September 17, 2017
Dean Baker
The Hankyoreh, September 17, 2017
Last month the Trump White House indicated that it was making plans to get out of the South Korea-United States Trade Agreement (KORUS). Like many statements from the Trump administration, it is difficult to know how seriously to take this threat. However as policy, this would be a bad move, which I say as someone who was opposed to the trade agreement.
As a first point, it is worth noting the obvious. At a time when North Korea is building up a nuclear arsenal and making threats that it could use its weapons it is probably not a good idea to upset the U.S. relationship with South Korea. While it is desirable to make changes in the trade agreement, this is not a good time to abruptly propose cancelling the deal.
The second point is that the effects of a trade deal are not reversible. The United States trade deficit with South Korea has increased rapidly in the years since the agreement took effect. While KORUS is certainly not the only factor responsible for this increase, one of the main points of the deal was to lend an element of certainty to U.S.-Korea trade relations.
In this context, it made more sense for Korean firms to actively cultivate the U.S. market since they had greater assurance that Washington would not subsequently impose protectionist measures to limit their market share. While the impact of this sort of assurance is difficult to measure, recent research shows that the granting of permanent normal trading relations to China following its entry to the WTO had a large impact on its exports to the United States. It is reasonable to think there is a similar story with the KORUS.
This increase of exports, contributing to a larger U.S. trade deficit, is a problem. Most immediately, a larger U.S. trade deficit means a loss of manufacturing jobs, since manufactured goods are responsible for the deficit. These are relatively high-paying jobs for workers with less than college degrees. The rapid loss of manufacturing jobs in the last two decades due to the explosion of the U.S. trade deficit has been a major factor in the rise of inequality over this period.
The other problem with a trade deficit is that it reduces demand in the economy. Economists have generally dismissed the idea that a trade deficit could lead to a shortfall in aggregate demand, and therefore higher unemployment, arguing that the central bank could just lower interest rates to move the economy back towards full employment.
However in the wake of the Great Recession this view is no longer credible. With The Fed’s short-term interest rate having bottomed out at zero back in 2009, there was no way that it could easily boost the economy back to full employment.
The Fed experimented with unorthodox monetary policy, and undoubtedly could have been more aggressive, but the key point is that we cannot assume the Fed and other central banks necessarily have the power to keep the economy at full employment. In this context, the loss of demand due to a trade deficit can have very serious macroeconomic implications.
Having said this, it doesn’t follow that exiting the trade deal will make things right. Changes in trade patterns are not easily reversed. The markets that Korean firms have won since the KORUS took effect will not just disappear if the KORUS is repealed. Furthermore, even if Korean firms were to surrender some market share after it was repealed, there is no guarantee that U.S. firms, producing in the United States, will fill the gap. The firms that fill this gap will be looking to produce in whatever country has the lowest case, and this is as likely to be Vietnam or Malaysia as the United States. There is no way to just go back to the pre-KORUS world.
This doesn’t mean that the agreement cannot be changed in ways that would make it better for the United States and quite possibly Korea as well. At the top of the list would be the inclusion of rules on currency.
Korea is now running a current account surplus of more than 6.0 percent of GDP. This implies a seriously under-valued currency. In standard trade models, a rapidly growing country like Korea would be expected to run a trade deficit, as capital flowed into the country. There are many extenuating factors which can prevent this simple story from strictly applying, but it is hard to tell a story whereby a trade surplus of 6.0 percent of GDP is not seriously out of line.
A gradual process of raising the won should be associated with an improvement in living standards for the Korean people as imported items become cheaper. With an unemployment rate below 4.0 percent the country should be able to withstand the loss in demand resulting from a lower trade deficit. Furthermore, if a lower trade surplus does start to raise the unemployment rate, the low budget deficit and national debt give the government plenty of fiscal space to boost demand with added spending and tax cuts.
There are many other areas where it would also be desirable to modify KORUS. For example, there is no reason to have the extra-judicial tribunals offered by the investor-state dispute settlement mechanism. Both countries have judicial systems in which foreign businesses can be assured of being treated fairly.
And, the strong rules on patent and copyright monopolies should be removed, especially for prescription drugs. We should be looking at more modern mechanisms for supporting innovation and creative work, not locking in these relics of the medieval guild system for all eternity.
In short, there are many ways in which KORUS can be improved. Unfortunately it doesn’t seem the Trump administration has any interest in going down this path. It is not clear what it could hope to accomplish by just pulling out of KORUS, but it not likely to have a positive outcome for either country.
