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SUMMARY OBSERVATIONS

1.                  Since its previous Trade Policy Review in 2000, Korea's impressive economic growth restored its GDP per capita (US$12,000) to pre-Asian financial crisis levels by 2003.  The current recovery since mid-2003 has been fuelled mainly by buoyant growth in industrial exports, which has compensated for the weakness in domestic demand, the main source of growth during the earlier part of the period under review. 

2.                  Despite the significant improvement in economic performance, Korea faces several related economic challenges.  In particular, there are downside risks to the sustainability of the present recovery.  Sluggish domestic demand has resulted in possible over-reliance on exports as the main source of current growth, thus making the economy vulnerable to a slowdown in export growth, particularly to China, which has been the major driving force behind the recent rise in exports.  Further structural reforms, including trade and investment liberalization, would contribute to a robust recovery by strengthening competition and thereby boosting productivity, especially in agriculture and services, where productivity is significantly lower than in manufacturing, by far the most open sector of the economy.  Improved industrial relations, and further corporate and financial sector restructuring would also contribute to a sustained recovery.  Confronted by these economic challenges, the Government has renewed its reform efforts.

(1)               Main Economic Developments

3.                  Following economic reforms in response to the Asian financial crisis in 1997, the Korean economy grew in real terms by 3.8% and 7.0%, respectively, in 2001 and 2002.  The recovery in 2002 was led by strong domestic demand, notably private consumption, which grew by 7.9%, and residential construction.  As a consequence of the economic downturn in the early part of the year, reflecting declines in both consumption and the growth of fixed investment, GDP growth was in the order of 3.1% in 2003, but based on continued export expansion is set to recover to over 5% in 2004.  The decline in consumption in 2003 may also reflect a slowdown in the growth of household borrowing, which had previously grown rapidly against the background of a boom in credit card use.  The Korean economy started recovering in late 2003, however, led mainly by external demand.  Since the first quarter of 2000, the unemployment rate in Korea has fallen, reaching 3.4% in the fourth quarter of 2003. Inflation has remained largely within the official medium-term target range, with consumer prices increasing by 2.7% in 2002 and by 3.6% in 2003.

4.                  The Government's fiscal stance was slightly expansionary in 2003; its medium-term target for fiscal consolidation is to achieve fiscal balance (excluding social security) by 2007.  The Bank of Korea has maintained a moderately expansionary monetary policy since 2002, reducing the target overnight call rate in July 2003 to 3.75% (a historic low), where it has remained.

5.                  The Government has continued to undertake structural reforms, notably of the financial and corporate sectors.  Its efforts to improve the domestic economic environment and to develop a more competitive economy, supported by the rules-based multilateral trading system and based on foreign investment, have been major factors in restoring confidence.  The Government has, by and large, resisted protectionist pressures, maintaining outward‑oriented non-agricultural trade and investment policies.

6.                  With gross national saving exceeding gross domestic investment, the current account balance has continued to record surpluses, albeit declining; international reserves have continued to accumulate, and external liabilities have been reduced.  Korea's current account surplus in 2001 stood at about US$8.2 billion (or 1.7% of GDP) reflecting a decline in the merchandise trade surplus and an increase in the services deficit;  in 2002, a reduced current account surplus (1.0% of GDP) reflected the recovery of domestic demand, which led to an increase in imports of services.  By the end of 2003, Korea's foreign exchange reserves had risen to US$155 billion, a level equivalent to more than ten months of merchandise imports.  Following a peak in 1999, the level of total external liabilities gradually dropped until 2001;  it rose again in 2002 and 2003, although the debt service ratio has been decreasing since 2002.

7.                  Korea is a major global trader; it was the world's eighth and seventh largest merchandise importer and exporter, respectively (counting the EU as one) in 2002.  The share to GDP of imports of goods and services declined from 37.7% to 35.6% between 2000 and 2002;  the share to GDP of exports also declined, from 40.8% to 38.2%.  Korea's high dependence on industrial exports increased from 90% of total merchandise exports in 2000 to 92% in 2002.  Manufactured and mining products account for most imports, about 63% and 27%, respectively, in 2002, followed by agriculture (9%).  The United States, Japan, and the EU have continued to be Korea's main trading partners, while China's share in Korea's trade, especially exports, has been rising. 

8.                  After peaking in 1999, foreign investment inflows have declined;  Korean overseas investment also dropped against the background of the recent slowdown in domestic recovery and increased external uncertainty. 

(2)               Trade and Foreign Investment             Regime

9.                  Since its previous Review in 2000, Korea has continued to liberalize its trade and investment policies to promote structural reform and thereby improve the economy's efficiency.  While there have been no significant changes in the general legal or institutional framework, nor in the way in which trade policy is formulated or implemented, trade and business laws have been strengthened and transparency improved as part of the Government's goal of achieving a "fair and transparent market-driven economy".  Regulatory reform, driven by the Regulatory Reform Committee, remains a high priority;  improved customs procedures were selected as a trade-related strategic goal in 2003. 

10.              Trade policy formulation and implementation is primarily the responsibility of the Ministry of Foreign Affairs and Trade (MOFAT).  The Ministry of Commerce, Industry and Energy (MOCIE) regulates imports and exports.  The principal trade policy objective is to build a "free and open economy" based on market principles to promote structural reform and efficiency.  Raising exports is seen as a major growth engine for meeting the political target of doubling average per capita annual income to US$20,000 (by 2010).  Korea's "global leadership" trade and investment strategy in key sectors, such as motor vehicles, steel, and IT industries, is aimed at enhancing the economy’s efficiency and achieving economic, including export-led, growth.  Expanding high-technology industries and higher-value-added exports, and making Korea a Northeast Asia business and financial hub are high priorities.  Advisory councils independently advise ministries, including MOFAT, and several government-funded institutions, including the Korean Institute for International Economic Policy, conduct relevant government research and analysis.  The outcome is greater transparency and consequent public scrutiny of trade policies.

11.              Korea participates actively in the multilateral trading system, especially to support stronger rules.  It took part in the extended GATS negotiations on financial services and basic telecommunications, and is a member and observer, respectively, of the plurilateral Agreements on Government Procurement and Trade in Civil Aircraft.  It resolves trade disagreements using in particular the WTO dispute settlement system.

12.              A major departure from Korea's previous trade policy has been its increasing willingness to negotiate regional free-trade agreements.  The Asian financial crisis was an important factor in altering its past opposition to preferential trade agreements.  Korea sees these agreements as a means of liberalizing its trade and investment regimes to revitalize the economy, and to secure foreign markets and promote regional integration in response to the trend of growing regionalism.  Korea's first such agreement, with Chile, effective 1 April 2004, covered industrial and certain agricultural products comprehensively.  However, rice and a number of other significant farm commodities were excluded, some permanently, thereby reducing the agreement’s liberalizing impact on agriculture, where high protection persists.  Korea is also negotiating free-trade agreements with Singapore and Japan, due to conclude in 2004 and by end-2005, respectively.  It has also launched a joint study on an FTA with ASEAN, and agreed to conduct similar studies with Mexico and EFTA.  Korea's longer term goals include a trilateral agreement with China and Japan, and the formation of an East Asian Free Trade Area (EAFTA) among "ASEAN+3" members.

13.              Korea's relatively liberal foreign direct investment (FDI) regime has benefited the economy.  Foreign firms play an increasingly important role and are seen as an essential source of export and employment growth.  All forms of FDI, including establishment, stock acquisitions, mergers (including hostile) and long-term loans, are allowed.  Sectoral restrictions on FDI have been relaxed.  Only radio and television broadcasting, plus rice and barley growing, are wholly closed to FDI.  Several, mainly infrastructure, sectors are partially closed and have foreign equity limits.  At the same time, Korea provides tax and other incentives in an effort to attract FDI, including in advanced technology activities, and in manufacturing, logistics, and tourism activities located in various types of designated zones.  Investment incentives are being extended, including through the creation of three Free Economic Zones (FEZs) in 2003 (Incheon, Busan, and Gwangyang ports).  A negotiable cash rebate was also introduced for foreign investors in 2004.  On the other hand, income tax holidays are to be reduced from ten to seven years from 2005, as incentives become available to more foreign investors.

(3)               Trade Policies and Practices

14.              Since 2000, the general thrust of Korea’s trade and investment policies has been greater liberalization, including the further opening of its economy to international trade and foreign investment.  This has exerted additional competitive pressure on domestic producers to improve productivity, and contributed to a more efficient allocation of Korea's resources.  Nevertheless, some protectionist measures continue to shield domestic producers, especially farmers, from foreign competition.

15.              The tariff is Korea's main instrument of trade policy.  It is also a significant source of tax revenue.  The Korean tariff remains a relatively complex instrument and as such constitutes a potential distortion to competition and an obstacle to the efficient allocation of resources.  The applied MFN rate averaged 12.8% in 2004;  falling slightly, from 13.8% in 2000, owing to implementation of WTO commitments.  No unilateral tariff cuts occurred during the period under review.  High tariffs, averaging 52.2% in 2004 (compared to 54.8% in 2000), apply to agriculture (WTO definition);  out-of-quota tariffs, often exceeding 200%, apply to many other commodities.  By contrast, industrial tariffs (WTO definition) averaged 6.7% in 2004 (7.5% in 2000).  The multiplicity of tariff rate bands (often involving small rate differences and decimal points) adds to the tariff's complexity.  Almost all tariffs are ad valorem, contributing significantly to tariff transparency.  On the other hand, alternate specific rates (mainly as out-of-quota duties) tend to conceal relatively high ad valorem equivalents, which vary between the same commodities (depending upon quality) and over time, providing greatest protection when world prices are lowest.  These non-ad valorem duties undermine tariff  transparency, and predictability.  Other measures (e.g. "autonomous" tariff quotas, usage tariffs, and duty concessions) that selectively reduce tariffs on inputs, often according to end-use, also contribute to tariff complexity and uncertainty.  Although 91% of tariff rates are bound, the predictability of the tariff is eroded by the considerable leeway to raise applied tariffs provided by the substantial gap between applied and bound MFN rates.  Korea has used this gap to apply higher "adjustment duties" as "flexible tariffs" on several products.

16.              Limited tariff preferences, restricted generally to certain manufactured goods from several developing countries, and all LDCs, means that Korea applies MFN rates on almost all (95%) imports.  However, the relevance of MFN rates to Korea's trade may have begun to erode with the recent granting of widespread preferential duties to Chilean imports, based on substantial and varied rules of origin.  This trend looks set to continue, with other FTAs in the pipeline, such as those with Singapore and Japan.   In 2004, imports from Chile were subject to average (unweighted) tariffs of 6.9%, just over half of Korea's average MFN rate.  Most reductions occurred on industrial goods;  the average agricultural tariff (WTO definition) on imports from Chile only fell to 49.8%, reflecting minimal liberalization at least to date of farm products under the Korea–Chile FTA. 

17.              Whereas tariff quotas for beef were replaced by a tariff (currently 40%) from January 2001, rice imports are still subject to quantitative restriction.  State-trading enterprises and producer associations still administer tariff quotas affecting many agricultural imports, although greater auctioning of import entitlements has introduced greater market discipline in quota management.  Import licensing and prohibitions apply mainly for health, safety or security reasons.  Korea has harmonized many voluntary standards and mandatory technical regulations with international norms to improve transparency and reduce unnecessary obstacles to trade, and continues revising food codes and related regulations in line with international requirements.  However, significant differences, including in conformity testing, inspection, and acceptance of overseas results, seemingly remain, mainly for pharmaceuticals, cosmetics, and possibly food.  Quarantine arrangements, especially for fruit, and SPS requirements also appear relatively strict, despite Korea's continuing efforts to comply with international norms. 

18.              Anti-dumping provisions have protected a number of industries from competitive imports.  General safeguard measures have been used only for garlic since the last Review.  While sector-specific safeguards on textiles have never been used, those on agricultural products are used frequently.

19.              A member of the WTO Government Procurement Agreement, Korea has largely computerized its government procurement system, including operating the e-Procurement System since September 2002.  This has increased transparency and access by foreign suppliers.  However, certain procurement is not covered by Korea's multilateral commitments;  for example, procurement from SMEs where private (non-competitive) tendering prevails.  Although no domestic price preferences apply, government procurement is still seemingly used as an instrument of economic policy, including regional and industrial development.  Procurement has become more decentralized.

20.              A range of financial measures are intended to support trade and production, including R&D investment.  These include tax incentives and provision of credit and equity, including venture capital, largely channelled through various government-operated funds and state-owned financial institutions.  SMEs are major beneficiaries, especially those engaged in information technology activities.  Direct export subsidies to reduce marketing costs apply to several agricultural goods, and the sector also benefits from substantial domestic financial support under the WTO Green Box or the de minimis provisions.

21.              Corporate restructuring is well advanced, helped by a strengthened corporate governance framework, including improvements in bankruptcy laws as well as in accounting and disclosure requirements.

22.              Although privatization is behind schedule, there has been considerable progress, and the Government remains committed to further divestment, including to foreign interests.  Application and enforcement of Korea's extensive competition policy has been strengthened, including extra-territorially, against cartels and other anti-competitive behaviour.  Conglomerates ("chaebols") are subject to special regulation, including ceilings on shareholdings in other domestic firms.  Certain collusion by SMEs remains exempt from competition legislation. 

23.              Korea has continued to strengthen protection of intellectual property through extensions of its comprehensive legislation in line with international developments, and enhanced enforcement.  It is currently acceding to the WIPO Copyright Treaty, which was expected to take effect on 24 June 2004.

(4)               Trade Policies by Sector

24.              Korea is a dualistic economy as regards protection.  Relatively low manufacturing protection, except for a few pockets of moderate protection (e.g. textiles, clothing, and footwear), contrasts with high levels of protection and low market orientation in agriculture, the most distorted sector.  Korea's net agricultural support exceeds the sector's GDP contribution (3.6% in 2003), and is among the highest in the OECD.  The average Producer Support Estimate (PSE) for agriculture was 60% in 2003 (equivalent to additional farm incomes of W 20.2 trillion), and was highest for rice (74%) and oilseeds (89%).  Most assistance involves market price support from trade barriers and price stabilization schemes.  These distort agricultural trade and production, and force Korean consumers to pay much higher prices (on average well over double world levels in 2002, or three times higher for rice).  MFN tariffs averaged 52.2% on agricultural products in 2004 (more than seven times higher than on non-agricultural goods).

25.              Agricultural protection also undermines Korea's economic efficiency and tends to penalize efficient exporters, including manufacturers.  Although self-sufficiency goals and other "non-trade" concerns underpin agricultural protection, the resulting higher food prices are borne disproportionately by poor consumers.  The measures used are an economically inefficient and costly means of achieving food security, and have contributed to surplus production of key commodities, like rice and dairy products.

26.              Manufacturing accounted for a substantial, albeit declining, 26.6% share of Korea's GDP in 2003.  The sector is heavily outward oriented, generating almost all of Korea's merchandise exports.  Information and communications equipment (mobile phones, PC equipment, and semi-conductors) comprise Korea's single largest export category.

27.              Services accounted for 69.7% of GDP in 2003 (up from 65.3% in 2000).  Korea is continuing to de-regulate and privatize the key energy markets of natural gas and non-nuclear electricity, albeit slowly.  State monopolies are being relaxed, and majority state-owned enterprises (Korea Gas Corporation (KOGAS) and Korea Electric Power Corporation (KEPCO)) structurally unbundled to facilitate further privatization and market orientation, based on third-party access and sectoral regulation to safeguard competition.  However, delays persist, and final arrangements, including the regulators' independence, remain unclear as plans change and many crucial details remain obscure.  Restrictive caps still apply to foreign equity (30% for KOGAS, 40% for KEPCO, 30% for KEPCO's five subsidiary power generation companies, and 50% for power distribution and transmission generally).  Prices are regulated based on rate of return (on assets) criteria, which encourages inefficiency.  Significant cross-subsidies between users, although being reduced, also create inefficiencies.

28.              A major policy priority and achievement has been the rehabilitation of the financial sector.  It has been considerably restructured, especially in banking, where policy reforms have been focused since the Asian financial crisis.  Government-led financial restructuring, involving public funds of W 161 trillion (one quarter of current GDP) has re-capitalized institutions, mainly banks, and cleaned up loan portfolios.  Non-performing loans (NPLs) have fallen in the sector, from 10.4% at end 2000 to 3.6% at end 2003.  However, while relatively low for banks (under 3%), NPLs are much higher for non-banks (averaging 6.4% at end 2003), reflecting significant but uneven and incomplete progress in non-bank restructuring.  Privatization is well advanced, especially of banks, where state ownership has fallen to about 20%, almost pre-crisis levels (compared with 60% at end 1998).  Full foreign equity is allowed in banks, subject to special permission;  it has risen, on average, from under 10% at end-1998 to 30% at end-September 2003.  The financial sector has returned to profitability, although recent exposures to household credit on real estate and credit cards have reduced it, and required the Financial Supervisory Commission to strengthen prudential measures further.  Further restructuring of the non-bank sector, notably investment trust companies and credit card companies, would strengthen the financial sector.

29.              The telecommunications market has been de-regulated and fully privatized;  the State's remaining share in Korea Telecom (KT) was sold in May 2002.  Foreign equity is unrestricted in most services, but is capped at 49% for KT and other basic telecommunications providers.  Weaknesses in the regulatory regime have hampered effective competition in basic telecommunications.  These weaknesses include:  the apparent non-independence of the regulator (the Korea Communications Commission);  possibly inappropriate use of the fully distributed cost method (FDC) for setting access prices;  and requiring approval instead of a price cap regime to regulate key prices[, including in the competitive mobile market.  The Government is addressing these issues, and plans, for example, to introduce a marginal cost-based measure for access pricing (long run average incremental cost, or LRAIC) in 2004.  Licensing restrictions for new entrants in basic telecommunications could perhaps be further eased, including introduction of a class licensing system.

30.              Greater private sector involvement is occurring in transport, especially in port development.  The highly indebted and inefficient state-owned rail monopoly, Korail, is also being restructured and its services unbundled to facilitate greater competition and eventual privatization.  Cabotage restrictions apply to air and sea transport.

(5)               Outlook

31.              Renewed economic growth of 5.5% is forecast in 2004, while inflation and unemployment are both expected to fall to 3%.  The Government's economic priorities in 2004 are to boost investment and enhance job opportunities. 

32.              Korea's future economic performance will depend to a large extent on external factors, such as the pace of recovery in the world economy, and especially on China's continued expansion, which through rising exports, has been a major source of Korea's recent economic growth.  Of greatest importance, however, to Korea's longer-term growth prospects will be its own efforts to implement structural and other economic reforms to curb the widening mis-match between domestic and export demand as a source of sustained growth.  Sustained growth is also likely to require further liberalization or deregulation of trade and trade-related policies, including in sensitive sectors, reform of labour markets (particularly industrial relations), and further strengthening of the financial, especially non-bank, sector.