The Korean Economy in the Era of Globalization

2007 KDI International Conference

The Korean Economy

in the Era of Globalization:

Issues and Policy Im plications

Edited by

M oonjoong Tcha

KDI

2007 KDI International Conference

The Korean Economy

the Era of Globalization:

Issues and Policy Implications

Edited by

M o o n jo o n g T c h a

LKDf

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r December 2007

Korea Development Institute

207-41. Cheongnyangni-dong, Dongdaemun-gu

P.O. Box 113. Cheongnyang

Seoul, Korea

ISBN 978-89-8063-315-9

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Contents

Opening Remarks by Jung Taik HYUN (President, KDI)

Conference Schedule

List o f Participants

KEYNOTE SPEECH

Trade Policy Options for Korea Outside the Doha Round...........................3

1. The Doha Round Im p asse............................................................................... 5

2. Options: Do N othing..........................................................................................6

3. Options: Retreat from Trade............................................................................7

4. Options: Use the WTO More Aggressively................................................ 7

5. Options: Free Trade Agreements................................................................... 9

5.1. Rules of O rigin .........................................................................................11

5.2. Expansion...................................................................................................12

5.3. Sensitive Sectors...................................................................................... 13

5.4. Other Commitments...............................................................................14

6. Options: Unilateral Liberalization...............................................................15

7. Conclusion...........................................................................................................17

CHATPER 1-1

Trade Policy and Productivity:

M icro-evidence from Korean M anufacturing................................................. 19

1. Introduction.........................................................................................................22

2. Literature Su rvey...............................................................................................23

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w The Korean Economy in the Era o f Globalization: Issues and Policy Implications

3. Productivity Dynamics of the Korean Manufacturing

Firm s..................................................................................................................... 25

3.1. Productivity Measurement..................................................................26

3.2. Productivity Decom position.............................................................. 27

3.3. Productivity Dynamics of the Korean

Manufacturing Firm s............................................................................28

4. Effects of Tariff Reduction: the Korean Manufacturing

C a se...................................................................................................................... 32

4.1. Empirical M odel......................................................................................32

4.2. Estimation R esults................................................................................. 33

4.3. Robustness Check: Fernandes A pproach...................................... 40

5. Concluding Remark......................................................................................... 45

C H A T P E R 1-2

Tariff-G row th Nexus in the Australian Economy, 1870-2002:

Is there a Paradox?.......................................................................................................51

1. Introduction........................................................................................................ 52

2. The Australian Tariff Policy..........................................................................54

3. The model, Econometric Methodology and D a ta ................................. 59

3.1. D ata.............................................................................................................. 62

4. R esults...................................................................................................................63

5. Conclusion...........................................................................................................69

C H A TP E R 1-3

Trade Reform s and Economic Growth:

The C hilean Experience............................................................................................. 74

1. Introduction.........................................................................................................74

2. The Chilean Economy: Policy and Economic Perform ance................76

2.1. Chile's Economic Perform ance...........................................................76

2.2. Economic Reform s.................................................................................. 78

3. Conceptual Framework to Analyze the Role of Trade P olicy...........82

3.1. Openness to Trade and G row th..........................................................82

3.2. Unilateralism versus Bilateralism...................................................... 83

4. How Trade Policy has Played a Role on the Chilean

Perform ance...................................................................................................... 84

4.1. Implications from Cross Country Regressions..............................85

4.2. Total Factor Productivity and Economic P olicy........................... 88

4.3. Free Trade Agreements: Static and Dynamic E ffects.................. 90

5. What did We Learn?..........................................................................................93

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Contents v

C H A TP E R 2-1

Trade Liberalization and Wage Inequality -

The Case for K o rea.................................................................................................. 101

1 Introduction......................................................................................................101

2. Trade Liberalization and Wage Inequality -

Literature Review.......................................................................................... 102

2 1. Trade and Returns to Factors...........................................................102

2.2. Empirical Studies..................................................................................103

2.3. More on the Effects of Trade Liberalization

on Wage Inequality.............................................................................105

2.4. The Korean Case of Trade Liberalization and

Relative W ag e....................................................................................... 107

3. The Effects of Import Liberalization on Wage Inequality

in Korean Manufacturing Secto r.............................................................. 112

3.1. Data............................................................................................................112

3.2. M ethodology..........................................................................................113

3.3. Wage Inequality and Trade Liberalization

for the Manufacturing Sector........................................................... 115

3 4. Wage Inequality and Trade Liberalization -

Industry Groups...................................................................................119

4. Implications and Conclusion...................................................................... 129

C H A TPER 2-2

Trade Adjustment Assistance in Korea: Theory and Practice.................133

1 Introduction...................................................................................................... 133

2. Trade Adjustment Assistance in K orea.................................................. 134

3. Import Competition and Labor Market in Korea................................ 137

3.1. The Impact of Import Penetration on Unemploym ent............ 137

3.2. Characteristics of Trade-related Unemployed

Workers in K orea..................................................................................139

4. Tariff Endogeneity in K orea........................................................................141

5. Policy Im plications.........................................................................................144

5.1. Characteristics of the TAA System ................................................. 144

5.2. Scope of the TAA System................................................................... 146

5.3. Unified Process of Certification.......................................................146

5.4. Strengthening the Monitoring System ...........................................149

5.5. Relevance of the Budget for Trade Adjustment

A ssistance................................................................................................149

6. Conclusion.........................................................................................................150

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VI The Korean Economy in the Era o f Globalization: Issues and Policy Implications

C H A TT E R 2-3

Assisting Workers, Firms, Farmers and Fishermen

and Com m unities Adversely Affected by Changes

in International Trade and Investment:

The US Experience.................................................................................................... 153

1. Why Targeted Assistance for Those Affected

by G lobalization?............................................................................................154

2. TAA for W orkers............................................................................................. 155

3. Wage Insurance (A TA A ).............................................................................. 158

4. Health Care Tax C redit..................................................................................159

5. The Next Round of Reforms.........................................................................160

6. TAA for Firm s...................................................................................................164

7. TAA for Farmers and Fishermen................................................................164

8. TAA for Communities....................................................................................165

9. International Comparisons...........................................................................166

10. Immediate Steps.............................................................................................167

11 Conclusion......................................................................................................168

C H A TP E R 3-1

A Political-Econom y of the Free Trade A greem ent:

Temporal and Distributional E ffect..................................................................171

1. Introduction....................................................................................................... 172

2. Literature.............................................................................................................173

3. The M odel...........................................................................................................175

3.1 Two-Level Game with Deadline.......................................................175

3.2. Analysis.....................................................................................................177

3.3. Comparative Statics...............................................................................182

3.4. Testable Hypotheses..............................................................................182

4. Empirical analysis............................................................................................ 184

4.1. D ata............................................................................................................. 184

4.2. Results of Empirical Analysis.............................................................186

5. Conclusion and Policy Implications...........................................................188

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Contents m{

Tables

C H A T P E R 1-1

Table 1. Channels of Productivity Growth through

Trade Liberalization...................................................................................24

Table 2. Comparison of Average Plant TFP Levels

(1992-2003)....................................................................................................31

Table 3. The Impacts of Tariff Reduction on

Plant-level Productivity............................................................................34

Table 4. The Impacts of Tariff Reduction on

Plant-level Price-Cost M argin.................................................................36

Table 5. The Impacts of Tariff Reduction on

Plant-level Em ploym ent...........................................................................37

Table 6. The Effects of Tariff Reduction by Firm Size

(Fixed Effect Estimation)...........................................................................38

Table 7. The Effects of Import Penetration by Firm Size

(Fixed Effect Estimation)...........................................................................39

Table 8 The Dynamics of TFP and Employment Adjustment..................... 41

Table 9. Fernandes(2006) Estimation..................................................................... 44

Table A .I. Decomposition of Aggregate TFP Changes

(by y ear)..........................................................................................................49

Table A.2. Decomposition of Within-industry TFP

Changes (by Sector).................................................................................... 49

Table A.3. The Effects of Tariff Reduction on TFP and

Employment (by plant size).....................................................................50

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viu The Korean Economy in the Era o f Globalization: Issues and Policy Implications

CHATTER 1-2

Table 1 Tariff-Grow th Nexus in the Australian Economy:

Regression Results...................................................................................... 64

Table 2. Long-Run (Steady State) Growth Elasticities.....................................67

CHATPER1-3

Table 1 Average Growth Rates of GDP per capita(% ).....................................77

Table 2. Effective Rate of Protection 1974-1979.................................................. 79

Table 3. Summary of the Main Reform s.............................................................. 81

Table 4. Explaining Growth: 1996-2000 with Respect to

1981-1985........................................................................................................ 87

Table 5. Overall Marginal Effect of Macro Stability and

Micro Reform s..............................................................................................90

Table 6. Steady state effects of Chile's FTA with the US

and the E U .....................................................................................................92

CHATPER 2-1

Table 1. Wage Inequality in the Manufacturing Sectors: Ratio

between Production and Non-production Workers 107

I able 2. Wage Ratio of Each Industry in Manufacturing Sectors

as the Level of Technology in Manufacturing Sectors............. 109

Table 3. Impact of Trade Liberalization to the Relative Wage

of Each Plant: Whole Manufacturing Sector................................... 116

Table 4. Impact of Trade Liberalization to the Relative Wage

of Each Plant: High Tech Industries.......................................... 120

Table 5. Impact of Trade Liberalization to the Relative Wage

of Each Plant: Medium High Tech Industries....................... 123

Table 6. Impact of H ad e Liberalization to the Relative Wage

of Each Plant: Medium Low Tech Industries.................................. 125

Table 7. Impact of Trade Liberalization to the Relative Wage

of Each Plant: Low Tech Industries............................................... 128

CHATPER 2-2

Table 1. Determinants of Job Displacement in K orea.................................... 138

Table 2. Characteristics of Displaced Workers in Korean

Industry Groups................................................................................. 140

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Contents IX

Table 3. Comparison of the Characteristics of Korean

and US Unem ployed............................................................................... 140

Table 4. Determinants of Tariffs in K o rea.........................................................143

Table 5. List of Industries in the Manufacturing and

Related Services........................................................................................ 148

CHATPER 2-3

Table 1. Distribution of Certified Petitions by R eason...................................155

Table 2. TAA for Workers Performance Data 1997 to 2005 ..........................157

Table 3. Re-employment and Earnings Experience of

Dislocated W orkers...................................................................................158

Table 3. Spending on Active Labor-Market Program s...................................167

CHATPER 3-1

Table 1. Regression Analysis of FTA Negotiation Period............................187

Table 2. Regression Analysis of Relative Size of Export

Growth Ratio before and after Agreements.....................................188

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X

The Korean Economy in the Era o f Globalization: Issues and Policy Implications

Figures

KEYNOTE SPEECH

Figure 1. WTO Disputes Filed 12-month Periods Ending July 12

of Indicated Y ear......................................................................................... 8

Figure 2. Evolution of Regional Trade Agreements in the world,

1948-2006...................................................................................................... 10

Figure 3. Dead-Weight Loss Due to a Tariff........................................................16

CHATPER1-1

Figure 1. Decomposition of Annual TFP Changes in Korean

Manufacturing............................................................................................ 29

Figure 2. Decomposition of Within-industry TFP Changes

across Industries........................................................................................30

CHATPER 1-2

Figure 1. Average Duty Rate, Australia 1871 to 20 0 2 ...................................... 58

Figure 2. Scatter Plot of Growth of GDP Against Tariff Rate,

1872 to 2002.................................................................................................... 58

Figure 3. Coefficient Estimate for Short-run Elasticity and

95 percent Confidence Bands for T ariffs........................................... 68

Figure 4. Coefficient for Long-run Elasticity and 95 percent

Confidence Bands for Tariffs..................................................................68

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Contents xi

CHATPER1-3

Figure 1. Log of per capita GDP Chile: 1960-2005.............................................76

Figure 2. Growth Effects of Higher Financial Openness as

a Function of the Level of Institutional Quality..............................86

Figure 3. Growth Effects of Higher Trade Openness as

a Function of the Level of Institutional Quality.............................. 86

Figure 4. Sources of Growth: Chile 1920-2005 ................................................... 89

Figure 5. Transition Dynamics to the Steady State.......................................... 92

CHATPER 2-1

Figure 1. Annual Growth in the Wage Gap and its

Decom position........................................................................................ 104

Figure 2. Impact of Globalization to the Relative Wage:

M ulti-Commodities............................................................................... 106

Figure 3. Changes in Wage Ratio between Production and

Non-production Workers as the Level of Technology

in Manufacturing Sectors..................................................................... 109

Figure 4. Change in Wage Ratio between Production and

Non-production Workers: 1992-2003..............................................110

Figure 5. Change in the Employment Ratio between

Production and Non-production Workers:

1992-2003...................................................................................................I l l

Figure 6. Change in the Employment Ratio between

Production and Non-production Workers as

the Level of Technology: 1992-2003................................................ 112

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Opening Remarks

by

Jung Talk HYUN

President o f KDI

Distinguished guests,

Ladies and gen tlemen

It is my great pleasure to welcome all of you to the international

conference on "The Korean Economy in the Era of Globalization: Issues and

Policy Implications." This conference is designed to present some results

from the project KDI just completed, and exchange our views and ideas on

various issues related to globalization. I would like to express my deep

appreciation to all distinguished speakers, who have made the effort to join

the conference, to share their insight and knowledge with us In particular, I

deeply appreciate and welcome those participants who have traveled such a

long journey to Seoul despite their busy schedules. I would also like to

thank the staffs who have successfully organized this important conference.

The progress in multilateral talks has not met our expectation, and DDA

was officially suspended last year Without clear promise of resuming the

talks in the near future, many economies are more actively seeking bilateral

and regional free-trade talks. As a newcomer in the arena of FTA, Korea has

successfully accomplished FTAs with Chile, Singapore, EFTA, and the US,

and is currently negotiating an FTA with the EU. I think that the successful

conclusion of FTA talks with our important trade partners will make a big

leap forward in Korea's economic history.

The most visible effects of FTA are the abolishment of trade barriers,

enhancement of mobility' of commodities and services and upgrading

economic system and institutional environment. Furthermore, there will be

an improvement in the country's credit, providing greater leverage for

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xw The Korean Economy w the Era o f Globalization: Issues and Policy Implications

Korea when promoting investments from the US, EU and other

international economies. Recent studies show that FDI substantially

contributes to higher employment in Korea, as more than 99% of employees

in foreign-owned firms are local workers. Inflow of foreign capital is also

accompanied by new technology and managerial skills. Economists point

out that the spin-off of these technology and managerial skills are

substantially contributing to domestic economy.

Korea's effort towards globalization offers great opportunities along with

great expectations. However, unless Korea has the underlying foundation to

accept these opportunities, what may come in the future might not be what

is expected. TTie "openness" that is accompanied by the FTA will bring

much more freedom and convenience in the economy, while at the same

time, present challenges in adapting the new environment. Removing

barriers to free mobility of goods, services and investment imply that

competition among producers will intensify. Each sector will see more

competition due to the presence of foreign companies equipped with better

efficiency and productivity. However, I believe performance improves as

competition intensifies.

In retrospect, Korea has consistently put efforts in restructuring for the

past four decades. During the dramatic economic development process led

by labor-intensive industry such as textile and wigs, to semiconductor and

information and communications industries, Korea has seen a number of

start-up companies as well as collapse of some. Restructuring is a process

that must be continued to further strengthen the foundation of the Korean

economy as well as the enhancement of efficiency.

We should not fear or "turn a blind eye" on restructuring. While we

wisely utilize restructuring to build up foundation for sustained growth, we

also have to prepare measures that will assist workforces and facilities left

behind during the restructuring process. The government must put efforts

in making the economy more flexible, and at the same time, cooperate with

both companies and the workforce so a smooth transition can be made to

the new changes. In this vein, more counseling and education must be

provided so that workers will not feel alienated during the process of

rooting FTA. This is why internal preparedness is as important as external

negotiation with the counterparts.

Growing concerns from some parts of the Korean economy are

complicatedly entangled with constructive critics, misunderstanding based

on incorrect information, and pessimism on future benefits arising from

openness. Surely, we cannot expect that the signing of FTA will bring

prosperity to every sector of the economy. It is naïve to think that FTA

would improve the welfare of everyone in the society — instead, we must

accept the fact that in the free market system, there will always be winners

and losers. However, in general, it should be understood that "openness"

will yield more total welfare gain than welfare loss therefore, a thoughtfully

designed compensation scheme will improve the overall quality of welfare

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