North Korea, and practical measures to implement the Panmumjom Declaration were discussed. South Korea becoming a full member of the Organization for Cooperation of Railways (OSJD) on June 7, 2018, was an important development as well. Despite seeking full membership to the Organization since 2015, the South had hitherto been blocked by North Korea’s veto votes.
  The virtuous cycle that began with these improvements in inter-Korean relations was continued with the first U.S.-North Korea summit in history. The leaders of North Korea and the U.S. met on June 12, 2018, in Singapore, releasing a joint statement agreeing to establish a new bilateral relationship, build a lasting and stable peace regime on the Korean Peninsula, and to make joint efforts toward the complete denuclearization of the Korean Peninsula. Chairman Kim Jong Un reconfirmed his commitment to the agreements made within the Panmunjom Declaration and pledged to work toward the complete denuclearization of the Korean Peninsula. The historic summit between the two leaders was followed by subsequent measures on the part of North Korea – such as the release of three U.S. citizens, repatriation of U.S. soldiers’ remains, and the closure of its Punggye-ri nuclear test site and dismantlement of the Sohae engine missile testing site in Tongchang-ri – in return for which it called on the U.S. to lift North Korean sanctions and formally end the Korean War. The U.S., on the other hand, is maintaining its position that North Korea must first begin substantial measures toward complete denuclearization, and that the lifting of sanctions can only be considered after major progress has been seen toward denuclearization. The U.S. is particularly keen on securing a list from North Korea outlining its nuclear arsenal, and is yet to make its position clear on the issue of an end-of-war declaration, instead focusing on both talks and pressure tactics toward North Korea.
  When considering the delicate situation currently unfolding between the three nations following the summit meetings, it is clear that the Moon Jae-in government in South Korea must play a crucial role. However, inter-Korean relations are mired in complications caused by North Korea’s nuclear program and U.S. sanctions against North Korea, making it difficult to realize any substantial progress in economic cooperation projects with the North. As of yet, the New Economic Map of the Korean Peninsula and the New Northern Policy, initiatives announced by the Moon administration, remain at the initial stage of planning. But as President Moon stressed in the August 15 Liberation Day speech, peace is vital to economic development on the Korean Peninsula, and the New Economic Map of the Korean Peninsula and New Northern Policy must be recognized as foundation-building efforts to resolve North Korea’s nuclear issue once and for all. In his Liberation Day speech President Moon emphasized that “establishing peace and forming an economic community on the Korean Peninsula is the actual realization of our liberation,” and that “developing relations between the two Koreas is the true driving force behind denuclearization of the Peninsula.” These sentiments carry the message that inter-Korean economic cooperation is an inevitable and essential means to reconstruct the virtuous cycle between the three parties through the third inter-Korean summit in September 2018, followed by nuclear talks between the U.S. and North Korea, and another North Korea–U.S. summit meeting scheduled to take place. During his speech President Moon also proposed an East Asian railway community, demonstrating how the New Economic Map of the Korean Peninsula will lead to economic cooperation with economies toward the north of Korea, strengthening connectivity with the Eurasian continent.
  As such, the New Economic Map for the peace and prosperity of the Korean Peninsula must be accompanied by a recognition for the geopolitical and geoeconomic value of the Russian Far East region. When North Korea begins its process of reform and opening up and economic cooperation projects between the two Koreas resume, the Russian Far East will rise as a key point for economic cooperation between Korea and its neighbors to the north. This would also open up more opportunities for bilateral and multilateral cooperation in hand with Russia’s development strategies in the Far East region, between the two Koreas and Russia. The Russian Far East region is strategically significant in that it connects with the Korean Peninsula, thus serving as a starting point for economic cooperation between Russia and the two Koreas and offering a bridgehead for the Korean economy to extend its growth. The Russian Far East region is also essential for the eastern axis of the New Economic Map for the Korean Peninsula, which involves forming inter-local cooperation in the East Sea region and developing the Northern Sea Route.
  There is no doubt that trilateral economic cooperation projects between the two Koreas and Russia will benefit South and North Korea and contribute to South Korea-Russia relations, while driving the denuclearization of the Korean Peninsula in an irreversible direction. Such cooperation projects would also make it possible to realize peace and mutual prosperity on the Korean Peninsula while strengthening connectivity with Eurasian nations. Ultimately, trilateral cooperation projects will add substantial momentum to Korea realizing its future vision of a “bridge country” that connects the ocean and continent, and to Russia gaining a strategic foothold to develop its Far East region and advance into the Asia-Pacific area.
  Russia is not a major presence in the ongoing talks between South and North Korea, the U.S. and China for the denuclearization of North Korea. However, when we recognize the limitations of producing a solution to the North Korean nuclear issue only within the framework of diplomatic security talks, it becomes clear that the Russian Far East represents great strategic value, and that trilateral cooperation projects between Russia and the two Koreas deserve much more recognition for their significance. On April 29, 2018, Russian President Putin stated the need for the progress realized through the inter-Korean summits to be continued through trilateral cooperation projects with Russia. President Putin also stressed how connecting Russia’s railways, gas pipes and power supply into Siberia through the Korean Peninsula would contribute to the stability and prosperity of the Peninsula. During his visit to Moscow in June 2018, President Moon reached a consensus with President Putin on how trilateral economic cooperation would create a virtuous cycle of furthering peace on the Korean Peninsula and promoting economic cooperation, and how this must be further developed into a multilateral security regime in Northeast Asia. If cooperation between the two Koreas and Russia could vitalize multilateral cooperation schemes with the U.S., China and Japan, this would add crucial momentum to the mutual prosperity and permanent peace of Northeast Asia.
  This volume contains the results of joint research conducted by Korean and Russian experts, focusing on the following objectives. First, we wish to illustrate the need for trilateral economic cooperation within the changing political situation on the Korean Peninsula and the Northeast Asian region, through which it will become possible to pursue mutual prosperity within the region and establish a foundation for permanent peace. Our second goal is to perform an in-depth study of the perceptions and situations on each side in regard to South Korea–North Korea–Russia cooperation, through which we can identify the basic directions, tasks and strategies to promote cooperation between the three parties. This approach is particularly timely and significant on an academic level when it comes to identifying strategic connections between Korea’s New Northern Policy and Russia’s New Eastern Policy, and to realize qualitative development in South Korea–Russia relations. Finally, we wish to offer important policy implications for the Korean government as it implements its New Northern Policy and the New Economic Map for the Korean Peninsula, and help produce measures to expand economic cooperation between Korea and Russia in the Russian Far East. 

Exchange rates have been changed unusually large these days. From 2011 to 2016, the Euro and the Japanese Yen have depreciated against the US Dollar by more than 25 percent. According to a theory, since competitively valued exchange rate helps to boost export growth, we should have observed a sub-stantial increase in export in the EU and Japan. However, the effectiveness of the exchange rates on exports appears to be weak across countries. This anomaly is one of the central puzzles in international macroeconomics: why large movements in the exchange rate have modest effects on the aggregate variables such as import prices, consumer prices, and quantity of exports. 

  In this paper, we examines the role of global production linkages on ex-change rate elasticities by using Korean firm-level data. At firm-level, foreign-owned firms or firms with foreign subsidiaries participated in the Global Value Chains (GVC) play an important role in weakening the effect of ex-change rate movements on firm exports. The empirical results show that the exchange rate elasticity of total export is about -0.64, which implies that 10% appreciation of Korean Won would make a drop in total export by 6.4%. However, the exchange rate elasticities of firms are not the homogeneous across firms. We find that the exchange rate elasticities of firm exports are significant and negative for domestic-owned firms and firms without foreign subsidiary whereas those are insignificant for foreign-owned firms and firms with foreign subsidiaries.

  After controlling exports to foreign affiliates, we still find that the estimated exchange rate elasticities of exports are statistically insignificant, but become negative and relatively larger for firms with global production linkages. More-over, firms with higher GVC integration measure or more imported inter-mediate inputs have the significantly lower exchange rate elasticities of firm exports. It suggests that developments of global production linkages via firm ownership, within-industry or within-firm in the last decade play an essential role in alleviating the effect of exchange rate movements on the firm exports.

Keywords: Exchange Rate Elasticity, Firm Export, Production Linkage, Global Value Chains

JEL Classification: F14, F15, F23, F31

About KIEP

Highlight 2017

Bright 2017

Research-Oriented Activities

General Projects

Appendix 

The year 2017 was a period of escalating external risks for the Korean economy, as advanced economies progressively normalized their monetary policies, the international trend of economic protectionism and nationalistic trade policies continued with the progress of Brexit and the Trump administration’s America First policies, and the North Korean nuclear issue deteriorated into a state of discord among the international parties involved.

To cope with these challenges, we at the Korea Institute for International Economic Policy (KIEP) identified eight major policy directions to focus on as we carry out our fundamental mission as a national research institute. The eight areas KIEP will focus its research capabilities on are: the proposal of coping measures in the face of trade protectionism; promoting strategic economic cooperation; the establishment of a Northeast Asia Plus Community of Responsibility; stronger development cooperation to maximize national interests; pursuing economic unification on the Korean Peninsula; the realization of income-led growth policies; the vision of Innovative Growth; and external risk management.

The global economy continues on the path of recovery from the past crisis, but as of yet we lack clear indications that this trend of growth will continue in the long term. The support of neighboring countries will be essential when it comes to the stable establishment of lasting peaceful relations between the two Koreas. As such, the geopolitical significance of Korea will continue to rise.

As our economy navigates these multiple challenges, KIEP will contribute to the establishment of sustainable cooperation strategies through research on the government’s New Southern Policy and New Northern Policy; we will guide the national execution of the New Economic Map of the Korean Peninsula, based on reconciliation and cooperation between the two Koreas; we will explore international economic and trade policies that can support the vision of inclusive growth; and we will identify promising new industries to concentrate our national resources in line with the Fourth Industrial Revolution unfolding around us. The research findings we provide will serve as a guide to formulate policy decisions that can drive national development.

On behalf of KIEP, I wish to extend my deep gratitude and appreciation for the interest and support you lend toward our progress. KIEP will continue its work in the areas of regional studies, trade investment, and international macrofinance, earning the trust of the people as we fulfill our mission as a responsible research institute and a national leader of sustainable growth and innovation through policy research. 

About KIEP

Highlight 2017

Bright 2017

Research-Oriented Activities

General Projects

Appendix 

The year 2017 was a period of escalating external risks for the Korean economy, as advanced economies progressively normalized their monetary policies, the international trend of economic protectionism and nationalistic trade policies continued with the progress of Brexit and the Trump administration’s America First policies, and the North Korean nuclear issue deteriorated into a state of discord among the international parties involved.

To cope with these challenges, we at the Korea Institute for International Economic Policy (KIEP) identified eight major policy directions to focus on as we carry out our fundamental mission as a national research institute. The eight areas KIEP will focus its research capabilities on are: the proposal of coping measures in the face of trade protectionism; promoting strategic economic cooperation; the establishment of a Northeast Asia Plus Community of Responsibility; stronger development cooperation to maximize national interests; pursuing economic unification on the Korean Peninsula; the realization of income-led growth policies; the vision of Innovative Growth; and external risk management.

The global economy continues on the path of recovery from the past crisis, but as of yet we lack clear indications that this trend of growth will continue in the long term. The support of neighboring countries will be essential when it comes to the stable establishment of lasting peaceful relations between the two Koreas. As such, the geopolitical significance of Korea will continue to rise.

As our economy navigates these multiple challenges, KIEP will contribute to the establishment of sustainable cooperation strategies through research on the government’s New Southern Policy and New Northern Policy; we will guide the national execution of the New Economic Map of the Korean Peninsula, based on reconciliation and cooperation between the two Koreas; we will explore international economic and trade policies that can support the vision of inclusive growth; and we will identify promising new industries to concentrate our national resources in line with the Fourth Industrial Revolution unfolding around us. The research findings we provide will serve as a guide to formulate policy decisions that can drive national development.

On behalf of KIEP, I wish to extend my deep gratitude and appreciation for the interest and support you lend toward our progress. KIEP will continue its work in the areas of regional studies, trade investment, and international macrofinance, earning the trust of the people as we fulfill our mission as a responsible research institute and a national leader of sustainable growth and innovation through policy research. 

  This paper examines the current situation of the US-China current account imbalances and the development of trade disputes. This paper also empirically analyzes the short and long-term causal relationship between current account imbalances and real exchange rates and the relationship between the current account persistence and exchange rate regime.
  In Chapter two, we study the current account imbalance between China and the U.S. in terms of trade structure. We find that China’s trade surplus with the U.S. is concentrated in a few specific items, including cell phones, automatic data processing machine and monitors and projectors. Looking at the processing stage of the trade between China and the US, China’s trade surplus with the U.S. has mostly come from the final goods. In particular, the surplus in capital goods trade has begun to surpass the surplus in consumer goods trade, in 2016. We also find that the surplus in high-technology manufacture exceeds that in low-technology manufacture. Meanwhile, China has run a deficit in the service trade with the U.S. and the deficit has surged since the global financial crisis.
  In Chapter three, we examine the development process of the dispute over the yuan exchange rate and the trade disputes after the Trump administration. Analyzing the existing research results on the misalignment of RMB exchange rate, we find that it is difficult to make a consistent conclusion according to the methodology and analysis period. However, the U.S. Treasury Department maintains its position that the RBM should be appreciated to resolve the trade imbalance. After the launch of the Trump Administration, the government is taking hard-line trade sanctions in addition to exchange rate pressures. In 2017, the Trump Administration increased the number of anti-dumping and countervailing duty investigations for import goods from China by 59% year-on-year, and the US Department of Commerce, for the first time in 26 years, exercised anti-dumping and countervailing duties investigation on Chinese aluminum alloy sheets. In addition, it is considering imposing tariffs based on Articles 201, 232 and 301. In response to these U.S. sanctions, China expressed its strong condemnation through government statements and countered in the same way as the United States.
  In Chapter four, we examined the relationship between the current account balance and the exchange rate in two ways. First, we analyzed whether the RBM exchange rates is a significant factor in determining the current account balance between China and the U.S.. In the long term, China’s US current account is affected not only by the real exchange rate but also by the difference in the real GDP growth rate, the difference in the financial account balance of two countries, the financial deeping of China. In the short term, only changes in trade openness have a significant positive effect on the current account. The change of the real exchange rate does not seem to lead to the short-term adjustment of the current account. Second, we study the relationship between the persistence of the current account and the Chinese exchange rate regime. The results implies that current account imbalance between the two countries is adjusted faster after the global financial crisis and China’s exchange rate system reforms contributed to current account adjustment.
  The empirical results provide that the RMB exchange rate only affects trade balance between China and U.S. in the long term, and China seems to contribute to the adjustment of trade imbalance through the exchange rate system reform. However, considering the global value chain of China and emerging Asian economies, it is unclear whether the RMB exchange rate adjustment alone will resolve the trade imbalance. Instead, structural rebalancing such as the U.S. fiscal deficit reduction, the increase of private savings, and the development of financial market in China can fundamentally solve current account imbalance. Although the Trump Administration has not yet designated as a currency manipulator, the U.S. government still suspects the foreign exchange market intervention and the undervaluation of the RMB. It is possible that the pressure of the U.S. on RMB appreciation would direct at KRW exchange rate. On the other hand, considering the dependence of intermediate goods trade between China and Korea, deepening trade disputes between China and the U.S. may cause China to shrink its exports to the U.S., resulting in a slowdown in Korea’s intermediate exports to China. In addition, with the spread of protectionism, there will be a possibility of trade disputes including the subsidy problem between Korea and China due to Korea’s continuous surplus with China. 

- 

Executive Summary

1. Introduction

2. Literature Review

3. Empirical Analysis
3-1. Variables and Data
3-2. Empirical Specification
3-3. Empirical Results
3-4. Robustness Tests

4. Theoretical Implications

5. Conclusions

References 

  Benefits of financial market integration include cheaper and alternative op-tions of saving and borrowing for households and entrepreneurs. In the global financial market, asset choices for households widen so that individu-als can manage their idiosyncratic income risk more effectively. On the other hand, financial market integration makes investors who hold foreign assets more vulnerable to global financial shocks. In the recent financial crisis, finan-cial market distress which initially arose in the U.S. had an enormous impact on the peripheral countries. This example shows that the strong shock prop-agation occurs via integrated financial markets.
  The existing literature shows that financial market integration has a sizable impact not only on business cycles in the short run, but also on economic growth in the long run. However, there has been little attention to income distribution, specifically in related to the financial market integration. In this paper, we fill the void in the literature by focusing on the following two styl-ized facts: income inequality has been exacerbated in most countries over the past two decades, and the financial market has been integrated across coun-tries during the same period. In particular, we answer three research questions to investigate the relationship between the two facts. First, how does financial market integration affect income inequality? Second, how do financial market integration and financial market development interact to change income ine-quality? Third, what components do theoretical model need to explain the interaction effect of financial market development and integration on income inequality?
  We test hypotheses that the effect of financial market openness on inequality is conditional on the level of domestic financial market development when the financial market opens. An empirical study with panel data comprised of 174 countries for the period 1995-2017 finds that the overall effect of finan-cial integration on income inequality is nonlinear. Financial market integration creates the intensive and extensive margins of credit supply which may de-pend on the development level of financial market disproportionally. This paper uncovers a novel empirical evidence that financial market integration and financial market development interact to change income inequality. When other things are controlled, the effect of financial market integration on in-come inequality depends on financial market development. In a country with underdeveloped financial market, income inequality gets worse as financial market opens. On the other hand, when financial market is highly developed, the effect of financial market openness on income inequality is mostly insig-nificant in a statistical sense. The results are still valid with different measures of financial market development, integration, and income inequality. We check that the results are robust as an endogeneity issue among financial market development and integration is controlled.
  We also suggest some important structures for the conventional economic model to account for our empirical finding as theoretical implications. Based on these implications, extensions of the conventional small open economy model with financial constraints having suggested components such as het-erogeneous holdings of foreign assets across income and asset levels and entrepreneurial shocks will be necessary to understand an interaction of fi-nancial market openness and domestic market development on the distribu-tion of income in a country. Our finding also echoes that studying an eco-nomic mechanism in which economic growth, financial market outcomes, and inequality are endogenously determined.

Keywords: Financial market development, Financial market integration, In-come inequality
JEL Classification: D63, F36, O11, O16