The Different Nature of Trade Imbalance in the U.S. and Korea


Paper for the Institute for International Economics, Washington, D.C., October 14, 1986.


               As you may know, so far this year Korea's economy has grown at a healthy rate. In fact, for the first time ever, Korea is enjoying an overall trade surplus. But these developments are largely the result of external factors. This year oil prices have gone down, the value of the yen has gone up, and interest rates have eased. This unusual combination of circumstances has led to a good year for Korea.

Trade Imbalance and Its Causes

On the horizon of the blue sky, however, dark clouds are looming. Korea has experienced chronic trade deficits with Japan that have increased sharply as a result of the recent appreciation of the yen. Although a stronger yen enhances Korea's price competitiveness in the Japanese market, it is more than offset by increased imports from Japan. By August of this year, the deficit has increased to $4 billion as compared with $3 billion for the whole year of 1985. Political as well as economic tension has grown between the two countries to such an extent that Prime Minister Nakasone, while attending the opening ceremony of the Asian Games in Seoul and meeting with President Chun, had to make a pledge to dispatch a large-scale buying mission to Korea late this year.

While the trade deficit with Japan is growing, an opposite trend is taking place in trade with the United States-the most important customer nation in the world. As of August 1986, Korea's trade surplus with the United States had reached $4.5 billion-about equal to last year as a whole. The Korean government is concerned about this situation and recognizes that it may invoke another round of protectionist pressure from the U.S. government.

The reason for the growing protectionist pressure in the United States is well known and understandable. The United States is suffering from an unprecedented trade deficit. What is frustrating for us is that those deficits continue to grow in spite of a number of actions taken both by the united States and by its major trading partners to reduce them. In recent years, for example, the U.S. government has taken numerous measures such as import quotas, Section 301 and Section 201 investigations, and bilateral negotiations aimed at removing foreign market barriers. Nevertheless, there is strong doubt within and outside the United States as to how effective these measures have been in containing the growing deficit.

Korea, for her part, has made a number of concessions at the request of the United States in an effort to narrow the trade gap between our two countries. For example, in the course of opening Korea's market for more than 7,000 items (classified by the CCCN eight-digit system) in the last six years, numerous items were selected for free entry at the specific request of the United States. More often than not, however, when a market has been opened it has been filled by Japanese rather than American companies.

Following the G-5 agreement last September, the Japanese yen has strengthened significantly against the dollar-by more than 40 percent. It may be too early to assess the full effect of the exchange rate realignment, considering so-called J-curve effects. Nonetheless, the results so far have been less than expected; in fact, the U.S. trade deficit has worsened.

The results of these measures seem to suggest that the causes of the U.S. trade imbalance go beyond the popular charges of "unfair" trade practices, high tariffs, and so forth, on the part of its trading partners. Rather, imbalances in trade are structural in nature. There unfortunately is no "quick-fix" policy that will change things in the short run.

The realignment of foreign exchange rates among major trading nations was certainly one of the major steps toward correcting trade imbalances, but it alone cannot solve the problem unless it is accompanied or complemented by more fundamental structural remedies-such as reduction of fiscal deficits and narrowing of investment-savings gaps in the United States and elsewhere; reallocation of domestic resources in line with international comparative advantages; and increased flow of capital and technology from the surplus to developing countries.

Unless these fundamentals are adequately addressed through international cooperative efforts, and unless the political will of the major nations is mobilized to carry out the difficult task of bringing about these structural adjustments, it is doubtful that the free economies will be able to overcome the present difficulties and prevent the current trade imbalances from deteriorating into outright trade wars involving both developed and developing countries.

Korea, a small but growing nation, is well aware of this danger and has been trying to do what it can on many fronts. In the past six years, the Korean government has pursued the policy of import liberalization in a persistent manner, and now about 92 percent of import items are free to enter the Korean market. Although various forms of invisible import barriers do still exist in Korea, there is no doubt that the Korean market is remarkably open for foreign products and will become more open in the years to come. Also, tariffs have been substantially lowered and will continue to be lowered according to an established schedule.

Recent agreements with the United States in the areas of intellectual property rights, insurance, banking, and the importation of tobacco products demonstrate Korea's good-faith efforts to cooperate with the United States by addressing U.S. concerns in the trade area. Korea has also consistently supported the positions of the United States in various international forums; and Korea has worked hard with the United States in an effort to get the Uruguay Round off to a good start.

Currency Revaluation in Korea?

Let me now make a few comments on the latest suggestion of the United States for Korea and Taiwan to revalue their currencies upward against the dollar. The suggestion is understandable, and the Korean government, I believe, appreciates the positive side of the effect of currency revaluation, such as favorable effects on price and wage stability at home. But it believes that the current exchange rate is about right, and no major change in value is needed. I should note that the IMF, in recent annual consultations, examined the level of the Korean won relative to other currencies, and reached the same conclusion. So did the Korean Development Institute in examining the long-term movement of purchasing parity between the dollar and won since 1973-when the so-called floating system was established by the IMF.

When the suggestion of won revaluation was first raised in Washington a few months ago, it created a heated controversy regarding the efficacy of the revaluation at the present time. The underlying sentiment was that, all too often, the United States fails to appreciate Korea's unique and special situation in dealing with trade issues. I am sure that some of you are familiar with Korea's complaints of this kind and even find them naive. Nevertheless, in the case of revaluation, I must say that their arguments are not without reason.

One of the major arguments against revaluation is that Korea's trading and financial situation is much weaker than Japan's or Taiwan's. Unlike Korea, these two countries have enjoyed trade surpluses for many years. As a result, they have huge foreign exchange reserves. Korea, on the other hand, has only seen an overall trade surplus for a few months. It is the first in her economic history. And the modest amount of the surplus-$1.4 billion so far-is the result of a fortuitous combination of lower oil prices and lower interest rates. If the effects of oil prices and interest rates are netted out, Korea would still be running a trade deficit. In other words, the surplus is recent and it is fragile; one year does not make a trend. In short, it is not a long-term structural phenomenon, as is the case with Korea's neighbors.

Moreover, Korea, unlike Japan and Taiwan, has suffered from a large foreign debt; it is the fourth-largest debtor nation in the developing world. It is imperative for Korea to reduce the level of foreign debt not only for the health of her economy, but also for the health of the international banking system, as has often been stressed to the Korean government by the IMF. Korea has often been cited as a showcase of successful international development in the sense that Korea has set an example of making good use of foreign capital. From Korea's point of view, however, we can hardly rest comfortably with this accolade as long as the large amount of debt remains a matter of concern in the international banking community and as long as our balance of payment position remains precarious in the wake of mounting protectionism. Hence, we strongly believe that our balance of payment management and foreign exchange rate policies should seriously take into account the heavy debt burden that exists today.

Of course, what Washington is most concerned with is not Korea's overall trade balance, but her bilateral trade balance with the United States. Korea has been running a surplus on the order of $3 to $4 billion a year in commodity trade since 1982, and the surplus may even reach over $5 billion this year. As a footnote to these figures, purchases of military equipment-about $1 billion in 1984-are not included in the statistics. Also, Korea has been running chronic deficits in the service account. In terms of a long-term trend, Korea has run surpluses in its merchandise trade with the United States in only 8 out of 25 years since 1960.

It is difficult to estimate how much the proposed upward revaluation, if realized, would help the U.S. redress its trade balance with Korea, or the overall balance with all countries. In 1985, Korea accounted for only 3.2 percent of the U.S. overall trade deficit, as compared with nearly 34 percent for Japan, 15 percent for Canada, 8.8 percent for Taiwan, 8.2 percent for West Germany, and 4.2 percent for Hong Kong. Price elasticity of Korea's exports in the U.S. market and other relevant information is not available, but I cannot help feeling that the effect of the revaluation on the U.S. trade balance would be almost negligible, given the marginal impact of Korea's trade on the external position of the United States.

On the other hand, the valuation of currency is not a tertiary issue for Korea. If a stronger won cut off the prospects for the recovery of exports from the standstill last year and, more importantly, foreclosed the prospect for debt reduction taking advantage of present low oil prices, then the dreams of a generation of Koreans would be shattered. The social and political implications of that result are not ones Koreans like to think about.

On a more practical level, the revaluation is feared for another reason. According to a recent survey conducted by my own organization, KTA, more than 30 percent of the firms surveyed replied that they would divert their imports away from Japan to the United States and elsewhere if the current exchange rate relations among the dollar, yen, and won remain stable. The upward revaluation of the won at this moment would certainly disturb this attitude against the interest of both Korea and the United States.

There is a particular reason why the Korean export sector is so sensitive to the foreign exchange rate. Korean companies are keenly aware of some of their disadvantages in international competition; they face higher interest rates-10 percent to 13 percent per annum-higher energy costs, and higher utility rates. This means that their room for cost and price adjustment in response to a revaluation is much more limited than is the case with many of their competitors abroad.

On balance, it may be safe to say that a hasty upward revaluation of the won under the present circumstances will contribute little to the improvement of the U.S. trade balance, whereas its implications with respect to Korea's economic health and social and political aspirations appear to be much more preponderant. Stressing this asymmetry, Korea's concern at the present moment is that the United States may easily "average in" Korea with other countries of the region, even though in reality her situation is quite different.

Korea's reluctance toward the discrete revaluation for the moment, however, in no way means that she wants to have the exchange rate fixed at a certain level regardless of changes at home and abroad. On the contrary-Korea's rate has been floating on the basis of the "basket" value of currencies of her major trading partners. Won value, in fact, has appreciated by more than 2 percent since September last year, and this trend is expected to continue.

Nor is Korea ignoring the growing accumulation of trade surpluses with the United States. The Korean government and the Korean business sector are now making concerted efforts to divert imports from Japan to the United States. For example, my organization, KTA, encouraged by the survey results that I mentioned earlier, has been working to produce a list of specific items in great detail that can be purchased from the United States instead of Japan. That list will be distributed widely in a few months. Major business organizations are now launching "Buy American" campaigns, organizing at the same time a buying mission to be sent to America early next year.

For the longer run, Korea will continue to pursue import liberalization in many forms. We will continue our efforts to share production and employment with Americans by setting up manufacturing plants in the United States, as has been or is being done in the area of electronics, steel, and automaking.

On the other hand, we have been urging American companies to come over to Korea and produce jointly with Korean companies and sell in the vast neighboring markets, taking advantage of the geographical vicinity to those markets, lower wage rates, and good economic and social environments that are found in Korea today.

One of the most striking developments in the Pacific region in recent years, in my view, is that industrial coproduction-or intra-industry specialization-is becoming one of the major forms of international economic cooperation. And this is, I believe, one of the surest ways to solve the problems of trade imbalances among nations in our region for common prosperity.

Concluding Remarks

In closing, let me say that no matter what happens in the trade and financial discourse between our two countries, there is one thing that we need to emphasize. Loud and publicly disputed claims on the issues only stir up bad feelings on both sides and make it harder for policy makers to work together. Under the glaring lights of public conflict, any concession looks like capitulation and gives ammunition to those calling for protectionism. Both sides must work together in good faith to actually solve the problems that arise. In doing so, the path of quiet negotiations is far more likely to lead to success.

As President Reagan has so succinctly put it, "protectionism is destructionism." The United States and Korea must work together to avoid the destruction of the open and free international trading system. With this common goal in mind, we must find out what each side really wants, and then negotiate to satisfy those needs to the greatest extent possible.