The Commission’s analysis of the possible economy-wide effects of the removal of tariffs and TRQs under the FTA includes a number of measures of U.S. economic activity, including the possible impact on U.S. exports, imports, production, and employment. The lack of necessary data precludes the quantification of the impact of the FTA provisions relating to services, investment, labor, and environment. A qualitative assessment of the impact of these provisions is provided in chapters 4 to 6 of this report. The method chosen for the quantitative analysis is a computable general equilibrium (CGE) simulation. The specific CGE model used for this analysis is the Global Trade Analysis Project (GTAP) model, described more fully in appendix F.2 The model includes domestic economic activity and trade patterns for the United States and Korea, as well as for multiple regions3 of the world economy and for multiple products produced in those regional economies. The model describes production and trade in 54 aggregate industry sectors, including 40 merchandise sectors and 14 service sectors.4
The use of a CGE model permits the Commission to measure the possible incremental effect of the negotiated U.S.-Korea FTA tariff and quota reductions on exports and imports, aggregate economic sectors, and labor markets. The model estimates the effects of tariff- and TRQ-related provisions of the agreement on an economy that resembles the U.S. economy in 2008, when the agreement is anticipated to enter into effect. The standard GTAP model begins with data reflecting conditions in 2001; for the present analysis the standard model has been updated in two steps to reflect the 2008 economy. The model was first updated to reflect the state of the economy in 2005 (e.g., reflecting U.S. trade with major partners and
5 For a summary of the tariff and TRQ liberalization schedules, see chap. 1 of this report.
6 In addition, the model results presented in the discussion below depend on a wide array of assumptions about the economic structure and relationship of variables (parameters that reflect how consumers and producers respond to price changes) in the model. Altering these variables, and the underlying assumptions they reflect, changes the resulting estimated effects accordingly, as shown by the sensitivity analysis conducted in this report.
7 See chap. 3 of this report, which discusses short- and medium-term effects for certain selected products.
8 These ranges are established by conducting systematic sensitivity analysis using the simulation framework and information from the econometric estimates of a key model parameter, the elasticity of substitution between foreign and domestic varieties, also known as the Armington elasticity. This technique yields estimates of the mean and standard deviation for reported model statistics. Ranges are established as
±2 standard deviations of each reported result. A full discussion of this technique is found in app. F.
9 The U.S. AVE tariffs for some Korean products such as vegetables, fruits, and dairy products include the estimated effects of TRQs. Korean AVE tariffs on some U.S. agricultural products include the effects of agricultural price support programs. Table 2.2 reports current average AVEs for aggregate industry sectors.
2-2
observed GDP for model regions). These 2005 values were then projected to 2008, when the FTA is estimated to take effect, based on current economic trends as described in appendix F. Consequently, the simulation results discussed below are relative to the estimated 2008 base, measured in 2005 dollars.
This analysis ties together many of the interrelated effects of the agreement. It shows, among other things, how prices of U.S. exports and imports change because of tariff and TRQ liberalization, how increased U.S. exports to Korea of some commodities are linked to increased U.S. imports, how industries that grow in response to increased export opportunities draw resources from other industries, and how all of these effects can be summarized in a measure of the net benefit (i.e., welfare) to the U.S. economy resulting from the agreement.
The model results are not intended as a forecast of what will happen to trade and output in 2008, or after full implementation of the FTA’s tariff and TRQ liberalization schedules.5 Rather, they are estimates of the marginal effect on the economy, relative to the constructed baseline, of the removal or reduction of tariffs and TRQs as specified in the FTA. For example, a negative effect, such as a decrease in a commodity price or decrease in a sector’s output, does not imply that the overall value will be negative as a result of the FTA. Rather the marginal effect of the FTA would buttress or suppress existing economic trends, which may be positive or negative.6 Additional information for interpreting the model results is presented in box 2.1. It is also important to note that model results reflect long-term adjustments of supply, demand, and resource allocations to the FTA. The model does not consider interim or phased effects that might be felt as different provisions of the agreement enter into force, nor does it consider various adjustment costs (such as temporary unemployment or changes in asset prices) that may occur over time.7 The simulation results presented in this report are given as ranges.8
Korea’s average ad valorem equivalent tariffs (AVE tariffs)9 for manufacturing imports from the United States are typically less than 10 percent, although tariffs and TRQs on many U.S.
agricultural and food products exceed 30 percent (figure 2.1). In contrast, most of the U.S.
average AVEs for imports from Korea are less than 5 percent, with five sectors—dairy products (16.8 percent), wearing apparel (16.5 percent), textiles (11.0 percent), sugar (8.8 percent), and paddy and processed rice (7.5 percent)—exceeding 5 percent.
2-3
Figure 2.1 U.S.-Korea FTA: Bilateral GTAP sector benchmark ad valorem equivalent tariffs (percent)
0.0 0.0 0.0 0.2 0.0 0.0 0.1 0.2 0.5 0.0 0.2 0.0 0.3 0.0 1.1 0.5 0.5 0.0
2.4 1.3 1.1
7.5 2.1
3.4 2.4
4.1 3.0 2.1
2.4 4.6
8.8 11.0 0.0
2.4
16.5 0.4
3.3 0.7
8.8
16.8
0.0 0.0 0.0 0.6
1.0 1.0 0.9 1.2 1.0
1.9 2.0 2.5 2.4 3.0 2.2
3.3 4.8
5.9 3.7
5.2 5.6 5.6 5.3
6.8 5.4
6.7 7.8 7.9
10.0 6.2
8.3
19.6
24.8 12.4
38.0 35.1
38.5
43.5 39.6
n/a
0 5 10 15 20 25 30 35 40 45 50
Raw milk Coal Oil and gas Electronic equipment Wheat Wool, silkw orm cocoons Transport equipment n.e.c.
Ferrous metals Plant-based fibers Minerals n.e.c.
Forestry Oilseeds Paper products, publishing Sugarcane, sugar beet Cereal grains n.e.c.
Animal products n.e.c.
Wood products Cattle, sheep, goats, and horses Metals n.e.c.
Machinery and equipment n.e.c.
Crops n.e.c.
Paddy and processed rice Petroleum, coal products Manuf actures n.e.c.
Metal products Vegetable oils and f ats Chemical, rubber, plastic products Mineral products n.e.c.
Motor vehicles and parts Food products n.e.c.
Leather products Textiles Fishing Meat products n.e.c.
Wearing apparel Bovine meat products Beverages and tobacco products Vegetables, f ruit, nuts Sugar Dairy products
U.S. AVE Tarif f Korean AVE Tarif f Source: Comm is sion calculations and GTAP version 6.1.
2-4 Box 2.1 Interpreting the model results
The analysis uses an economic model that compares a depiction of a world in equilibrium without a U.S.- Korea FTA to a world in equilibrium with the FTA. The latter situation is a world in which the removal of tariffs and TRQs under the FTA is fully implemented, all markets have fully adjusted to it, and all other things are held equal.
The Commission employs a comparative static model that does not show the adjustment path the economy might take in moving from the pre-FTA condition to the post-FTA condition, but that portrays the effects of full tariff and TRQ liberalization under the FTA relative to the projected state of the economy before liberalization in 2008. It maintains a balance in the factors of production—labor, capital, and natural resources—so that if some sectors expand and need more labor, other sectors must contract and release that much labor. In contrast, in the real world there is a dynamic process of adjustment to the policy changes inherent in a trade agreement. In growing economies, the expansion of certain sectors does not require the absolute contractions of other sectors, and the overall supply of labor may increase or resources may remain unemployed.
In addition, the model’s depiction of industry sectors is highly aggregated—for example, it does not portray sufficient detail to show the man-made fiber fabrics industry (which is part of “textiles”). Nor does it incorporate the myriad of world events or economic trends that could counter or enhance the estimated effects of this analysis. For instance, it does not take into account the effect of increasing demand on commodity markets, changes in interest rates, or other factors that may affect the expansion or contraction of sectors.
Results identified in the analysis are illustrative. They are useful for showing the direction of sectoral change and factor movement in a world in which trade policy changes and in which these changes work their way through the interlinked sectors of the economy. The results are not a forecast of what will actually occur. They are best interpreted in the context of actual domestic and international economic trends. For example, the reduction of Korean tariffs on U.S. goods means Korea will import more from the United States. To pay for this, Korea must acquire more foreign exchange. It must either borrow more (or receive more foreign investment) or it must export more to earn foreign currency. The simulation model, focused on trade, assumes most of the foreign exchange comes from increased exports. Furthermore, much of the increase in Korea’s imports from the United States comes as imports are diverted from other countries that do not receive the preferential liberalization of duties on their products in the Korean market. These products, formerly imported by Korea, must find new buyers in the world market and exert downward pressure on their world market prices. The model captures this price effect and, untouched by actual global trends, calculates the effect of a drop in world prices on U.S.
imports.
The effect of removing import barriers related to services was not estimated in this simulation due to the lack of necessary data. The reported changes in trade and output in services arise from secondary (general equilibrium) effects, including trade balance effects, changes in demand for services by other sectors, and changes in supply of services resulting from the reallocation of labor and capital resources to other sectors that are growing more strongly as a result of the policy changes. Thus, while the reported results for service sectors reflect effects of some parts of the FTA, they are indirect effects, and do not result from FTA-negotiated policy changes in services trade. A detailed discussion of the changes in trade in services that might be expected from provisions of the FTA is presented in chapter 4 of this report. Similarly, the model analysis presented in this section does not consider effects of all provisions of the FTA discussed elsewhere in this report; for example, it does not consider changes in the investment or regulatory environments in Korea because of the lack of data on the scope of these changes that can be incorporated into the model. Hence, a qualitative assessment of these chapters of the FTA is provided in chapters 5 and 6 of this report.
10 See table 2.2 for a list of the AVE tariffs.
11 The agreement provides for no change in the treatment of rice and rice products; products within the model’s raw milk sector and within the sugarcane and sugar beet sector are effectively not traded between the United States and Korea, and Commission staff have determined that no substantial change in manufactured sugar trade is expected as a result of the agreement.
12 See the analysis of meat products in chap. 3 for additional information on U.S.-Korea beef trade and related SPS issues. The ability of the industry to quickly attain 2003 export levels was confirmed by industry representatives. Truitt, testimony before the USITC, June 20, 2007, 223.
13 See the analysis of passenger vehicles in chap. 3 for additional information on the implications of the agreement.
14 See app. F for a full description of the model assumptions, updates, and modifications.
15 Findings of the Commission’s analysis are broadly consistent with those identified in other studies employing a similar model and scenario assumptions. See chap. 7 of this report for a literature review of relevant studies.
16 GDP, the measure of all economic activity within a country, consists of private consumption, investment, government consumption, and net exports. GDP here is defined as nominal GDP, which takes into account both the price and quantity changes of its components. Welfare, on the other hand, summarizes the real (i.e., exclusive of price effects) value of present and deferred consumption. Welfare may be expressed as the sum of real private consumption, real government consumption, and real net savings.
Increases in the prices of consumption or investment will lead to an increase in GDP, but not in welfare. A decline in the depreciation rate of capital with no corresponding change in current investment will cause no change in nominal GDP, but will increase welfare as net savings (real current investment less depreciation) increases. These examples emphasize the difference in these two measures: GDP captures the nominal value of all economic activity within the country, while welfare measures consumers’ benefit from economic activity at constant real prices.
2-5
The specific policy assumptions are that the bilateral AVEs10 are all reduced to zero (i.e., free of duty), with certain exceptions. No change in quantity traded is anticipated in products that fall within the rice sector, the raw milk sector, the sugarcane and sugar beet sector, or the manufactured sugar sector.11 In addition, as U.S. exports of oranges to Korea do not experience full liberalization because of the ongoing seasonal orange TRQ in the FTA, the Korea AVE tariffs in the vegetable, fruits, and nuts sector declines from an initial 38.5 percent to 6.7 percent rather than to zero. To isolate the effect of FTA tariff reductions on beef trade from the effects of SPS issues, U.S.-Korea beef trade is based on 2003 data, the most recent year of normalized trade prior to the Korean ban on beef imports from the United States. This assumption allows for an estimate that measures the potential changes in trade based solely on the removal of tariffs resulting from implementation of the FTA, and assumes no significant SPS measures that would restrict access to the Korean market.12 Lastly, Korean liberalization with respect to motor vehicles also includes the reduction of the excise tax on automobiles with an engine displacement over 2,000 cubic centimeters (cc).13 The tax, currently 10 percent, is expected to decline to 5 percent. Although the reduction is included in the FTA, it would apply to all producers; consequently, this change is implemented for all suppliers to the Korean market, including the United States and domestic Korean producers, prorated based on market share across the motor vehicles and parts sector. 14