In July 2018, President Moon Jae-in announced the new target of achieving $50 billion in trade between India and Korea by 2030 following a summit meeting with Narendra Modi, the Prime Minister of India. Despite the Korean government naming India as a key partner in line with its New Southern Policy, trade between the two countries has remained stagnant since reaching the $20 billion mark in 2011. As such, this is a timely opportunity for research that can contribute toward attaining the trade target. This study mainly focuses on Korea’s export to India, identifying the factors contributing to export stagnation, and going on to present policy suggestions to enhance Korea’s export competitiveness in the Indian market.
   Chapter 1 introduces the factors that determine stagnation of trade examined in previous studies, which can be classified into internal and external factors. The former category refers to factors that determine intra-company competitiveness, while the latter factors are those beyond the control of individual companies and which can also be explained as cyclical or structural factors. Based on these factors, the following chapters analyze the main factors that are affecting the stagnation of Korea’s export towards India from various perspectives.
   Chapter 2 identifies three noticeable factors behind export downturns based on the changes in the structures of Indian imports and Korea’s exports to India. The first factor is an expansion of local production and non-tariff barriers in India. The government of India is promoting local production by utilizing the “Make in India” campaign and has been implementing various non-tariff barriers which have contributed to a slowdown in Indian imports. Another factor is the massive expansion of China’s export to India. China’s share in the Indian import market has been increasing rapidly, especially in major categories such as electronic devices, machinery, organic chemicals, steel, plastic and automobile parts. Lastly, Korea’s lack of export capacity also seems to have contributed to export stagnation. There are some items in which Korea’s exports are unable to fully meet India’s import demand, including various plastic polymers, synthetic rubber products, some kinds of machinery, electronic devices, and automobile parts. These products are being replaced by goods from other countries, mostly China, and considering that these represent some of Korea’s main export items, the situation is highly critical.
   Chapter 3 examines changes in the export competitiveness of major items that Korea exports to India. Our results indicate that many of the items that show a deterioration in competitiveness within the Indian market bear relation to the decline in global competitiveness of Korean products. Some other items showed a rise in competitiveness in the global market but declined in the Indian market, which largely seems to be due to lower price competitiveness compared to Chinese products. Meanwhile, changes caused by localization, the India-Japan Comprehensive Economic Partnership Agreement (CEPA), and non-tariff measures also seem to have had a negative impact on the competitiveness of Korean goods. For example, the expansion of localization in India has led to a decline in the export competitiveness of Korean automobile parts, and the concession ratio of the Korea-India CEPA, set at a less favorable level to the India-Japan CEPA, has had a negative impact on the competitiveness of Korean plastic goods. Moreover, India’s non-tariff measures partially affected the declining competitiveness in Korean exports of organic chemicals, rubber, and steel.
   Chapter 4 examines the internal and external factors of stagnation in Korean exports to India based on the results of a questionnaire survey conducted on 300 exporting companies. The external factors reported as the most influential were excessive competition in the Indian market and decline of Korean companies’ competitive advantages. On the other hand, the lack of competence in locating the local market and securing distribution and sales networks, the decline in productivity and competitiveness of individual enterprises, and the decline in export due to localization were the major internal factors identified. In addition, the low awareness and utilization of the Korea-India CEPA is also likely to have contributed to Korea’s sluggish export to India.
   Based on the above analyses, Chapter 5 examines the factors of export stagnation for individual items by structuring them into a matrix, and presents policy directions and tasks to enhance export competitiveness for the individual factors. In terms of enhancing competitiveness against internal factors, the results suggest that implementing active response measures to changes in India’s industry and demand structure, establishing active partnerships with local companies, and reinforcing intra-company export capabilities through the utilization of the existing CEPA would be beneficial. Against the external factors, the study emphasizes the necessity of strengthening inter-governmental cooperation to build a long-term, stable trade network. Reducing non-tariff barriers, advancing negotiations for the improvement of the CEPA, and establishing a virtuous cycle of trade through localization and the global value chain (GVC) are also recommended.
   This study confirms that the stagnation of Korea’s export to India is not a temporary phenomenon or limited to specific items, and could become prolonged or even permanent. In this regard, Korean companies and the government need to find new breakthroughs to enhance export competitiveness in the Indian market. To this end, it is imperative to build a virtuous cycle between export and investment that can enhance the scope and quality of trade by increasing investment or localization, and constructing bilateral cooperation projects. In order to develop more specific cooperation plans, the government should promote joint research on Korea-India trade, expand business-matching programs, establish a cooperation fund to support collaborative projects between the two nations, and develop a Korean-style manufacturing city within India to promote localization and GVCs. 

   This study empirically investigates whether monetary policy of small open economy that does not have international currency and monetary policy of small open economy that has international currency have a different effect on exchange rate. This is because general economic theory explains that the same effect will occur in all countries without explicit distinction between these distinctions.
   Chapter 2 defines the meaning of the international currency and details its exchange rate characteristics. This allowed us to see the importance of distinguishing between international currency and non-international currency. Next, the relative volatility of exchange rates was measured by dividing the period into the Asian financial crisis, the global financial crisis, and the stabilization period. As a result, the relative volatility of the crisis period was higher in the non-international currency than in the international currency. We then looked at the statistical characteristics of the difference between the two groups’ covered interest differentials. In the international currency, the average of the covered interest differentials was close to zero and the variability was relatively lower.
   In Chapter 3, the effect of monetary policy on exchange rates was analyzed using structural vector autoregression (VAR) models with sign restrictions. The target countries are the international currency countries (British, Canada, Switzerland) and Asian non-international currency countries (Korea, Thailand, the Philippines, Indonesia, Malaysia) among small open economies, and we investigate the inflation targeting periods.
   The responses of exchange rates to the impact of monetary policy in international currency of Britain, Canada and Switzerland was not much different from predictions of theories in general. As most theories predict, interest rate hikes have significantly lowered the exchange rate. It was also shown that exchange rates were overshooting, as predicted by Dornbusch (1976). On the other hand, the effect of monetary policy on exchange rates in most non-international currency countries has been considerably different from that of theory. In Thailand and Indonesia, ‘exchange rate puzzles’ appeared.  In the Philippines, the currency exchange rates were not significant. Malaysia’s exchange rate decline tends to stay too long. Exceptionally for Korea, the impact of interest rate hikes on the currency exchange rate was relatively less significant, but the rate fell, the exchange rate was overshooted and the maximum effect was in the second month after the impact.
   On the other hand, the responses of the accumulated risk premium  was also found to be significantly different from zero. However, it was not clearly different between the international and non- international currencies. 
   Chapter 4 used event studies to identify the excess rate of return from monetary policy impacts and its statistical significance. Four cases were selected, which consisted of three incidents of interest rate changes in Korea under the freeze of U.S. interest rates, and another one wanted to pick a similar time to the current situation to get suggestions for future situations.
   The study found that the Korean exchange rate fluctuates more significantly on the basis of the dollar index than on the emerging countries index. The outcome of the case study was that one of the four events changed the exchange rate in the opposite direction to the theory, while the other three events showed that the exchange rate changed in line with the theory. But the impact of the incident did not last long.  And there was only one statistically significant event. Therefore, Korea’s monetary policy was limited to changing the exchange rate in the direction presented in the theory. In case of an incident similar to the recent situation, the exchange rate has been shown to fall even if Korea and the United States raise interest rates to the same level. The reason for this is that the U.S. rate increase has reduced its marginal influence on the Korean currency and it could last longer than the U.S.  However, this event does not have any statistical significance.
   The following are policy implications that can be derived from the results of this study:
   First, we need to internationalize Korea won. The reason why Korea’s monetary policy has limited predictions about how it affects the exchange rate is that the won has not been globalized. Therefore, efforts to improve the transparency of the market and the effectiveness of monetary policy should be made to internationalize the won.
   Second, Korea needs to consider the U.S. monetary policy and the fluctuations in interest rates between the two countries in its monetary policy decisions because of the economic characteristics of the small opening. Because the U.S. monetary policy has more influence than Korea’s, it is highly likely that the effect of the policy will be weakened if the two countries implement it in a different direction.
   Third, it is necessary to expand the operational instruments of monetary policy. Until now, Korea’s monetary policy has focused on adjusting the benchmark interest rate. However, it is necessary to develop various operational instruments that can change not only nominal interest rates but also real interest rates.
   Fourth, since monetary policy has limited external effects, the development of various indirect policy means is necessary in case exchange rate policy is necessary. Of course, the role explicitly given to the central bank is inflation and financial stability. However, the role of the central bank should be interpreted more comprehensively, as the exchange rate and other macroeconomic indicators are closely linked to financial stability.
   Fifth, it is possible that the impact of South Korea’s monetary policy on the won/dollar exchange rate will increase. As interest rates have reversed and the exchange rate has continued to rise, the U.S. rate hike has lowered its marginal impact on the dollar. It is also because there is more room for future interest rate hikes in Korea. 

  This study aims to prepare the way for Korean infrastructure construction companies to enter the ASEAN infrastructure market which is growing in line with the rise of the ASEAN economy. To this end, the study examines the characteristics of ASEAN infrastructure markets and each countries’ development plans and efforts to improve ASEAN connectivity taking place in the background. In addition, it provides implications for Korea by comparing the support strategies of Korea with those of Japan and China for entering the ASEAN infrastructure markets. The study also identified difficulties by surveying the management practices of Korean construction companies operating in the ASEAN infrastructure markets. The lessons learned from the companies’ inroad into the business were summarized and government’s support policies were also analyzed based on them. Finally, based on these analyses, we provide policy suggestions for the Korean government.
  In Chapter 2, the growth of the ASEAN construction infrastructure market can be seen through various indexes. ASEAN countries are growing fast but cannot maintain their economies under current levels of infrastructure, meaning they are likely to actively develop infrastructure for sustainable growth. As Figure 2-4 shows, the share of the construction industry in GDP is increasing in all ASEAN countries. The survey results reported in Chapter 3 also gave a positive outlook on growth in the ASEAN infrastructure market (see Figure 3-21). Comparing infrastructure indexes of each country, a larger demand for development is expected in Vietnam, Indonesia, the Philippines and Cambodia than in the rest of ASEAN countries.
  As ASEAN pushed for economic integration, it focused on reducing the development gap. The Initiative for ASEAN Integration (IAI) work plan III also recognizes that economic integration cannot be achieved successfully without reducing the development gap. Therefore, it is likely that the project will be actively promoted throughout ASEAN to improve physical connectivity, including the construction of infrastructure, and business related to ports, roads, and railways. This is also evident in the MPAC 2025. Table 2-8 shows that infrastructure investment needs in major countries may differ in terms of the areas they are needed even though this might result from the gap in their respective economy scales. In other words, as demands vary from market to market, approaches should also be different. Indonesia has a large demand for transportation infrastructure while the Philippines has a high demand for power infrastructure. Vietnam has much greater demand for power and communication infrastructure than other areas. Accordingly, each country has different policies depending on their demands.
  Chapter 3 analyzed major countries’ strategies for entering ASEAN infrastructure markets. Japan’s support strategy is summarized into four major categories. First, it strengthened its capability to win contracts through an expansion of public funds and improvement of systems. Public finance was increased by expanding support from JICA, cooperation with ADB, and the supply of sunk costs by the Japan Bank for International Cooperation (JBIC), Nippon Export and Investment Insurance (NEXI). In 2017, NEXI was converted into a specialized company for government investors and has actively responded to issues such as the creation of dollarized trade insurance, extension of investment insurance periods, and local governments and corporations lacking government guarantee. Second, it has been working to develop conditions to strengthen the global competitiveness of its infrastructure companies. This study illustrates cases that can serve as a benchmark for the Korean government, taken from the examples of Japan and China, which are considered the biggest competitors of Korean companies in the ASEAN region. Japan formerly entered the ASEAN market, emphasizing high-quality infrastructure partnership. In the long term, Japan is implementing policies for international standardization of infrastructure development (see Table 3-4). In other words, it is implementing a strategy to create a market where it is difficult for other competitors to operate in, strengthening its standards and certification basis in the ASEAN infrastructure market. It is known that Japan is trying to make this a key agenda at the G20 Summit in 2018. China, on the other hand, is placing more of an emphasis on quantitative approaches in the region. If Japan leads the way and forms the international standard and certification basis for the development of the ASEAN infrastructure, Korean companies may face difficulties in following those standards. While closely examining Japan’s strategy, Korea should also open a way to participate in the standardization process jointly with Japan or in consultation with ASEAN. Third, Japan is focusing on cross-sectional development by establishing packaged strategies for developing infrastructures overseas. This strategy consists of strengthening the international competitiveness of related industries, strengthening public fund support, strengthening cooperation and strategic matching in the upper-class sectors, strengthening packaging and top sales, responding to international norms, and strengthening the government’s promotion system. To that end, the Japan Overseas Infrastructure Corporation for Transport & Urban Development (JOIN) was established in 2014. Benchmarking JOIN, Korea also established the Korea Overseas Infrastructure & Urban Development Corporation (KIND) in 2018. It is too early to assess KIND’s performance, but its operations seem to be proceeding in an appropriate direction. Fourth, Japan is participating in infrastructure projects through the “All Japan” initiative, which is based on the nationwide public-private cooperation system. The association held 37 strategic meetings until July 2018. Japan’s top sales diplomacy is achieving good results under the initiative. One of the major achievements is the Thilawa special economic zone in Myanmar.
  China’s strategy to help Chinese companies enter the infrastructure markets is similar to that of Japan, albeit less concerned with quality. China is also expanding its participation in the ASEAN infrastructure market through the expansion and utilization of public finance mechanisms such as the Silk Road Fund, including the AIIB, and the China-ASEAN Infrastructure Fund along with strategic approaches like the BRI. China is entering the ASEAN market under disadvantages as a latecomer. Faced with worries over the so-called “China threat,” the nation is strengthening its management system, discouraging rash winning of contracts, and reducing the overseas posting of Chinese workers.
  In order to compete with China and Japan in the ASEAN infrastructure market, Korea will first need to substantially expand its public finances. Working with significantly less public finances than China and Japan will limit the development of Korean businesses. Japanese companies have an advantage in terms of loans, international credit, information sharing, experiences, techniques, evaluation of risks, and their dominant position in advanced countries, while Chinese companies have an advantage in terms of the size of loans they can secure, government support, decision-making skills, risk burden, and their dominant position in emerging countries. This means Korea must develop strategies to target ASEAN infrastructure markets by discovering strengths that both Japan and China do not have. In order to achieve this, Korean companies must prepare to compete with Japanese firms.
  Chapter 4 analyzed Korea’s participation in the ASEAN infrastructure market using data from the International Constructors Association of Korea and conducted a survey on Korean companies who have entered the ASEAN market. The ASEAN market is different from the Middle East market, in which Korean construction infrastructure companies are posting the biggest orders (see Figure 4-4). The ASEAN market had orders in various fields such as civil engineering, industrial facilities, electricity, telecommunications, services and architecture, whereas the Middle East had a very high concentration on plants. Orders in the ASEAN market are concentrated in Vietnam, Thailand and Singapore, with the distribution weighted towards a few countries. Our results also showed that the value added per order varies from region to region. Vietnam, Indonesia and the Philippines had a lower value added per order, while the construction sector in Singapore had a higher value added per order (see Figures 4-5, 4-6). While most Korean construction companies in recent years have mainly focused on simple subcontracting, they should transition into high-value-added investment development projects. It is expected that KIND, which was launched this year, will play an important role. However, as construction orders tend to be concentrated in specific fields, competition among domestic companies is becoming fiercer. Korea must come up with a method to ease competition among its companies.
  Korean infrastructure construction companies that have entered the ASEAN market have a relatively high level of competitiveness. However, they assess themselves as slightly less competitive in the areas of purchasing and procurement capability, maintenance and construction capability. The companies appeared to be well aware of their problems in that they saw the importance of strengthening their marketing capabilities and competitiveness in property, plant and equipment to enhance their competitiveness (see Figure 4-14, 4-15). According to our survey on what is important in assessing marketability by country, entry barriers and attractiveness of target markets against competitive markets were important to countries like Myanmar, Vietnam and Indonesia, while all factors such as barriers to entry, level of competition, and attractiveness of target markets were important in evaluating marketability in advanced countries such as Singapore. In order for Korean infrastructure construction companies to enter a developing economy, efforts to resolve entry barriers through intergovernmental negotiations are required. The government should establish an organization that can systematically collect barriers to entry that Korean companies experience when entering the market and provide a window that can be reflected in inter-government negotiations.
  Moreover, small and medium-sized enterprises (SMEs) and large enterprises had different factors that had sensitive effects on the decision of business orders (see Figure 4-19). The international situation had a more acute effect on large companies than on SMEs, which were more affected by factors such as the exchange rate and situations in the construction sector than their larger counterparts. As the factors that come into play are different depending on the size of businesses, policies should be differentiated as well. Currently, the government needs to classify the policies of supporting companies entering construction infrastructures into those for large companies and SMEs, and develop policies that meet the different demands they have. In addition, 66.6 percent of SMEs responded they do not have countermeasures to respond to risks, while 64 percent of large companies replied they had such countermeasures. Because there is a clear difference in the capacity of risk response between large and small businesses, it is necessary to strengthen risk mitigation plans for SMEs that have entered the ASEAN market.
  Fifty-five percent of Korean construction companies said they had never heard of the New Southern Policy. The number of SMEs which have not heard of the New Southern Policy was higher than that of large companies. On the other hand, the Korean companies predicted that the policy would have be advantageous for future business. The largest reason for this they stated was that the Policy would enable them to utilize government investment funds with a high level of public confidence to stabilize their business (58.1 percent of businesses who were aware of the New Southern Policy). Responses varied by the size of the businesses surveyed. The perception that the New Southern policy would help them to win more contracts was more widespread among larger companies than smaller companies. As these perceptions of the New Southern policy differ by the size of the business, the Korean government should make more of an effort to publicize the New Southern Policy to companies. When Korean companies try to win orders based on the New Southern Policy, the Korean government should create conditions that do not cause excessive competition among Korean companies. The New Southern policy was not expected to help improve their profitability in the short-term, but was expected to help ensure a long-term increase in the profitability of businesses (see Figure 4-21). Thus, Korean construction companies that have entered the ASEAN infrastructure market need to understand the implementation direction of New Southern Policy and reflect it in their long-term development plans when preparing entry strategies. As the ASEAN Economic Community (AEC) has been launched, Korean construction companies should focus on efforts to link the New Southern Policy with the AEC.
  Only 23 percent of the companies were aware of the Master Plan on ASEAN Connectivity (MPAC) which ASEAN has promoted since 2010. It seems that Korean companies are finding it more difficult to obtain detail information on the changes in the ASEAN community than on changes in each country’s economic policies. On the other hand, 62 percent of companies knew about the launch of the AEC in late 2015 and many Korean companies were aware the fact that it was advantageous to enter the third country as a local company.
  Korean construction companies that entered the ASEAN market expected the business environment of ASEAN will improve in the future (see Figure 4-23). Sixty-seven percent of Korean companies believed the infrastructure construction market would expand and many of them were local competitors. According to a survey on difficulties of construction companies entering the ASEAN market, the most difficult element was found to be the high level of competition in the sector (see Figure 4-24). There is no wonder that competition is becoming fiercer as the ASEAN market’s attractiveness increases, necessitating active efforts on the part of the companies to survive. Aside from this competition, the Korean government needs to concentrate on creating an environment in which Korean companies are more comfortable to operate when the government promotes the New Southern Policy. As it is difficult to improve the business environment by itself, the Korean government should maintain favorable relations with the local government and support Korean companies by bringing the agenda to the negotiating table. Meanwhile, difficulties faced by Korean companies that entered the ASEAN infrastructure market differed by the size of companies and by major construction types (see Figure 4-24, 4-25). Therefore, the government needs to reflect the difficulties that companies feel differently depending on the type of construction or the size of the company when it comes to developing policies to support overseas construction companies. In addition, the requirements of Korean construction companies differed depending on the size of the companies, so it is necessary to develop customized strategies to their requirements (see Figure 4-26, 4-27). Moreover, when considering how infrastructure indices differ by region, as shown in Chapter 2, the government should consider providing supporting policies that reflect differences in regional demand.
  In addition, we listed current policies to support Korean companies entering the foreign infrastructure market, and how companies who had participated in the survey felt about these policies. While the companies were relatively satisfied with the government’s efforts to explore overseas markets, conduct feasibility studies, and provide support for overseas project orders, they were negative about the level of overseas field training being provided and support measures such as one-stop packages to venture abroad. As 70 percent of the companies surveyed were SMEs, these opinions were more representative of SMES rather than large companies. SMEs found it difficult to compete in terms of the quality of their manpower. Requests for the government were also different by the size of the companies surveyed. Therefore, it is necessary to consider both the size of the companies and the type of construction when establishing policies.
  Appendix 3 outlines the implications for Korean companies through analyzing the cases of construction and operation projects of power plant “C” in Cirebon, Indonesia and the company “P” major highway construction project in Vietnam. First of all, the Indonesian case showed how Japan’s project financing capability and Korea’s knowhow on operation and maintenance of power plant can be combined together when advancing into a third country, meaning that Korea, Japan and China are not necessarily competitors but also partners. Of course, the capabilities of Korea must be supported in order to form such a business structure. The case of company P in Vietnam was valuable as it shows how a large-scale corporation can utilize the self-enrichment system it has established over the years through its experience as a large company. The 20 years and more of experience in Vietnam allowed the company to enjoy a distinct advantage when entering other countries and to manage its risks. The self-enrichment system shown in this case would also be helpful for companies entering the market if it could be deployed by Korean public institutions. Creating and maintaining a long-term store of these experiences can reduce the risk burden for companies entering new markets. Therefore, it is necessary to create a storage system for companies to accumulate and share their experiences. Of course, it would also be necessary for the government to provide incentives to encourage companies to share their experiences for such a system to be operated in a sustainable manner. 

   Following the global financial crisis, some advanced countries recognized that the manufacturing sectors play an important role in mitigating the negative effects of the economic crisis. Also, as there has been some indication of firms bringing back manufacturing activities back to their home countries in recent years, reshoring has received broad attention by policy makers in advanced coutnries such as U.S. and Europe. Firms once offshored are relocating production back to the home country as production costs have significantly increased in emerging countries, and as they encounter a variety of difficulties such as low quality of products and low flexibility in production processes.
   The Korean government announced reshoring policies which provide reshoring firms with tax or subsidy incentives in December 2013. However, the policies appeared to be ineffective because only a very limited number of firms chose to reverse their previous offshoring decisions, leading to the concern that only a small number of firms are realizing the benefit of the reshoring policies. Therefore, this study aims to analyze the background of reshoring and effectiveness of reshoring policies from various angles. First of all, this study examines the definition of reshoring used in the literature and compares this with the concept of reshoring used in the media or policies. In addition, we infer the possibility of reshoring based on Korean firm data and develop a model to study the effectiveness of the reshoring policies. Lastly, we study reshoring trends and policies for Korea, U.S., Europe, and Taiwan to provide policy implications.
   First of all, this study examines the definition of reshoring broadly used in the literature, finding that it covers more patterns than those used in the media and policy. The act of reshoring, as perceived by the media and policy, only includes cases where firms move back to their home country by investing in new production facilities. Reshoring in academic literature, on the other hand, also includes cases in which production moves back to the home country through outsourcing increasing domestic production. Reshoring is motivated by an increase in the production cost in emerging countries, improvement of the product quality and proximity to the customers. In addition, it is encouraged by policies which aim to strengthen the manufacturing sector, create new jobs, and complement inward foreign direct investment. For example, the U.S. Europe, and Korea implement reshoring policies by providing a variety of tax exemption and subsidy measures for firms which reverse their previous offshoring decision.
   Next, we use data on the sourcing of Korean firms to measure the possibility of reshoring. The data presents that the portion of intermediate goods procured abroad decreases in 10 sectors among 24 sectors in recent years, implying that the sectors have relatively high probability of moving production facilities back to their home country. In particular, the reduction in foreign sourcing is pronounced in the manufacturing of other transportation equipment and manufacture of leather, luggage, and footwear. Also, most of the reshoring is incurred by moving their foreign outsourcing to domestic outsourcing. The relationship between sourcing patterns and productivity shows that the firms which procure intermediate goods from foreign affiliates or foreign in-sourcing have the highest productivity, implying that strong economic incentives are needed to reverse their offshoring decisions.
   Chapter 4 extends Grossman and Rossi-Hansberg (2008) and Wright (2014) to investigate firms’ offshoring and reshoring decisions and evaluate the impact of reshoring policies on employment and production. The firms choose offshoring when foreign production cost is less than domestic production cost. However, when they establish foreign affiliates, they may encounter unexpected costs from low quality of products or difficulties in management and so on, incurring additional costs related to foreign production and resulting in a reversal of their offshoring decision. In addition, if the government provides subsidies for reshoring, more firms are encouraged to move their production facilities back to their home country. On the other hand, as the reshoring policies lower the expected cost of offshoring, it also has the effect of encouraging the offshoring of firms. To summarize, reshoring policies expand offshoring as well as reshoring, and as such they do not guarantee additional job creation and an increase of production.
   Chapter 5 investigates reshoring trends and policies in Korea, U.S., Europe, and Taiwan. Korea implemented reshoring policies in 2013 to support firms which cut back foreign production and return to their home country by proving them with tax exemption and subsidy. As a result, 44 firms decide to reverse their foreign production as of Feb. 2018, mainly in industries of electronics and jewellery. Some papers conducted a survey targeting domestic reshoring firms and they show that reshoring policies are negatively assessed, and high labor cost, unavailability of skilled workers, troubles in closing production facilities abroad are pointed out as the difficulties associated with reshoring.
   Reshoring in the U.S. is reported in the “Reshoring Initiative Report,” which includes all types of reshoring introduced in Chapter 2. According to the report, there are about 700 cases of reshoring between 2010 and 2014. About 60% of firms came back from China as labor cost in China has rapidly risen in recent years. However, experts say that reshoring is not a main trend and does not substitute for offshoring. The U.S. government tries to attract domestic multinational firms by providing favorable conditions for investment through tax reduction, low energy cost, and construction of infrastructure.
   The EU encourages multinational firms to come back to their home country to achieve 20% of value added in the manufacturing sector until 2020. In particular, the reshoring policy is conducted in relation to the innovation strategy, such as Industry 4.0. Reshoring is most often observed in Sweden and Ireland, and is concentrated in high-tech sectors or the fashion industry to explore cutting-edge technology and high-skilled workers and to improve the proximity to the customers and response to rapidly changing trends. Also, the main reasons for reshoring in EU are low-quality of products and low flexibility in the production process. However, EU experts and policy makers still see that reshoring is a limited trend and a natural decision of the firms following offshoring.
   The Taiwanese government conducted a comprehensive survey for offshoring firms, asking whether they would be willing to return home, going on to provide subsidies for land and labor, and tax exemption for firms which were willing to come back to Taiwan. In particular, the government supports R&D operations to attract firms which possess advanced technology and materials. As a result, 255 firms returned to Taiwan between September 2006 and March 2009, followed by 85 more firms moving their production facilities to Taiwan in 2015 and 2016, achieving the target of the government. 
   Lastly, Chapter 6 discusses policy implications based on the data analysis, model development and case studies above. First of all, the goal of reshoring policies should be revised to improve industrial competitiveness rather than to create jobs. Specifically, the government needs to survey offshoring firms to understand their demand for reshoring and provide what they need to move production facilities back to their respective home countries. The government should apply a broad definition of reshoring to include reshoring from foreign outsourcing to domestic outsourcing because these forms of reshoring also contribute to an increase in production and employment. Also, the government should provide appropriate reshoring policies for high-tech sectors and the fashion industry in which reshoring is mostly observed, by providing pricing information or supply-chain information. Above all, it is important to provide favorable conditions for firms to increase their investment, which would have the effect of increasing both reshoring and inward foreign direct investment even without implementing reshoring policies. Lastly, differentiated incentive systems for different types of investment must be revised to prepare the basis for transparent investment policies.

  This study examines the economic cooperation between China and the EU and analyzes major trade issues in both regions. In addition, we analyze the competition between Chinese products and Korean products in the EU market, and draw up implications for the Korean government's EU trade policies and companies.

  Chapter 2 outlines the issues of bilateral trade and investment, including EU-China high-level dialogue, as well as a brief overview of cooperation in a wide range of fields. China and the EU are becoming more closely linked not only in terms of trade and investment, but also their cooperation in the fields of climate change, transportation connectivity, and innovation. The EU is China's largest trading partner and China is the EU's second trading partner. The EU's trade with China has exploded since China joined the WTO in 2001 and the two entered into a strategic partnership in 2003. In particular, the increase in goods imports from China has exceeded the increase in exports, and the EU's trade deficit with China continues to grow. The EU's main export commodities to China are concentrated in high-skilled machinery and chemical products, while China's export items to the EU include a variety of products from low-skilled to high-skilled. However, since 2010, China's machinery and transportation equipment exports to the EU are showing rapid growth, and the proportion of high-skilled products is rapidly expanding. In addition, China's recent increase of direct investment in the EU not only aims at the entry of Chinese goods and services into the European market, but also to secure brand value, expertise and technology through M&As with European companies. As a result, the Chinese economy is rapidly transitioning into high-value-added industries, and China's export items to the EU are rapidly reorganizing into high value-added products.

  Chapter 3 researches the major issues and prospects of trade disputes between China and the EU from the perspective of trade remedies like anti-dumping and countervailing duties, China's market economy status and bilateral WTO disputes. The biggest pending issue in trade disputes between China and the EU is identified as the market economy status related to anti-dumping measures and their effectiveness. The trade conflicts between the two regions will persist for the time being. If trade disputes between the US and China continue to expand and deepen, and the trend of global protectionism remains unchecked, more cases of trade friction will likely ensue between China and the EU. However, unlike the US, the EU is more inclined toward a dispute settlement method based on the rules of the multilateral trading system rather than unilateral sanctions. Therefore, as seen in the US-China trade dispute, it is relatively unlikely that full-scale retaliation to trade tariffs will take place.

  Some changes in the nature or form of trade disputes between China and the EU can be detected, one of which is the possibility of expanding the countervailing duty dispute related to the “Made in China 2025” initiative. EU industries are raising concerns that the Chinese government's support for Made in China 2025 could lead to over-production and thus strained trade relations. In the process of promoting Made in China 2025 as a national industrial development strategy, Chinese local governments as well as the central government are likely to implement financial support and preferential treatment measures for each core industry sector, which could constitute unfair subsidies. This means countervailing duties could play a larger role in China-EU trade disputes, which have hitherto focused mainly on anti-dumping measures.

  In Chapter 4, we consider the competitiveness of Korea and China in the EU market through a quantitative analysis of trade competitiveness, intra-industry trade and export similarity index.

  In the EU market, we can confirm that the export similarity between Korea and China for the 15 industry groups we examined is definitely on the wane. According to HS 4-digit classification, the top 30 export items of Korea and China to the EU do not show a high level of similarity, particularly in the case of higher-ranking items, and a large number of items indicate that intra-industry trade is active. In addition, Korean or Chinese products have secured global trade competitiveness in almost all of these items, and many of the top 30 items for Korea represented areas in which both countries have secured a high level of competitiveness. This shows that intra-industry trade in both countries has had a positive effect on the trade competitiveness of both countries and is one of the major factors that alleviated competition between the two countries despite the increase in market share.

  Finally, Chapter 5 evaluates the main characteristics of the China‒EU trade relationship, forming the conclusion of this study, and goes on to draw implications for Korea. It should be kept in mind that trade disputes between China and the EU may have an impact on the expansion of trade disputes with Korea, depending on future developments. Korea is ranked third in terms of the number of anti-dumping and countervailing duty measures taken by the EU, and is also the third most targeted by China for its anti-dumping duties. In particular, Korea has been subjected to more anti-dumping measures from China than the EU. This shows how Korea can always become involved in trade disputes with China and the EU regarding trade remedies. Accordingly, it is necessary to prepare for the possibility that the expansion of trade disputes between the US and China, and the escalation of trade disputes between China and the EU, will lead to further strengthening of trade regulations against Korea. In other words, by analyzing the development process and changes in trade disputes between China and the EU, it will become possible to understand the characteristics of these disputes and accumulate experience on the logic used in these situations, thus enabling preliminary measures to prevent such trade disputes or at least minimize any potential damages.

  As can be seen in the case of China-EU disputes, anti-dumping measures are initiated primarily at the request of interested parties or associations. Therefore, in order to minimize trade disputes with the EU and China, efforts should be made to strengthen cooperation with industry and foreign partners in other countries. This is a very important factor in resolving disputes after antidumping measures have been implemented.

  It is necessary to closely examine the development process of trade issues discussed in the “High-level Economic and Trade Dialogue (HED)” between China and the EU. In particular, we can expect for matters of utmost importance to both regions and Korea, including trade and investment cooperation, sustainable development, trade facilitation and IPR, to be discussed at the HED. Therefore, it is necessary to review the bilateral trade issues discussed during the China-EU HED and establish a proper stance on issues that can affect Korea's interests and prepare countermeasures.

  As the Korea-China export similarity analysis shows that intra-industry trade in both countries has had a positive impact on trade competitiveness on both sides, as well as easing competition relations despite the expansion of market share in the EU, trade disputes between China and the EU hold particular significance for Korea.

  Therefore, it appears inevitable that the Korean economy will be adversely affected by the intensification of such trade disputes, and we must work to minimize the negative effects by establishing comprehensive alternative measures such as the utilization of niche opportunities that appear during trade disputes, reorganization of GVCs, and diversification of export markets. 

  The sudden turn of events on the Korean Peninsula – the historic inter-Korean summit held on April 27th, second inter-Korean summit on May 26th, the Singapore summit between North Korea and the U.S. on June 12th, and the third inter-Korean summit held on September 18th and 19th – are raising expectations for North Korea’s denuclearization, easing of military tensions between the two Koreas, the official ending of the Korean War and a permanent peace settlement.
  The ongoing negotiations between North Korea and the United States, which has the most impact among all factors on the Korean Peninsula, ended in a stalemate because the U.S. demands a preemptive and complete denuclearization while North Korea is demanding an immediate lifting of sanctions. If positive results can be derived from the second summit between the North and the United States scheduled for early 2019, it is highly likely that an easing of economic sanctions will be initiated in accordance with progress toward denuclearization, rather than additional sanctions being imposed.
  This research aimed to study the lifting of international economic sanctions on North Korea in connection with the North’s denuclearization process and to deduce implications in response. In particular, the purpose of this research is to see how lifting economic sanctions against North Korea in the course of future nuclear negotiations between the United States and North Korea can contribute to the North’s denuclearization, and how this process could be mutually beneficial to both North Korea and the rest of the world. Towards this, we analyzed the UN Security Council’s multilateral sanctions on North Korea, bilateral sanctions against North Korea by the United States and Japan, related laws and issues arising during the process of lifting sanctions, and the economic effects to be gained by lifting the sanctions. Finally, we analyzed the process by which the United States and Vietnam re-established diplomatic relationships, going on to draw implications for North Korea.
  Going on to the content of the study, in the second chapter, we explore the UN Security Council’s sanctions against North Korea. These can be divided into two types, the first of which are those imposed on the North from 2006 to 2015 when the North conducted its first nuclear test, and those from 2016 to 2017. In order to measure the effect of the UN Security Council’s sanctions on North Korea, we calculated the Sanctions Effectiveness Index – a composite index that combines the Trade Effectiveness Index, Market Effectiveness Index, and Foreign Currency Achievement Index. Our results show that the effectiveness of sanctions against North Korea has significantly increased after March of 2017, thus indicating that sanctions imposed by the UN Security Council have remained firmly in place.
  Next, we present plans for multilateral cooperation measures that could be implemented before complete denuclearization, and a possible scenario of lifting sanctions in accordance with the North’s pre- and phased denuclearization. Ways to lifting or easing economic sanctions in proportion to the level of North Korea’s denuclearization are suggested, as the economic sanctions have had a severe impact on North Korea’s exports of minerals, marine products, clothing and textiles, dispatched workers, imports of crude and refined oil, and joint investment, in that order. Multilateral cooperation prior to complete denuclearization should be faithful to the purpose of completing the North’s denuclearization, and if the relevant sanctions are lifted, the international joint development and management of North Korea’s mines and special industrial zone development projects in North Korea are suggested as promising areas for further multilateral cooperations.
  In Chapter 3, we examine the lifting of sanctions against North Korea imposed by the U.S. The U.S. imposed sanctions on North Korea on the grounds of executive orders issued by its government, which is delegated the authority to impose sanctions in accordance with legal statutes, and laws enacted by the U.S. Congress. More specifically, the legal grounds for these sanctions on North Korea are as follows: the Trading with the Enemy Act (TWEA), Export-Import Bank Act (EIBA), Export Control Act (ECA) and the Trading Agreement Extension Act (TAEA), laws enacted in the name of national foreign policy, preventing the spread of socialist countries, non-market economies, WMD development, and proliferation threats. In addition to these comprehensive sanctions, there are laws that justify sanctions specifically on North Korea, such as the North Korean Human Rights Act (NKHRA), Iran, North Korea and Syria Non-Proliferation Act (INKSNA), North Korea Sanctions and Policy Enhancement Act (NKSPEA), and the Countering America’s Adversaries Through Sanctions Act (CAATSA). The other way that the U.S. has imposed sanctions on North Korea is by issuing executive orders by the president. The first executive order was issued on June 28th, 2005, followed by six more, including Executive Order 13466, which was issued after the U.S. government listed eight agencies as WMD proliferation agencies, of which three were North Korea’s organizations. The U.S. sanctions include restrictions on trade, aid, arms sales or transfers, and access to assets.
  It is unlikely that the U.S. will lift the sanctions all at once. A more realistic scenario is that the government will first exempt or postpone enforcement of some of the sanctions, and then lift the sanctions as the situation progresses. Partial suspension or exemption of sanctions can have the same effect as lifting sanctions in the short term, and any agreement to lift sanctions will likely incorporate “snapback” clauses stating that sanctions will be imposed again if the North reneges on the terms. As such, it would also be reasonable for North Korea to utilize such clauses as it seeks partial suspension or exemption from sanctions.
  In Chapter 4, we analyze Japan’s lifting of its bilateral sanctions on North Korea. Our analysis takes into account the fact that Japan has a special relationship with the North due to unresolved issues regarding the abduction of its citizens. During the six-party talks to reach a solution to the North Korean nuclear program, Japan caused difficulties for the denuclearization process by raising the Japanese abductees issue through international channels.
  Meanwhile, Japan could also provide North Korea with the biggest economic benefits and compensation in the process of lifting economic sanctions. Japan was once the North’s largest trading partner, and it is estimated that the amount of compensation money North Korea will claim from Japan in reparations for the colonial period will be substantial when the sanctions are lifted and diplomatic ties between the two countries are resumed. In addition, considering the international share of North Korea’s nuclear dismantlement, Japan will be able to financially support economic recovery in the North after its denuclearization. If the compensation money is used to build manufacturing facilities in North Korea, its foreign trade structure can expect tremendous change in addition to a rapid increase in trade with Japan.
  Chapter 5 discusses the process by which the United States lifted its sanctions against Vietnam and the issues that arose during this process. Prior to the establishment of diplomatic ties between the two nations, the U.S. implemented restrictions on trade or international aid to Vietnam and isolated the country from international partners. There was no choice for Vietnam but to cooperate with the U.S. in order to gain access to the world market and initiate trade with the U.S. as the sanctions continued to pile on. The United States used this position as leverage and demanded a high degree of openness in the Vietnamese trade market, as well as the resolution of political issues between the two nations. In light of the current denuclearization talks between the U.S. and North Korea, the process by which the U.S. lifted sanctions against Vietnam can be seen as a combination of a “front-loading” approach and phased, yet simultaneous efforts. During the early stages of the normalization process, Vietnam withdrew its troops from Cambodia and actively cooperated with the U.S. to excavate and repatriate the remains of U.S. troops. In response, the U.S. presented a four-stage roadmap corresponding to Vietnam’s efforts to normalize relations. We determined that economic sanctions were lifted sequentially, beginning with those of small effect but easy to remove, and eventually proceeding on to sanctions of strong effect and more difficult to remove. 
  Vietnam has benefited considerably from the elimination of economic sanctions. Its nominal GDP, which was $27.84 billion in 1980, jumped about eightfold to $22.04 billion in 2017. The amount of FDI and ODA flows also show that normalizing relations with the U.S. had a significant impact on the Vietnamese economy. Eventually, the U.S. granted Vietnam a permanent normal trade relationship (PNTR) status, which allowed it to join the WTO and be recognized as a normal country from the international community, and to create the institutional grounds for its economic growth.
  Lastly, Chapter 6 presented policy directions for lifting sanctions against North Korea in the process of denuclearization and proposed policy tasks for the South Korean government. First, we must lift multilateral and bilateral sanctions by cooperating with the United States, which holds a dominant position in negotiating the degree of sanctions against North Korea. Neither should we undermine the cohesion of the member states of the United Nations. In particular, it will be important for the UN Security Council to work with the United States, partially mitigating sanctions in line with North Korea’s denuclearization progress while strengthening the solidarity of multilateral sanctions and ensuring that the UN member states maintain the framework of sanctions against North Korea. In addition, a snap-back clause should be inserted in the negotiating terms to ensure North Korea implements its denuclearization measures within the prearranged time frame. Next, lifting of sanctions should start with ones which are easy to remove and have a small effect, and hold a strong leverage until the very last stage of the critical denuclearization phase. Of course, it will also be necessary to encourage North Korea to take decisive steps toward denuclearization by providing comprehensive support packages and other concrete economic incentives.
  In the process of lifting sanctions, the Korean government should coordinate each country’s interests and promote international cooperation by playing the role of a mediator. It will be highly important to create an environment that will allow North Korea and the United States to build trust with each other. The government needs to properly inform opinion leaders in the U.S. who affect U.S. policy, by engaging in public diplomacy efforts to promote understanding of the situation on the Korean Peninsula.
  North Korea’s denuclearization process will eventually require the United States to lift its sanctions against North Korea, yet this could take some time to resolve domestic legal procedures. In the meanwhile, the South should seek cooperation from the U.S. government to pursue inter-Korean economic cooperation first while the U.S. government lifts international sanctions against the North. The South should also make efforts to seek exemptions from and lifting of sanctions imposed by the U.S. government from the early stages of the North’s denuclearization, thus ensuring that South Korean corporations can become active partners in economic cooperation with North Korea. If North Korea gains a normal trade relationship(NTR) status from the U.S., South Korean companies will enjoy much more favorable conditions for economic cooperation in North Korea. Finally, it will be necessary to reassure North Korea about the benefits it will gain after sanctions are eased by presenting multilateral cooperation programs in the process of denuclearization. 

  The fourth industrial revolution is the next generation industrial revolution driven by intelligence information technology. Specifically, the digital innovations related to artificial intelligence, big data analysis, cloud computing, and the internet of things have driven hyper-connection between all products and services through global networks, thereby advancing the data-driven economy.
  This study describes the trend of digital innovations in the wake of the fourth industrial revolution, discussing the changes in the economic paradigm and international trade patterns in the future. This study also compares industry-level digital innovation by country using the data on patents reported to the US Patent and Trademark Office (USPTO), as well as the dataset provided by the OECD and the International Federation of Robotics. We simulate the effect of digital innovation on trade according to various scenarios, setting up the theoretical model for counter-factual analysis using data from World Input-Output Table released in 2016. In order to quantify the trade effects from digital innovation, we add fundamental productivity into a multi-country and multi-sector Ricardian model with input-output linkages, trade in intermediate goods, and sectoral heterogeneity.
  According to the results of the analysis, the significant improvement in the world’s digital innovation, led by the US and Japan, shows an increasing step curve during the years of 1998 and 2010. The quantitative and the qualitative level of Korea’s digital innovation is steadily rising, and the latest data rank it at a high level. However, Korea’s level of digital innovation is still relatively low compared to the US and Japan. When considering the recent drop in Korea’s H index with an increase in the level of digital innovation in China and India, Korea may experience a similar decline as the EU.
  Overall, industrial robots are showing an increase in the level of digital utilization. Around 72% of the world’s industrial robots are installed and operated in the US, Japan, Korea, China and Germany. Korea is the third largest robot installation station, and the fourth largest robot operator country which uses industrial robots actively. In particular, the number of robots that are operated per 10,000 workers in Korea is 631, the largest rate in 2016. As for the other indicators of digital utilization, despite the nation’s high usage rate of high-speed internet at enterprises (99.3%) and households (99.5%), the usage of ICT at enterprises is not that high in Korea, with the exception of the RFID utilization rate.
  For the simulations, this study considers ten different scenarios depending on productivity shocks from sector-level and country-level. At a bottom line, counterfactual analysis based on a variant of the Ricardian model shows that digital innovation is beneficial to international trade. In other words, if digital innovation boosts fundamental productivity, it triggers growth in international trade at both sector-level and country-level. If countries/sectors have higher productivity due to digital innovation, those become much more competitive in producing goods or services, affecting trade share, price, expenditure, and many others within the model.
  As fundamental productivity induced by digital innovation becomes higher and the number of countries that experience enhanced productivity grows larger, the model predicts that world trade volumes will become larger accordingly. However, the growth in trade volumes are uneven. Although digital innovation contributes to growth in world trade volumes, increases in world trade are concentrated in certain countries and/or sectors that lead digital innovations.
  The above-mentioned results of this study indicate that the Korean government must step up wide-ranging deregulation measures to facilitate digital innovations. In addition, trade rules such as Technical Barriers to Trade (TBT), Intellectual Property Rights (IPR), Telecommunication Agreements, and Electronic Commerce need to be urgently revised through the WTO negotiations. Policy governance also needs to be set up to systematically support digital innovation in private sectors.

Executive Summary

1. Introduction

2. Value Added Exports (VAX) in Services
2-1. Value Added in Exports of Service Sectors
2-2. Contribution of Service Sectors to Value Added in Exports of Manufacturing Sectors
2-3. Comparative Advantage of Service Sectors

3. Empirical Model and Data
3-1. Comparative Advantage in Services
3-2. Institution and Social Capital as Sources of Comparative Advantage

4. Estimation Results
4-1. Relative Labor Productivity and Comparative Advantage
4-2. Sources of Comparative Advantage
4-3. Robustness Check

5. Summary and Conclusion

References

Appendix
1. Country and Industry Classification
2. Derivation of Value Added in Exports (VAX) 

Previous studies that have identified the impacts of institutions or cultural traits on comparative advantage focused on goods trade, but not services trade. In contrast to the rapid increase in trade in services, empirical examina-tion on sources of comparative advantage in services trade remains limited. This paper attempts to fill this gap by investigating empirically the impacts of institution as well as social capital on comparative advantage in services trade. Services are exposed to relatively more pre-choice risks than goods, because it is difficult to obtain information on the quality of services before the con-sumer decides to purchase. In addition, trade in services involved in global value chains possibly takes on the risks of contract breach by other firms along the same value chains. As a result, the transaction risks for trade in ser-vices are higher than for trade in goods. Using the World Input Output Da-tabase, we estimate the importance of social capital for comparative ad-vantage in services. We find that countries with more social capital tend to specialize in the production of contract-intensive services. We also find that social capital rather than institution matters for comparative advantage in ser-vices.

Keywords: Services Trade, Comparative Advantage, Institution, Social Capital
JEL Classification: F11, F14 

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