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The Impact of Trade Liberalization on Consumer Welfare: A Focus on Quality Diversity
This study investigates the impact of domestic price changes due to external shocks such as trade liberalization or global inflation on quality diversity and consumer welfare. Free trade agreements (FTAs) can reduce the prices of ..
Chul Chung et al. Date 2023.05.25
Trade policy, Free tradeDownloadContentSummaryThis study investigates the impact of domestic price changes due to external shocks such as trade liberalization or global inflation on quality diversity and consumer welfare. Free trade agreements (FTAs) can reduce the prices of imported goods through tariff elimination or reduction, making it crucial to evaluate academically and in terms of policy how this price reduction affects consumer welfare. In contrast to prior literature on trade liberalization, this study emphasizes the role of quality diversity in explaining its impact on consumer welfare. We focus on how consumers’ qualitative responses to price changes, such as selecting high-quality products when prices decrease due to tariff reductions or responding to price increases due to tobacco taxes by adjusting the quality of their purchases, can influence consumer welfare. This study also provides policy implications regarding the impact of trade liberalization on consumer welfare.Using time-series data on wine and cigarettes in South Korea, this research estimated price elasticities and separated them into consumers’ quantitative and qualitative responses to price changes. The results indicate that the qualitative margin accounts for as much as 40% of the total, demonstrating that consumers’ qualitative responses to price changes are quite significant. We also found a statistically significant consumer behavior mechanism of quality shading in response to price increases for both wine and cigarette consumption, suggesting that consumers’ qualitative responses are as important as their quantitative responses. Moreover, we found that price reductions not only increase the consumption quantity of the same product but also lead to a shift to higher quality products, further enhancing consumers’ welfare. For the first time in the literature, we analyzed qualitative margins by income level and found that the price elasticity is higher for lower-income consumers, and most of it can be attributed to qualitative responses. These empirical findings suggest that consumers can adjust their spending on a particular good through qualitative adjustments while maintaining their overall consumption, particularly in response to rapid inflation. This response mechanism is particularly more effective for low-income households.Similarly, this study confirmed the existence of consumer quality adjustment responses to income changes through income elasticity analysis, with the size being larger among low-income households. Qualitative responses to income changes demonstrate that consumers can adjust their expenditure by maintaining the consumption level of staple goods such as rice or pork while reducing the expenditure amount, particularly in situations of declining real income during economic crisis. As with the analysis of price changes, our results suggest that this consumer behavioral mechanism in response to income changes can be also more effective for low-income households.The findings of this study indicate that trade liberalization’s expansion of quality diversity has a positive impact on consumer welfare by strengthening consumer mechanisms, particularly in response to inflation, drastic price changes, and real income declines during economic crises. These results provide a novel perspective on trade liberalization’s contribution to consumer welfare, with the analyzed quality diversity effect distinct from the product diversity described in traditional trade literature, thus representing a new source of gains from trade. Consequently, when assessing trade liberalization’s economic impacts, the quality diversity factor should also be considered. In addition, this study demonstrated that quality diversity expansion for consumers can be achieved for agricultural products through not only agricultural production policies but also trade liberalization. The resulting policy implications are significant for both average consumers and low-income groups in terms of welfare.However, the qualitative response of consumers to price changes may not always improve policy efficacy, particularly for certain types of goods, such as harmful goods taxes, where product quality diversity may not necessarily have a positive impact and can even have a negative one. For instance, if consumers switch to low-quality cigarettes in response to an increase in cigarette taxes, the quality-downgrading response may ultimately have adverse effects on health indicators related to cigarette taxes. Furthermore, when discussing harmful goods taxes, such as soda taxes and fast-food taxes, to combat obesity problems, the expansion of quality diversity can have the opposite effect, increasing the supply of unhealthy low-quality carbonated drinks or fast food. These discussions hold significant policy implications, indicating that to achieve health policy objectives through harmful goods taxes, it is necessary to prevent low-quality goods from entering the market, which could pose greater health risks. Finally, empirical research follow-up is needed for staple goods such as rice or pork, with future studies needing to consider consumers’ qualitative responses when using price elasticity. -
Recent Regulatory Trends in Mega FTA SPS Chapters
Previous studies on mega Free Trade Agreement (FTA) Sanitary and Phytosanitary (SPS) provisions have primarily focused on the translation and preparation required for implementing the SPS regulations outlined in the Comprehensive ..
Minji Kang Date 2023.05.19
Trade policy, Free tradeDownloadContentSummaryPrevious studies on mega Free Trade Agreement (FTA) Sanitary and Phytosanitary (SPS) provisions have primarily focused on the translation and preparation required for implementing the SPS regulations outlined in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP). However, in order to gain a comprehensive understanding of the current state of SPS regulations in recent FTAs, this study goes beyond the CPTPP and also includes the Regional Comprehensive Economic Partnership (RCEP), which is currently the largest FTA in existence and came into effect in Korea in February 2022. Additionally, the study compares these regulations with those of the United States-Mexico-Canada Agreement (USMCA).In addition to examining the SPS provisions of these mega FTAs, this study also investigates the status of domestic legislation related to SPS regulations in four specific areas: livestock quarantine, plant quarantine, fishery quarantine, and food quarantine. By conducting this analysis, the study aims to provide a comprehensive overview of the SPS chapter regulations in these mega FTAs as well as the domestic measures implemented in relation to SPS in the aforementioned sectors.Prior to the introduction of the Mega FTA, all of Korea’s bilateral FTAs included SPS provisions or chapters, but few included WTO Plus provisions. Furthermore, most bilateral FTAs specified that the dispute settlement procedures of the FTA would not be applicable to SPS provisions or chapters. The primary WTO SPS Plus provision found in these FTAs was the inclusion of an FTA SPS Committee, which served as a platform for bilateral discussions on SPS issues and facilitated information exchange. Additionally, depending on the FTA partner, FTA SPS chapters included WTO Plus provisions such as regionalization procedures, risk analysis in their own country, and cooperation on animal welfare.However, there has been a notable shift in this trend with the introduction of Mega FTAs. The SPS chapters of the CPTPP, the RCEP, and the USMCA have witnessed a significant increase in the number of provisions. On average, these mega FTAs contain 18.3 provisions in their SPS chapters, which is considerably higher than the average of 5.7 provisions found in Korea’s previously concluded FTAs.The SPS chapters of these mega FTAs encompass a range of WTO SPS plus provisions. These provisions cover various aspects such as regionalization, equivalence, risk analysis, emergency measures, audit, certification, import inspection, transparency, and more. The inclusion of these provisions demonstrates a greater emphasis on enhancing and expanding the regulatory framework related to sanitary and phytosanitary measures within the mega FTAs.The CPTPP and USMCA acknowledge the importance of adapting to regional conditions, including the concept of compartmentalization, as a means to facilitate trade. While the CPTPP and USMCA do mention this approach, they do not explicitly outline specific obligations regarding compartmentalization, unlike the EU-Japan Economic Partnership Agreement (EPA) which recognizes the concepts of zones and compartments as defined in the OIE Terrestrial Animal Health Code and OIE Aquatic Animal Health Code.However, the Mega FTAs do aim to enhance the transparency of the regionalization process by incorporating non-binding procedural provisions outlined in the Guidelines to Further the Practical Implementation of Article 6 of the Agreement on the Application of Sanitary and Phytosanitary Measures (G/SPS/48). By mandating these provisions, there is an expectation that the transparency surrounding the regionalization process will improve. It is worth noting that the Mega FTAs commonly impose the obligation to consider international standards, guidelines, and recommendations, necessitating the identification of trends in the establishment of such standards by international standard- setting bodies (ISSBs).The SPS chapters of the CPTPP and USMCA require the application of equivalence for a measure, a group of measures, or on a systems-wide basis, “to the extent practicable and appropriate.” It is worth noting that the Mega FTAs also share the characteristic of incorporating increased transparency regarding various procedural requirements in the application of equivalence.The Mega FTAs introduce the notion of “risk analysis,” which encompasses not only the “risk assessment” outlined in the WTO SPS Agreement but also includes the concepts of “risk management” and “risk communication.” This expanded perspective strengthens the procedural obligations related to SPS measures within these FTAs. In addition, except for emergency measures, if an importing Party has permitted the importation of a product from another Party at the time it initiates a review of SPS measures, it shall not suspend the importation of that product solely because the importing Party is conducting a review.The Mega FTA SPS Chapters enable Parties to take the emergency measures they deem necessary to protect food safety, and human, animal and plant health. In addition, the Mega FTAs introduce an audit provision that were not included in the WTO SPS Agreement. These provisions establish specific rules and procedures to prevent different audit-related regulations in different countries from becoming trade barriers, especially when it comes to conducting on-site due diligence.The Mega FTAs have implemented provisions to ensure that certification requirements only require information related to SPS issues to the extent necessary. Import checks for SPS requirements are based on the actual potential risks posed by the import. The Mega FTAs also include provisions to enhance transparency, such as allowing at least 60 days for other Parties to provide written comments after, notification of a proposed or changed SPS measure.Korea has undertaken significant legislative revisions to align with the quarantine requirements of the Mega FTAs. With the exception of fishery quarantine, the country appears to be well-prepared and continues its efforts to enhance preparedness. However, despite having established these legal frameworks, there may be challenges in effectively conducting risk analysis for quarantine purposes.In addition to legislative improvements, it is crucial to address the demands of the Mega FTA quarantine environment through additional measures. This includes providing training for professionals in the field and expanding financial resources and infrastructure. These efforts are essential to ensure that border quarantine measures are not compromised in practice. Notably, the CPTPP and USMCA explicitly specify the application of FTA dispute settlement procedures to SPS chapters, enabling disputes to be resolved swiftly. However, in the case of RCEP, the decision on whether the SPS chapter will be subject to the FTA dispute settlement procedure is set to be discussed two years after its entry into force. Given the potential for SPS-related disputes within the Mega FTA quarantine environment, it is imperative to be prepared for such scenarios.In particular, considering the trade concerns that have emerged in recent discussions at the WTO SPS Committee, issues such as regionalization and equivalence recognition are of utmost importance. It is crucial to develop legislation based on a comprehensive understanding of relevant international laws and to provide training for trade experts to effectively address these matters.The Korean government is currently participating in IPEF negotiations. Some US agricultural companies have proposed that the IPEF Pillar 1 agriculture sector negotiations be based on the CPTPP and USMCA SPS chapters, indicating that the influence of Mega FTA SPS chapters will continue to strengthen in the near future.Furthermore, there is a possibility that the Mega FTA SPS chapter will serve as a reference point in the ongoing negotiations for the improvement of existing FTAs. Considering the difficulties in using FTAs to claim exceptions for violations of the non-discrimination obligations under the WTO SPS Agreement, the establishment of procedural regulations within a single FTA SPS chapter can contribute to enhancing transparency in SPS procedures on a global scale. Therefore, any revision of the FTA SPS chapter should be approached cautiously, taking into account domestic considerations and the potential increase in administrative costs.It is hoped that through the collaborative efforts of the government, industry, and academia, we can successfully navigate the challenging waters of the Mega FTA quarantine environment. This requires careful preparation and consideration of various factors to overcome the obstacles and uncertainties that lie ahead. -
Introduction of the ‘Trade and Gender’ Rules and its Policy Implications
This study examines the latest standard linking trade and gender and suggests policy implications as Korea prepares to introduce the first gender chapter in an FTA.Inclusive growth or sustainable growth approach, an alternative to..
Soo Hyun (Catherine) Oh and Bomin Ko Date 2023.05.06
Economic growth, Trade policyDownloadContentSummaryThis study examines the latest standard linking trade and gender and suggests policy implications as Korea prepares to introduce the first gender chapter in an FTA.Inclusive growth or sustainable growth approach, an alternative to the growing inequalities that have emerged during globalization and trade expansion, is also applicable to trade and women. The discussion on trade and gender is based on the idea that the impact of trade may differ by gender. Factors that prevent women from reaping the benefits of trade include the existence of unique barriers to trade for women; the low level of direct participation in trade by the service sector, where women predominantly work; and the generally small size of firms worked in or owned by women. Therefore, there is a need to elaborate trade policies to provide opportunities for women to participate in trade and to ensure that women share in the benefits of trade, which will lead to quantitative and qualitative economic growth.In response, the WTO adopted ‘the Buenos Aires Declaration on Trade and Women’s Economic Empowerment’ at its 11th Ministerial Conference in 2017, established voluntary reporting in the WTO’s Trade Policy Review Process. WTO, through an informal working group and a dedicated unit on trade and gender, is actively engaged in discussions on women’s empowerment through trade.In FTAs, provisions on ‘trade and gender’ have evolved as follows. The gender standard was first included as a few articles in other chapters, such as labor and development, and then in the late 2010s, as Chile, Canada and others became active international advocates on the issues, a chapter on trade and gender was included in FTAs. In 2020, Chile, Canada, and New Zealand agreed to the Global Trade and Gender Arrangement(GTAGA), which provides a stand-alone text for a trade and gender rules.The ‘Trade and Gender’ chapter in an FTA consists of four main types of provisions. These are: general provisions, provisions citing international agreements, provisions relating to cooperation activities, and provisions on institutional arrangements. The general provisions state that adopting a gender perspective in the economic and trade matters can contribute to inclusive economic growth and emphasize the need to reduce barriers and create opportunities for trade and investment from a gender perspective.The next clause reaffirms the commitment to implement UN conventions such as CEDAW. The Cooperative activities section commits to undertake cooperative activities for the empowerment of women entrepreneurs, detailing specific areas of activity. The committees and points of contact provision provides for the implementation of agreed cooperation activities, review of the operation of the agreement and reporting on its implementation, and monitoring of the impact of other chapters of the FTA on gender equality. Through these provisions, the Committee, comprised of representatives from each Party, is tasked with holding annual meetings, formulating and implementing programmes related to the Agreement, and exchanging information on each Party’s experience. The institutional arrangements clause deals with dispute settlement.Chile has proposed a gender chapter in the Korea-Chile FTA revision negotiations. If a gender chapter is included in the Korea-Chile FTA revision negotiations, it will be the first of its kind in Korea. Korea will need to make political efforts to discuss the scope of acceptable cooperation activities during the negotiation process and use it for domestic reforms.The inclusion of a gender chapter in a trade agreement should be preceded by efforts to build social consensus. In particular, the inclusion of measures to support women traders and enterprises in provisions on cooperation requires building social consensus on the need for such measures. To this end, it will be necessary to present data on the significant under-representation of women in trade, to review the situation in Korea through international comparisons of gender equality indicators, and to analyse and discuss the causes of this phenomenon. In addition, it is necessary to raise awareness that the expansion of gender equality leads to quantitative and qualitative economic growth, and that the international community has normed the link between trade and gender equality on this basis. In Korea, gender equality indicators are among the lowest among OECD countries in terms of economic participation and opportunity, and action is needed to improve them. Since Korea’s industrialization, the labor market has been male-dominated as a result of exports led by large companies in the manufacturing sector, and the gender distribution of workers in different industries has been different, so the expansion of manufacturing exports through trade policy may have contributed to the widening of the gender wage gap.As Korea may be proposed to include a chapter on ‘trade and gender’ in future FTA renegotiations with Canada, the EU, New Zealand and the UK, as in the case of Chile, it is necessary to prepare for this and for the possibility of universal standardization of this issue by preparing in advance a ‘standard draft of a Korean-style FTA chapter on gender’. -
International Conflicts and Economic Interdependence: Implication for Economic Security
In this paper, I suggest a microeconomic foundation on the recent conflict between the United States and China. In addition, I review some formal models of international conflicts that examine the relationship between intern..
Youngseok Park Date 2023.04.28
Economic security, International tradeDownloadContentSummaryIn this paper, I suggest a microeconomic foundation on the recent conflict between the United States and China. In addition, I review some formal models of international conflicts that examine the relationship between international conflicts and economic interdependence. Furthermore, I present a simple bargaining model of economic sanctions against a dictatorship country, which are increasingly employed around the world in recent years. -
The Taiwan Issue and Korea's Economic Security in the Era of U.S.-China Strategic Competition
During the Cold War, the United States and China began visible efforts to normalize relations in 1972, with the strategic intent of jointly responding to the common threat posed by the Soviet Union, and finally established diploma..
Jaichul Heo Date 2023.03.09
Economic security, Chinese politicsDownloadContentSummaryDuring the Cold War, the United States and China began visible efforts to normalize relations in 1972, with the strategic intent of jointly responding to the common threat posed by the Soviet Union, and finally established diplomatic relations in 1979. In this process, the Taiwan issue was one of the biggest obstacles to normalizing bilateral relations. Nevertheless, the two countries succeeded in establishing diplomatic relations by agreeing on the “One China” principle (policy) and recognition of non-governmental exchanges between the U.S. and Taiwan, and have managed the Taiwan issue based on three joint statements made by the two countries. However, the Taiwan issue has been brought to the forefront again, mainly due to great transformation in the international order and strategic competition between the U.S. and China, created by the rise of China and the response of the U.S. to contain it. Of course, even after the establishment of diplomatic relations between the U.S. and China, friction between the U.S. and China over the Taiwan issue and confrontation between both sides of the Taiwan Straits (i.e. Chinese mainland and Taiwan) have continued. However, the recent U.S.-China strategic competition has further increased the risk and uncertainty of the Taiwan issue. In addition, with the outbreak of the Russia-Ukraine War, the international community's concern about the Taiwan Strait has grown, and the strategic value of Taiwan is rising even more in the era of the Fourth Industrial Revolution, as an important actor in the global semiconductor supply chain. Against this background, this study analyzes the impact of U.S.-China strategic competition on the Taiwan issue and considers the implications for Korea in terms of supply chain stability, industrial competitiveness, and economic statecraft, which are important elements of economic security.First, the supply chain instability that can result from an emergency in the Taiwan Strait will mainly occur along the maritime transportation route, which accounts for an overwhelming portion of Korea's import and export volume. The maritime transportation routes passing through or near the Taiwan Strait account for 33.27% of Korea's maritime transportation, and if an issue arises along this route, it is calculated that an economic loss of KRW 445.2 billion per day would result even when only accounting for major resources and products. According to a wargame scenario of an emergency situation in the Taiwan Strait, fierce battles are expected to take place between seven days and 70 days, which could cause up to 31 trillion won in economic losses during the period of active engagement alone. In addition, the expected amount of economic damage is expected to increase further when including other resources, products, and air transportation routes in the analysis.Meanwhile, military skirmishes between South Korea and China or between the two Koreas, that may occur as a result of a military clash between the U.S. and China in the Taiwan Strait, can be expected to destabilize the Korean Peninsula and have a major negative impact on the Korean economy. In other words, the instability of the Taiwan Strait can be added as an element of the so-called “Korea discount.” In addition, if South Korea intervenes in the Taiwan issue in any way, China is expected to use its own economic power to deploy economic statecraft toward sanction measures against South Korea. Judging from various circumstances, China may impose more high-strength economic sanctions in relation to the Taiwan issue than those seen during the THAAD issue. Accordingly, as in the case of the THAAD issue, we can expect suspension of various economic cooperation projects, the promotion of boycotts, restrictions on tourism, strengthening of sanctions against Korean companies in China, and restrictions on imports of Korean products, as well as more systematic and sophisticated forms of economic statecraft implemented in accordance with the Export Control Law of the People’s Republic of China (中华人民共和国出口管制法) and the Law of the People’s Republic of China on Countering Foreign Sanctions (中华人民共和国反外国制裁法), which came into effect in 2021.In order to prepare for risks and uncertainties caused by U.S.-China strategic competition and cooling cross-strait relations, Taiwan, which has a high economic dependence on China like Korea, is pushing for diversification of its supply chain and imports/exports, stronger competitiveness in key industries such as semiconductors, and closer economic cooperation with allies. Such strategic measures by Taiwan, conducted to ensure its survival, present not only opportunities but also challenges for the Korean economy. In fact, Taiwan's New Southbound Policy (新南向政策), the Moon Jae In government's New Southern Policy (NSP), and the Yoon Suk Yeol government's Strategy for a Free, Peaceful, and Prosperous Indo-Pacific Region all aim at competing over the ASEAN market and fierce competition to gain the upper hand in the semiconductor industry.As such, in a situation where tensions over the Taiwan issue escalate as U.S.-China strategic competition intensifies, Korea must make thorough preparations to cope with the direct and indirect impacts this will have on Korea's economic security.From the perspective of Korea’s economic security, the worst case scenario regarding the Taiwan issue is a situation where military conflict breaks out in the Taiwan Strait and Korea is drawn into this conflict. It will be necessary to consider such a situation as Korea carefully assesses the benefits and risks associated with the U.S. Army deploying a Multi-Domain Task Force (MDTF) to the Korean Peninsula, or transition of the mission assigned to the USFK, focusing on national interests.In addition, more attention and measures are needed at the national level to ensure the safety of major maritime traffic routes, including the Taiwan Strait. This is because strengthening maritime power is essential not only in terms of traditional security, but also in terms of economic security, as examined in this study.And, from the perspective of tensions on the Taiwan Strait and economic security, another important factor will be to improve inter-Korean relations. This is because even should a military conflict occur in the Taiwan Strait, efforts to improve inter-Korean relations could minimize the destabilizing effect this has on the security of the Korean Peninsula. If inter-Korean relations are not managed stably and left in a confrontational state, military clashes in the Taiwan Strait could directly escalate into security instability on the Korean Peninsula, for instance in the form of military provocation by North Korea.Meanwhile, as seen with Taiwan's New Southbound Policy, the Korean government needs to establish a more detailed foreign policy focused on ASEAN and South Asia to promote stability in the supply chain and diversify its import sources and export markets. The Strategy for a Free, Peaceful, and Prosperous Indo-Pacific Region announced by the current government of Korea presents the direction of these efforts, and further steps should be taken to establish detailed policies.In addition, just as Taiwan is striving to strengthen its competitiveness in the semiconductor industry as a survival strategy amid U.S.-China strategic competition, Korea should implement more active policies to strengthen its competitiveness and improve the conditions for corporate investment in the area of system semiconductors. More active support will be necessary at the national level to maintain or widen the existing technology gap Korea currently enjoys in the memory semiconductor field, and to gain competitiveness in the areas of system semiconductors, materials, and equipment.Lastly, the Korean government must carry out active measures and increase its policy focus on trust-building efforts with other stakeholders in the region, another key element of economic security. While it is very important to de-escalate potential threats by building trust with other parties for economic security, as well as to secure a material and institutional basis, interest and efforts in this area appear to be relatively lacking. We should reduce the uncertainty of economic sanctions by building trust with China and actively seek a constructive role as a middle power country to restore trust between the U.S. and China. -
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The Structural Improvement for Korea’s Foreign Exchange Market and Its Implications on Korean Economy
The Korean government has identified the need to ‘improve the structure of the foreign exchange market’ as a pivotal step in aligning the accessibility of the foreign exchange market with global standards that foster a mor..
H.S. Kim et al. Date 2022.12.30
International finance, Financial liberalizationDownloadContentSummaryThe Korean government has identified the need to ‘improve the structure of the foreign exchange market’ as a pivotal step in aligning the accessibility of the foreign exchange market with global standards that foster a more open and competitive market structure. This plan can be summarized in the following two ways. One is to overhaul foreign exchange laws and regulations. The foreign exchange transactions of domestic individuals, enterprises, and financial institutions are governed by the Foreign Exchange Transaction Act, which was enacted in 1999, and which the government intends to reform in line with the changes in the domestic and external economic environment. The other is to strengthen the foreign exchange market infrastructure. The government plans to introduce electronic trading methods in the foreign exchange market, allow foreigners to participate in the interbank market and extend the trading hours of the foreign exchange market.
By improving the foreign exchange market structure, Korea will become more in line with the trend of financial globalization that began in the 1970s. Financial globalization refers to the process by which global financial markets are becoming more interconnected and integrated, although assessments of financial globalization are mixed. Financial globalization has contributed to expanding access to capital at the national level, reducing the cost of capital, and diversifying external portfolios through international risk-sharing, although it has also led to increased volatility in domestic financial markets and the transmission of external shocks through international financial markets, sometimes resulting in financial crises in some countries. The benefits of financial globalization have been different for advanced and emerging economies. Emerging economies can raise scarce capital through international financial markets, while developed economies can earn higher returns by deploying their capital abroad. In the process, a Pareto improvement could be achieved worldwide.
Given Korea’s economic circumstances with its rapidly aging population, it is necessary to further improve the foreign exchange market. In Korea’s export-led growth economy, the government’s foreign exchange market policy may have contributed to improving the trade balance by ensuring financial stability and bolstering competitiveness through currency depreciation. However, it is necessary to transform Korea’s external economic structure into a more advanced one in preparation for the weakening of structural growth engines and a future trade balance slowdown. Improving the foreign exchange market could be a milestone in expanding the capacity and scale of the financial market in the long term by expanding financial openness and further securing the engine of economic growth.
This study consists of five chapters, including the Introduction. The current status of Korea’s foreign exchange market and the government’s plans to improve the foreign exchange market are presented in Chapter 2. Chapter 3 examines the impact of expanding trading hours in the foreign exchange market on the exchange rate volatility using an agent-based market model. Chapter 4 analyzes the impact of financial globalization on economic growth and volatility, especially for advanced economies, and Chapter 5 concludes.
Chapter 2. Korea’s Foreign Exchange Market: Current Status and Government Plans
The Foreign Exchange Transactions Act, which replaced the Foreign Exchange Management Act, was enacted in April 1999, shortly after the Asian financial crisis. It made significant advances in foreign exchange transactions characterized by a shift from pre-reporting to post-reporting mechanisms and a significant move toward prudential supervision. In essence, this legislative reform represented a shift from the previous emphasis on strict management to a more autonomous approach that reflects domestic and international economic environment.
Following the enactment of the Foreign Exchange Transactions Act, Korea continued on the path of financial liberalization, implementing measures such as the liberalization of foreign exchange transactions for individuals, the abolition of the permit system for capital transactions, and the adoption of negative regulation systems. In line with this ongoing momentum, a new foreign exchange law was planned to be enacted in 2009. However, the global financial crisis of 2008 disrupted these plans, leading to related discussions and revisions to legislation being postponed.
The Foreign Exchange Transactions Act is essentially rooted in two key perspectives. First, it reflects a perception of historical context, shaped by foreign exchange shortages, aiming to regulate foreign exchange outflows and encourage foreign exchange inflows. Second, the legislation is underpinned by the recognition that maintaining the stability of the foreign exchange market is of paramount importance, based on the nation’s experience during the Asian financial crisis and the subsequent global financial crisis.
At present, however, the Foreign Exchange Transaction Act has limitations in adapting to the evolving domestic and global economic environment. For example, despite the abolition of the licensing system, a substantial portion of capital transactions remains subject to the pre-reporting system. Moreover, the reporting system for capital transactions introduces a layer of complexity, with different reporting requirements depending on transaction size, the counterparty involved, or the occurrence of foreign exchange outflows. This complexity imposes significant inconvenience and administrative costs on the public, thereby compromising the convenience and autonomy of transactions. Moreover, the prevailing structure of the foreign exchange institution system is particularly bank-centric, with domestic banks playing a central role in operations. Designated as the exclusive channels for foreign currency transactions, except for small remittances, banks enforce a system centered on foreign exchange banks. This concentration runs counter to contemporary trends, as non-bank financial institutions gain importance with the introduction of diverse financial products and the expansion of cross-border capital flows.
This regulatory approach may be detrimental to supporting external resilience in the long run. The excessive emphasis on stabilizing the foreign exchange market, particularly the obsessive concerns over exchange rate volatility, has led to a delay in the deregulation and internationalization of the won. Consequently, the development of the foreign exchange system has been relatively overlooked. Despite the remarkable growth of capital markets such as stocks and bonds, Korea is still not treated as a fully developed country in the international arena due to the lack of a 24-hour foreign exchange market and foreign exchange regulations, highlighting the need to address these gaps for comprehensive economic progress and global recognition. The recent initiatives undertaken by the Korean government to improve the foreign exchange market can be divided into two main components. The first is the comprehensive restructuring of foreign exchange laws and regulations, reflecting the domestic and external economic environmental changes. The second is the systematic improvement of the foreign exchange market infrastructure in order to make the market more accessible to foreign investors.[Foreign exchange laws and regulations reform] The government unveiled its strategy for reforming the foreign exchange system on February 10, 2023, aiming to modernize regulations and enhance the competitiveness of the financial industry. This comprehensive direction will unfold in two distinct phases, taking into account both the potential economic impacts and the necessity to overhaul longstanding practices. In the initial phase, the government will focus on refining regulations related to transaction procedures and various foreign exchange business areas. This includes streamlining the foreign exchange transaction process for individuals and businesses through revisions to executive orders and regulations. This will be followed by a second phase of deeper structural reforms and legislative changes, and will include the complete liberalization of capital transactions and the abolition of industry-specific business regulations, all guided by careful consideration of the prevailing economic circumstances.
[The FX market infrastructure improvement] On February 7, 2023, the government announced its "Foreign Exchange Market Structure Improvement Plan" with the aim of improving global market access. The overall goal is to refine the foreign exchange market structure to improve access to the foreign exchange market on a global scale while taking into account external stability. This included a strategy to transform the domestic foreign exchange market into an open and competitive market structure, rather than opening an offshore market for the Korean won beyond domestic regulatory oversight.
To achieve these goals, the government has outlined three specific improvement measures: first, opening the domestic foreign exchange market to registered foreign institutions (RFIs); second, significantly extending market opening hours of the domestic foreign exchange market from 09:00-15:30 to 09:00-02:00; and third, building an advanced market infrastructure. This includes the adaptation of real-time electronic trading in the client-to-client market. Specifically, the Application Programming Interface (API) currently provided to domestic financial institutions by licensed foreign exchange brokers will be made available to RFIs. Additionally, the government intends to institutionalize and permit foreign exchange electronic brokerage services, commonly known as aggregators, in line with prevalent global market practices.
The government also introduced two complementary measures: establishing cooperative relationships between RFIs and domestic financial institutions and adjusting the regulatory system for a greater external soundness. The first aims to bridge transaction gaps for RFIs and provide administrative support for domestic financial institutions. By facilitating cooperation and adjustment, this measure strengthens the role and competitiveness of domestic financial institutions. The second involves fine-tuning the regulatory system to ensure a greater external soundness. This includes revamping macroprudential policy, implementing a contingency plan (safeguard), and formulating effective supervisory measures.
Korea has already crossed the threshold of an advanced economy. Through the process described above, Korea desires to develop a deeper and more market-oriented foreign exchange market, thereby improving the convenience and efficiency of participants. Also, it endeavors to internationalize the Korean won in the longer term. Simultaneously, these improvements are expected to improve the positioning of the Korean financial market, including in prominent global market indices such as the MSCI and WGBI.
Chapter 3. The Impact of Extending the Trading Window on the Foreign Exchange Market
The Korean government has planned to improve the foreign exchange market due to its concerns that the market needs to respond sufficiently to the growing demand for foreign exchange. The critical points of the improvement are to allow overseas-based financial institutions to participate in and to extend the trading hours of the onshore foreign exchange market. While there can be various forms of enhancing the foreign exchange market structure, we are focusing mainly on the extension of the opening hours and the participation of foreign investors who have been trading the Korean won in the offshore market.
To analyze the effect of extending foreign exchange market hours on exchange rate volatility and foreign exchange transactions, we build an agent-based model of the foreign exchange market, as a simple model that provides a counterfactual tool. This approach contributes to the existing literature by providing a methodology to estimate the effect of extended trading hours, given that intraday data and volume information on the foreign exchange market are currently not available for analysis.
According to the simulation results with randomized parameters, the effect of extending trading hours on exchange rate volatility depends on the proportion of new participants in the market. The extended hours are expected to increase the exchange rate volatility if participants in the extended hours are about half of the participants in the regular trading hours. Meanwhile, it will increase the volatility of the exchange rate somewhat, but not enough to be of concern if the proportion of participants in the extended hours is as high as in the regular hours.
The percentage of investors participating in extended hours is also critical to the effect of extended trading hours on trading volume. If the investors in the extended hours are half the size of investors in the regular trading hours, trading in the extended hours appears to be less active than in regular hours. However, if the number of investors in extended hours approximates the number of investors those in regular trading hours, trading volume in the extended hours will be similar to that in regular hours.
When interpreting the effects of extending trading hours in the forex market predicted by the model, we should keep the following in mind: first of all, the predictions of the model are affected by assumptions imposed to simplify the complex foreign exchange market into a theoretical model. Thus, changes in the assumptions may lead to changes in the exchange rate volatility and trading volume predicted by the model to a greater or lesser extent. Second, due to data limitations, many of the parameters used are borrowed from existing studies and calibrated to fit some moments of the Korean foreign exchange market. Finally, we ignore the possibility that the extension of trading hours may lead to changes in the parameters.
In summary, we use an agent-based model to assess the potential effects of extending trading hours in response to the Korean government’s plan to improve the foreign exchange market. The simulation results show that the impact of extended hours on exchange rate volatility and trade volume hinges on the proportion of new participants during these hours, which, consistent with the key facets of improvement, involves enabling overseas financial institutions’ participation and extending the hours of the onshore foreign exchange market hours.
Chapter 4. Financial Globalization on Economic Growth and Volatility
The objective of reforming the foreign exchange system and improving the foreign exchange market structure is to increase financial openness by expanding the market functioning of the foreign exchange market. This implies that Korea wants to be in a position that increases de facto financial openness while being more in line with the trend of financial globalization that has accelerated over the past three decades. This chapter analyzes the impact of increased financial openness on economic growth and volatility. In particular, we examine how the impact differs across economic conditions as Korea has become an advanced and a net foreign asset economy.
Korea has been classified as an advanced economy and transformed into a net foreign asset country in 2014, thanks to a prolonged current account surplus. Notably, its ability to respond to financial instability through the external sector has improved remarkably. Despite these achievements, the traumas of the 1997 Asian financial crisis and the 2008 global financial crisis have led it to prioritize maintaining external soundness over full opening of its financial market. As a result, Korea’s financial openness, as measured by the size of external assets and liabilities, remains relatively low at 86.9% of GDP in 2021, compared to the average of advanced economies (370.1% of GDP).
Our analysis examines the impact of financial openness and other measures on economic growth and volatility. We define economic growth and volatility as the mean and standard deviation of real per capita GDP growth over the next five years. We consider trade and financial openness as the main explanatory variables: trade openness is measured as the sum of exports and imports as a percentage of GDP, and financial openness as the sum of external assets and liabilities as a percentage of GDP.
The empirical analysis underscores that increasing financial openness in advanced and net external creditor economies contributes to economic growth with minimal impact on economic volatility. However, the effect of financial openness may be insignificant in emerging economies and net external debtor economies. It could even lead to increased economic volatility, even if trade openness significantly boosts economic growth. These results suggest that trade openness can support economic growth in the early stages, given the stage of economic development. However, after the economy reaches a certain level of development, financial openness may be essential for economic growth.
In addition, we find that foreign exchange reserves positively affect economic growth and reduce volatility for net external debtors, while these effects diminish for net external creditors. These results suggest that when a country is a net external debtor in the early stages of economic growth, the accumulation of foreign exchange reserves has a positive impact on economic growth. In contrast, the impact diminishes when a country becomes a net external creditor. These results have implications for Korea’s policy trajectory, which has historically focused on trade-driven growth and reserve accumulation to ensure external stability.
Chapter 5. Policy Proposals and Conclusion
When considering Korea’s economic conditions, it is necessary to continue to promote the improvement of the foreign exchange market from the perspective of promoting economic growth. On the other hand, the improvement of the foreign exchange market should be implemented gradually in line with market conditions, taking into account the global economy and international financial market conditions. In the second half of 2022, interest rates in many countries sharply increased in response to high inflation. Under such a tight monetary policy framework, there is a high probability of capital flight, triggering financial turmoil that could lead to a crisis. Therefore, it is difficult to say whether this is the best time to promote the improvement of the foreign exchange market. However, the fact that there was little likelihood of a financial crisis even during a period of sharp depreciation of the won/dollar exchange rate, which exceeded 1,400 won in the second half of 2022, suggests that Korea’s economic fundamentals have strengthened considerably.
The results of this study offer several policy implications. First, the adjustment of the scope of business-by-business category in the new foreign exchange law should be promoted in a same-businesssame-regulation manner to prevent regulatory arbitrage. If different regulations are applied to the same business, capital flows may be concentrated in relatively less regulated sectors, and risks may accumulate. Therefore, if banks’ current foreign exchange business is gradually expanded to non-bank financial companies, supervision and regulation should be expanded gradually and symmetrically. Second, when promoting policies to improve foreign investors’ access to the foreign exchange market, it is necessary to explore ways to expand the number of foreign exchange market participants in order to reduce exchange rate volatility. In this study, we find that exchange rate volatility increases when the proportion of investors participating in the foreign exchange market decreases when the trading hours of the foreign exchange market are extended. To extend the trading hours of the foreign exchange market, Korea can consider improving trading systems and institutions to allow overseas-based financial institutions to participate in the foreign exchange market or provide incentives for financial institutions to participate. In addition, China’s experience in extending the trading hours of its onshore foreign exchange market may be a helpful reference to benchmark to minimize the negative impact of extending trading hours. Finally, it is also necessary to prepare countermeasures against potential risks (such as excessive exchange rate volatility) that may arise from the enactment of the new foreign exchange law and policies to improve foreign investors’ access to the foreign exchange market.
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The US Financial Sanctions on China and Its Implications on Korea
Economic sanctions are typically imposed as coercive measures to restrict a target’s economic activities, with the aim of achieving foreign policy and national security objectives. The United States has employed many methods of e..
Wonho Yeon et al. Date 2022.12.30
Economic security, Financial liberalizationDownloadContentSummaryEconomic sanctions are typically imposed as coercive measures to restrict a target’s economic activities, with the aim of achieving foreign policy and national security objectives. The United States has employed many methods of economic sanctions, such as imposing import and export limitations, withholding foreign aid and investment, seizing foreign assets, and forbidding its nationals from doing economic transactions with sanctioned individuals and companies. Financial sanctions encompass a range of measures that particularly limit the movement of funds and other forms of asset value to countries, companies, and individuals subject to sanctions. These measures have a wide-reaching impact as they can freeze assets, prohibi t or restrict financial transactions, and even disrupt the settlement of import and export activities.The utilization of economic sanctions as a geopolitical instrument has a lengthy historical background, but, the current impact and efficacy of U.S. sanctions are unparalleled. Although countries other than the United States have the authority to enforce tariffs, import and export controls, and other non-tariff barriers, they lack the ability to independently limit access to the global financial system, unlike the United States. Therefore, the secondary sanctions imposed by the United States, which limit dollar transactions, enables the United States to exert its influence on a worldwide scale through working in conjunction with other economic restrictions, such as export controls.Amidst the escalating strategic rivalry between the United States and China, the United States is broadening both the extent and substance of its financial sanctions. In the ongoing competition for technological supremacy between the United States and China, the United States can leverage its influence in the financial sector to impede China’s access to the necessary resources for the advancement of its own high-tech sectors. Furthermore, the United States has the ability to intervene in transactions occurring within the supply chain of high-tech enterprises that utilize U.S. currency, in addition to imposing restrictions on domestic U.S. companies selling components to China.Chapter 2 explores the legal foundation, governance, and enforcement procedures of U.S. financial sanctions imposed on China. It also provides an account of the present situation and future possibilities of U.S. financial sanctions against China. It concludes that U.S. financial sanctions are based on a legal foundation and are implemented through a coordinated process among Congress, the President, and key executive branch agencies. While the United States has a long history of using financial transaction sanctions to address violations of international norms, it has recently adopted financial sanctions to block the flow of funds, including equity investments in certain Chinese companies, in response to China’s technological rise and national security threats.Chapter 3 examines China’s response. In China, finance is an important industry that supports economic growth and is still one of the fastest-growing industries in the country. Chinese companies also rely on the U.S.’s advanced financial system to finance their businesses and invest abroad. However, with the U.S. utilizing sanctions as one of its tools, China has been forced to respond and prepare for external shocks to its financial industry. Chapter 3 analyzes China’s response to the recent U.S. financial sanctions, categorized into short-, medium-, and long-term strategies. It analyzes China’s short-term responses to U.S. financial sanctions in terms of its position statements and the adoption and application of laws and regulations in response to foreign sanctions; its medium-term responses in terms of standardizing overseas listings and diversifying financing sources; and its countermeasures against U.S. financial sanctions in terms of developing the renminbi international payment system and expanding capital market capacity.Chapter 4 examines the economic consequences of a protracted period of significant financial de-globalization caused by financial sanctions between the United States and China. In this context, “substantial” refers to a decline in local investments abroad and foreign investments within the country. We aimed to analyze the economic consequences of a country’s gradual shift from an open to a closed economy, where foreign capital inflows are replaced by domestic investments. Our research indicates that a reduction in trade openness has a detrimental effect on economic growth, whereas the influence of financial openness is not statistically significant. Nevertheless, if there is a rise in fragmentation within the global economy, leading to limitations on capital investment in China to specific nations, namely an increase in financial concentration, it would adversely affect economic growth. In addition, we analyzed the current level of financial interconection between the United States and China in order to assess the immediate expenses associated with an escalation of hostilities and the severance of their financial systems.Even if the introduction of financial sanctions between the U.S. and China reduces financial globalization in a de jure sense, it is difficult to say with certainty that it will reduce outward investment globally or between the two countries in a de facto sense. However, it is possible that competition in the financial sector between the U.S. and China could reach new extremes. In response to Russia’s invasion of Ukraine in 2022, Western countries such as the U.S. and EU took measures such as freezing the Russian Central Bank’s foreign exchange reserves and excluding major financial institutions and corporations from SWIFT. Under extreme conditions, such as a Chinese invasion of Taiwan, it is conceivable that the U.S. could impose such measures on China, and that China would be forced to dramatically reduce its reliance on the dollar payment system, even at the cost of significant short-term losses, and stick to the RMB international payment system.However, it is unlikely that the U.S. would want to see China accelerate the internationalization of the RMB and the internationalization of the RMB necessitates consensus among nations, rather than solely China’s endeavors. Consequently, a scenario of intense confrontation or competition in the financial sector between the United States and China is unlikely to occur. The United States is likely to choose a course of action that involves strengthening regulations on financial transactions involving specific high-tech or strategic goods. In this scenario, our government will need to devise strategies to minimize the negative impact on our industries, while our companies will need to take measures to avoid being subjected to sanctions by improving their own compliance. -
A Study on Updating Korea’s Services Trade Statistics System
This report aims to provide directions for improving Korea’s service trade statistics. Ultimately, the purpose is to enhance the understanding of Korea’s service trade and contribute to the establishment of service trade policie..
Jong Duk Kim et al. Date 2022.12.30
International trade, Industrial policyDownloadContentSummary정책연구브리핑This report aims to provide directions for improving Korea’s service trade statistics. Ultimately, the purpose is to enhance the understanding of Korea’s service trade and contribute to the establishment of service trade policies through improved data. To this end, the report categorizes Korea’s service trade statistics into short-, medium-, and long-term agendas based on the progress of discussions on international service trade statistics, domestic policy demand, and data availability for statistical improvement, and studies each agenda.Chapter 2 first look at the historical discussions regarding the definition of services in economics, and the definition of service supply modes stipulated in trade agreements such as the GATS. Modern service trade statistics collected on the balance of payments are compared with suggested statistics by mode of service supply under the GATS. Based on these discussions, the report presents two considerations for improvements from the perspective of services statistics construction. First, it is necessary to put an effort to converge the classification of the balance of payments to the CPC. Second, statistics by mode of supply defined in services trade agreements need to be reflected in the collection of balance of payments statistics, currently aggregated without distinction by mode of supply.Chapter 3 discusses how to convert trade statistics by service sector on the balance of payments, which is a transaction standard, into industrial standard service trade statistics such as the Korea Standard Industry Classification. The convergence to activity-based classification is helpful in setting out policy directions at the industry level, and matching with other activity-nased statistics, e.g. foreign direct investments, which are readily prepared based on the Korean standard industry classification. In Chapter 3, service trade statistics from the balance of payments are reclassified according to the Korea Standard Industry Classification. In this process of bridging and fill the gap between the two statistics, a fair amount of addition information and complementary data in each industry are required. Ultimately, in order to increase the rigor of the statistical correspondence between the international balance of payments and the standard industrial classification, it is necessary to test the consistency between them.In Chapter 4, service trade statistics by mode of supply were estimated as a medium-term improvement issue. There is a great interest in statistical estimation by mode of supply in that different mode implies distinctive impacts on services market. Recently, statistics by mode of supply for individual countries, TISMOS (Trade in Services by Mode of Supply), have been released by the WTO and OECD. However, since Korea’s statistics shown in TISMOS were estimated indirectly using estimates from some countries such as the United States and the EU. In order to initiate discussions to accurately estimate service statistics by mode of supply in Korea we conducted surveys regarding how Korean companies in services sector have traded in terms by mode of supply, focusing on Mode 1 in particular. Then, for more accurate estimation of Mode 2, most of which is accounted for by travel services, we suggest to use additional information and data from Korea’s Foreign Tourist Survey or National Travel Survey. In the case of Mode 3 services trade estimation, we discussed ways to utilize information and data such as “Overseas Direct Investment Management Analysis” provided by the Export- Import Bank of Korea for Mode 3 exports and “Foreign-invested Company Management Survey Analysis” by KOTRA.Chapter 5 discussed the concerns pertaining to classification of digital products as service products, which have recently grown in interest. Currently, discussions on the classification of intangible products in the traditional dichotomous product classification of goods and services are underway internationally. In this report, we discussed how to add another mode of supply (i.e. Mode 5) in addition to the existing four modes of services supply as an idea. However, since it is difficult to fully reflect the relationship between service providers and consumers by the introduction of Mode 5, it is possible to consider ways to adopt the digital modes proposed by Ciuriak and Ptashkina (2018) within Mode 5.In Chapter 6, two suggestions for institutional improvements were proposed. The first is related to the convergence of statistical classification on the balance of payments and service statistical classification in trade agreements, and the second is related to the collection of corporate- or individual-level data on service trade. The first issue is where international consensus is needed. Therefore, it is considered important to actively monitor the classification discussion of newly formed digital services and participate in international discussions so that our positions and opinions can be reflected in these processes of discussion. The second is regarding the policy directions for supplementing current statistics with various information and data from the broader perspective of services trade. As in most countries, Korea’s service statistics are in fact mostly from the balance of payments statistics, which are collected sporadically as needed, resulting in a lack of statistical consistency. Therefore, this report discusses the approaches for improvement of Korea’s service statistics in three directions, focusing on the Korea’s legal system adjustment, improvement of service trade statistics governance, and establishment of a comprehensive service trade statistics platform. -
The Role of Cross-Border e-Commerce in Shaping Global Value Chains
The continuous development of the digital economy has led to a rising volume of e-commerce. From 2014 to 2020, global B2C e-commerce sales witnessed a yearly increase of 21%, while B2B e-commerce transactions grew by 16% annually ..
Sangjun Yea et al. Date 2022.12.30
Trade structure, Electronic commerceDownloadContentSummaryThe continuous development of the digital economy has led to a rising volume of e-commerce. From 2014 to 2020, global B2C e-commerce sales witnessed a yearly increase of 21%, while B2B e-commerce transactions grew by 16% annually from 2014 to 2019. As e-commerce gains ground rapidly, its impact extends to international trade as well. China, being the world’s largest trade partner, experienced an annual increase of 18% in cross-border B2B e-commerce since 2016. With the long-term global trend of digital transformation, e-commerce is expected to continue growing, and cross-border e-commerce will play a significant role in global trade. This study analyzes the economic impacts of expanding cross-border e-commerce on global trade, with a particular emphasis on intermediate goods trade and global value chains.Chapter 2 explores recent trends in e-commerce and global value chains (GVCs). According to the 2021 data from UNCTAD, total global e-commerce sales reached approximately $26.7 trillion in 2019, with 81.7% attributed to B2B transactions and the remainder to B2C transactions. The United States, Japan, China, and South Korea emerged as the leading countries, contributing the largest share of total e-commerce sales. Among these countries, B2B e-commerce sales accounted for over 85% of total e-commerce sales in the United States, Japan, and South Korea, whereas in China, it constituted only 41%. Notably, various metrics related to B2C e-commerce, such as retail e-commerce sales, the number of global digital shoppers, e-commerce’s share of total retail sales, and user penetration, experienced significant growth during the COVID-19 pandemic. In contrast, the size of the B2B e-commerce market, as measured by total merchandise value, has experienced double-digit growth since 2016, but in 2020, the pandemic slowed the year-over-year growth rate. The different growth rates of B2C and B2B e-commerce during the pandemic suggest that the pandemic has had a significant impact on supply chains. Despite the supply chain shocks during the pandemic, B2B e-commerce’s share of global trade is expected to grow further in the future. With many companies recognizing e-commerce as an efficient sales channel and making it an important strategy to maintain multiple sales channels alongside offline channels, B2B e-commerce is expected to continue to grow as a share of total trade in the future.Next, we look at recent changes in GVCs through various measures, including GVC participation rates and value chain length. Focusing specifically on the manufacturing sector and comparing the years 2018 and 2021, we observe a decline in the average GVC participation rate from 53.8% in 2018 to 52.9% in 2021. In the case of South Korea, there was a decrease from 54.3% in 2018 to 53.1% in 2021, primarily driven by a reduction in forward participation and a slight increase in backward participation during this period. The decline in forward participation indicates a decrease in the proportion of Korean intermediates being exported to third countries, while the increase in backward participation suggests a rise in the usage of foreign intermediates in Korean exports. Looking at the changes in forward and backward production lengths in GVCs for the major manufacturing countries of South Korea, Germany, Japan, and Taiwan, we find that forward production length decreased in all countries from 2018 to 2021, while backward production length decreased in all countries except South Korea. This implies a reduction in the number of production stages involved in the manufacturing of final goods during this time frame.In Chapter 3, we conduct two empirical analyses of the relationship between cross-border e-commerce and GVCs. The first empirical analysis utilizes firm-level data from the Business Activity Survey of Statistics Korea. GVC participation of firms is identified from their engagement in two-way import and export activities, while e- commerce participation is identified among firms that implemented an integrated e-commerce management system during the observation period. To examine the changes in GVC participation before and after the adoption of the integrated e-commerce management system, a difference-in-differences model was employed, along with propensity score matching to mitigate selection bias.The estimation results indicate that e-commerce participants exhibit increased overall GVC participation compared to non- participating firms. There is also a significant positive effect on GVC participation with affiliates. Comparing overall GVC participation and GVC participation with affiliates, the adoption of an integrated e-commerce management system demonstrates a long-term impact on increasing overall GVC participation to a greater extent than GVC participation with affiliates. Among specific industries, the analysis reveals a significant impact of e-commerce integrated management systems on both overall GVCs and GVCs with related parties in manufacturing and wholesale industries. In particular, the adoption of e-commerce systems in wholesale sectors significantly increases firms’ participation in GVCs with related parties compared to the case of manufacturing. We also find that the adoption of e-commerce integrated management systems has a significant impact on the increase in imports in the manufacturing industry, while it has a significant impact on the increase in exports and imports in the wholesale and retail industry. Finally, when counting into the differences in productivity levels of firms, we find that the introduction of the e-commerce system increases the participation in GVCs by firms who have difficulties in entering into overseas markets due to their low productivity.The second empirical analysis in Chapter 3 uses country-level data to analyze the impact of the level of e-commerce on the rate of backward and forward GVC participation in each country. To this end, a dynamic panel model is constructed, incorporating control variables such as market size, manufacturing share, tariff rate, and FDI liberalization. The export-based rates of backward and forward GVC participation, calculated using ADB MRIO data, are utilized as the dependent variables in the analysis.The findings of the analysis reveal a statistically significant positive correlation between e-commerce expansion and the rate of backward GVC participation. This can be attributed to the intensified competition fostered by e-commerce, which enhances the incentives for firms to utilize foreign intermediates possessing advantageous price and quality attributes. This effect is stronger in manufacturing industries than in services industries.In Chapter 4, we develop a theoretical model to examine the quantitative relationship between cross-border e-commerce and global value chains based on data from the World Input-Output Table. Our model incorporates key features of cross-border e-commerce such as the expansion of trading networks due to the reduction of information frictions and the efficient provision of goods and services through digitization technologies. Specifically, the expansion of trading networks allows final goods producers being engaged in e-commerce to connect with intermediate goods producers offering lower production costs, which is not feasible for producers not involved in e-commerce. Additionally, the efficient provision of goods and services through digitization technologies refers to how participating intermediate goods producers reduce their production costs through digitization innovations or bypassing tariff and non-tariff barriers.Using this theoretical model, we conduct two simulation analyses. In our first simulation, we examine the changes in final goods exports, intermediate goods exports, and GVC participation of major countries when the trade costs associated with cross-border e-commerce in Korea are reduced by 5%. We find that a 5% reduction in trade costs associated with cross-border e-commerce in Korea results in an overall increase in intermediate goods exports to the Asian region. Consistent with the results of the empirical analysis in Chapter 3, we find that Korea’s backward participation in GVCs increases with the expansion of e-commerce. In our second simulation, we examine the relationship between e-commerce and the stability of global supply chains. We assume a trade shock that raises the trade costs between China and other countries by 5% and find that the impact of the shock heavily affects the GVC measures with underlying cross-border e-commerce than without underlying cross-border e-commerce. This outcome arises from the fact that e-commerce opens up new trade channels and increases the reliance on cross-border supply chains, thereby magnifying the impact of a trade shock. Consequently, as digital cooperation between countries continues to advance, the reduction of trade barriers remains crucial.Lastly, in Chapter 5, we draw conclusions and present four policy implications for cross-border e-commerce and GVCs policies Firstly, recognizing e-commerce as an effective channel for firms to maintain market access amid rising protectionism and the COVID-19 pandemic, governments should explore strategies to promote e-commerce, such as simplifying customs procedures related to e-commerce as observed in China or adopting market-driven digital trade policies as seen in the United States. Secondly, since the introduction of e-commerce systems has significant positive effects on exports and GVC participation for low-productivity firms, governments may consider supporting the capacity building of such firms by assisting in the establishment of e-commerce systems, utilizing web hosting services, and providing advice on maintaining an omni-channel approach. Secondly, as the introduction of e-commerce systems has significantly positive effects on exports and GVC participation for low-productivity firms, government may consider to support capacity building of these firms through the assistance of building e-commerce systems, utilizing web hosting services, and advising to maintain omni-channel. Thirdly, as cross-border e-commerce becomes more active, the potential for external shocks propagating within the supply chain increases. Therefore, multilateral cooperation in building stable supply chains should prioritize efforts to lower trade costs. Fourthly, it is imperative for the government to establish pertinent statistical indicators that comprehensively capture the present condition of e-commerce in Korea, thereby facilitating future research endeavors and informing policy formulation. In this regard, it is advisable to consider the inclusion of separate metrics specifically dedicated to Business- o-Business (B2B) e-commerce, distinct from those pertaining to Business-to-Consumer (B2C) e-commerce.
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