REPORT IMPACT ASSESSMENT OF ASEAN KOREA FTA ON VIET NAM S ECONOMY ACTIVITY CODE: FTA 2. Ha Noi, 11/2010. Prepared by:

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1 REPORT IMPACT ASSESSMENT OF ASEAN KOREA FTA ON VIET NAM S ECONOMY ACTIVITY CODE: FTA 2 Ha Noi, 11/2010 Prepared by: Ms. Veena Jha Mr. Francesco Abbate Mr. Nguyen Hoai Son Mr. Pham Anh Tuan Mr. Nguyen Le Minh This document has been prepared with financial assistance from the Commission of the European Union. The views expressed herein are those of the author and therefore in no way reflect the official opinion of the Commission nor the Ministry of Industry and Trade.

2 This report prepared by Dr. Veena Jha builds on an earlier interim report submitted by Francesco Abbate and Veena Jha against the consultancy on Effects of ASEAN Korea Free Trade Agreement on Viet Nam. Pages 6-18 on the details of the agreement were compiled by Mr. Francesco Abbate. This report also incorporates the important contributions of the PTF experts and facts learnt by the team during its field mission which lasted from 31 st August to 11 th September

3 TABLE OF CONTENT EXECUTIVE SUMMARY... 5 Introduction... 9 PART A. THE SETTING CHAPTER I KEY FEATURES OF AKFTA I.1Background I.2 The architecture of AKFTA I.3 Framework Agreement on Comprehensive Economic Cooperation I.4 Trade in Goods Agreement I.5 Services Agreement I.6 Investment Agreement I.7 Dispute Settlement Agreement CHAPTER II IMPLICATIONS OF THE GLOBAL ECONOMIC CRISIS FOR AKFTA AKFTA II.1: Implications of the crisis on Viet Nam II.2 The AKFTA in this global crisis Section B: Trade of Vietnam with Korea Chapter III. Trade and Investment Flows between Vietnam and Korea III.1 Evolution and structure of Vietnam s trade with Korea III. 2 : Trends in and composition of Korea s FDI flows to Vietnam III. 3 Evolution and structure of trade in services with Korea Chapter IV: Stylized Facts about Korea and Vietnam s tariff structure before and after AKFTA IV.1: Evolution and structure of Vietnam and Korea's tariffs IV.2 Major changes in Vietnam s and Korea s tariff profiles after full implementation of AKFTA IV.3 Non tariff measures in Vietnam and Korea IV.4 Effective rates of protection in Vietnam PART C. ECONOMY WIDE & SECTORAL ASSESSMENT:A QUANTITATIVE APPROACH Chapter V: The Methodological Approach

4 V.1 The Economic Model V.2 Literature survey of main results from Economic models Chapter VI: Economy wide Impact VI.1 Welfare and Output Effects IV.2 Trade flows VI.3 Wages VI.4 Changes in skilled and unskilled employment Chapter VII. IDENTIFICATION OF WINNING AND LOSING PRODUCTS VII.1 Selected Export and import competing products in the primary sector VII.2 Selected Manufacturing export and import competing products VII.3 Selected export and import competing services Part D Conclusions and Recommendations Annex Annex Annex

5 EXECUTIVE SUMMARY Vietnam is one of the brightest emerging markets in Southeast Asia. Vietnam is one of the major exporters of footwear and garments for the global supply chain. In this context, the signing of AKFTA along with its accession to the WTO in 2007 would be expected to give a big boost to its trade strategy. Vietnam's present trade regime is characterized by a 'dual' approach. On the one hand, the government promotes export-oriented sectors in which private firms, especially the foreign-owned firms which are fully integrated into cross-border production networks, play the leading roles. The share of foreign-owned firms in Vietnam's total manufacturing exports increased from about 20% in the mid-1990s to over 70% by 2002 and was about the same in The private sector is mostly labor-intensive, and exports on average are three-quarters of its production; this contrasts sharply with the state sector that is mainly capital-intensive and inward-looking, but still dominates the economy. On the other hand, the foreign trade regime of Vietnam is designed to protect some of its large import-substituting industries and related State-Owned Enterprises (SOEs). In the face of increased competition from abroad, the trade regime is still considered to be restrictive by maintaining controls in key imported commodities such as oil and gas, mining, transport equipment, cement and steel, petrochemicals. In fact, the Vietnamese government maintains protection of capital intensive SOEs that are dominant in import-substituting sectors but remain generally weak, although they benefit from FDI. Such issues reflect Vietnam's rather special circumstances as an Asian transition economy, where the SOEs still enjoy rents from existing barriers to trade because of their leading role in policymaking, revenue collection and distribution. Vietnam's case is similar to the early industrialization experiences of South Korea. While some tariff barriers will continue to exist post liberalisation, the huge increase in trade is a testimony to the beneficial effects of the FTAs and accession to the WTO. The impact assessment of AKFTA cannot be conducted in isolation. Such an assessment has to incorporate the effects of ASEAN+3 agreements as Vietnam's trade is composed of low value added products with a high import content. Hence the other agreements, including AFTA are of material concern. As with other ASEAN FTAs, the ASEAN-Korea FTA (AKFTA) is characterized by a sectoral approach to negotiations. First an agreement was reached on trade in goods. It was followed by agreements on trade in services and on investment. As this agreement is only about three years old and data at this point of time is available only till the end of 2009, this impact assessment study has to be, necessarily, forward-looking, rather than stock-taking. For goods, the AKFTA deals exclusively with tariff dismantling and related rules of origin (ROO), leaving aside non-tariff barriers, apart from reiterating the relevant WTO disciplines. This implies that while there is substantial supply capacity in Vietnam for exporting products such as rice, Korea despite the FTA will not figure as one of its major destination markets. This is because Korea has several non-tatriff barriers on rice.(see Table VI.3) In comparing ROO in selected ASEAN FTAs (Table 1.2), it is interesting to note that AKFTA appears to be the most liberal as the change in tariff classification (CTC), as an alternative rule to the 40% regional value content (RVC) criterion, is applicable to a greater number of products. This outcome reflects Korea s preference for CTC over RVC, because of difficulties in calculating the value added. AKFTA is further characterized by a much greater use of the wholly obtained (WO) criterion and by the introduction of the back-to-back Certificate of Origin (CO), which allows the granting of preferences to the re-exports of partner A into partner B of products first exported by 5

6 partner C into A. With regard to product-specific ROO, as with the other ASEAN FTA, AKFTA is generally liberal even in the sensitive sectors, although in varying degrees. The relatively liberal ROO have resulted in a huge increase in trade exports from Vietnam to Korea and a relatively moderate increase in imports from Korea. (see below) Regarding services, Vietnam's commitments have not gone further than theirs in the WTO, while Korea's commitments are much deeper. In fact, Vietnam's commitments in the context of the ASEAN FTA go much deeper and if this is any precursor of its future commitments in the AKFTA, it is likely that many sectors would be liberalized. Investment liberalization commitments will only be implemented gradually, but Vietnam has already seen a huge increase in investments from Korea. AKFTA came at a fortuitous time for Vietnam. The global economic crisis starting in 2008 has had an impact on both export- and import-dependent industries in Vietnam. The sectors affected include textile and garments, leather shoes, wood processing, seafood processing, electronic components and tourism. The huge boost in exports to Korea in these sectors after signing the FTA would in part compensate for the decline in exports elsewhere. By end 2010 bilateral trade was expected to increase to over US$10billion and is expected to rise to US$20bn by Following the FTA there has been a big jump in trade values with both exports and imports increasing exponentially. According to data released by customs authorities, the bilateral trade value was US$4.2 billion in 2005, US$4.7 billion in 2006, US$6.6 billion in 2007 and US$9.9 billion in 2008 despite difficulties triggered by the global economic crisis. In 2009, the two-side trade turnover sank 8.5 % to US$9 billion because of direct effects of the global economic downturn. Trade of Vietnam with Korea almost doubled since signing the FTA in 2007, with almost a three fold increase in exports and a 50% increase in imports. That most of the increase in trade can be attributed to the FTA is shown by the huge increase in certificates of origin in Vietnam for trade with Korea. In 2009, South Korea was the seventh largest importer of Vietnam s goods, it was however the largest exporter to Vietnam. South Korea was the fourth largest trade partner of Vietnam in Vietnam s main exports to South Korea in the first five months of 2010 included seafood, apparel, crude oil, coal, timber, coffee, electronics, computer parts, transport parts and rubber. The top ten exports account for over 60% of the total exports in terms of value through the three years, Meanwhile, Vietnam s key imports from South Korea consisted of fabric, steel, machinery, equipment, tools, parts, petroleum, plastic materials, computers, electronic products and parts, textile materials, leather shoes, ordinary metal, automotive parts and ships. The top 10 imports accounted for nearly 72% of Vietnam s spending on imports from South Korea. The concentration of products in the trade profile of the two countries also reflects the investment profile of Korea into Vietnam. The export of electronics, telecommunication as well as transport equipment to Korea is a post FTA phenomenon consequent to investment in these sectors by Korea. South Korea is Vietnam's second largest foreign investor after Taiwan as Korean companies had registered $20.15 billion for more than 2,200 projects from 1988 to July In services, retail and franchise trade were among the attractive business sectors to Korean investors as consumer spending was expected to grow some 20 percent a year. In 2008, South Korea was the second largest investor in Vietnam s clothing sector after Taiwan with an investment of US $737 6

7 million. South Korea was the sixth largest garment importer from Vietnam in 2008 with turnover reaching $139 million. Investment in electronics by Korea into Vietnam has also been significant. In Mode 4 as well Vietnam is one of the major recipients of Korea's EPS scheme though supply of Vietnamese labour is far greater than that absorbed by Korea. Training schemes were also undertaken by the two countries to enable the level of skill development required for working in Korea. That the increase in trade in goods can be mainly attributed to the FTA is shown by the fact that the number of C/O (certificate of origin) forms used for the ASEAN Korea FTA by Vietnamese exporters has increased (exporters using C/O form AK can enjoy preferential tariff when exporting goods to South Korea). In 2009, Vietnamese enterprises used 33,479 C/Os form AK to export $1.66 billion worth of goods to South Korea, accounting for 86 percent of Vietnam s total export revenue to the country. However, non-tariff barriers even post AKFTA may damper Vietnam's expectations of increasing agricultural exports to Korea. In some products, such as textiles and garment, ERP will continue to be high post AKFTA which may have a dampening effect on exports. Tariff jumping investments may however negate some of the effects of high tariffs, especially if Korea's import tariffs on these products are low. As AKFTA is of relatively short duration, it is important to use GTAP to predict how trade and other macroeconomic variables are likely to change in the coming years. While the formation of AKFTA will increase aggregate welfare in the long run, this increase will only amount to about half a billion dollars. Terms of trade are likely to become adverse in the long run for Vietnam. This is because labour and wage costs are likely to rise with free trade agreements and labour intensive exports may thus suffer an adverse terms of trade. However, AKFTA may lead to a decrease in the costs of capital goods to the Vietnamese economy as cheaper capital goods imports from Korea and other FTA members will become available. The most important gains would however accrue from better allocation of resources consequent to trade liberalisation. Broadly speaking, real output effects more or less correspond to welfare effects so that increases in welfare correspond to gains in real output. Output losses can be partly traced to total imports rising faster than total exports. Viet Nam will enjoy welfare and output gains under AKFTA. In fact, Viet Nam s output gains will be greater than those of higher income countries such as Indonesia, Thailand, or Philippines. This is mainly because Viet Nam s total exports will grow rapidly, the fastest among member-economies. Viet Nam s total export growth will be much higher than its total import growth. All the sectoral differences and changes are consistent with the model and equations explained in the methodology (annex IV). For example, exports from all regions to Viet Nam increase due to tariff-cuts, while exports from Viet Nam to Korea increase in many sectors. Viet Nam manages to increase exports in some sectors mainly because the corresponding tariff-cuts are not too high. This is also because of the cheaper imported intermediate inputs to such sectors, as implied by the Input- Output structure of the data and underlying model. Changes in exports and imports affect those in output. (See Annex IV on Methodology). Output growth or decline has an impact on labor demand and price. For example, fall in agricultural output results in fall in agricultural employment of both skilled and unskilled labor. (see Annex IV on methodology). Wages increase because of increase in output and hence labor demand in many other sectors. As expected, the long-run results are far more pronounced because their corresponding tariff-cuts were far higher than the short-run counterparts. Welfare results are mostly driven by the 7

8 tariff-cuts and hence the international trade part of the economy, mostly in terms of allocative efficiency, but also partly due to terms-of-trade changes. GTAP analysis does suggest that agriculture exports to Korea would particularly rise in the long run. However, GTAP analysis does not take account of non-tariff barriers nor of the supply capacities of Vietnam. Given that Korean investment in agriculture in Vietnam has been minimal and non-tariff barriers in rice in Korea are insurmountable in the short run, the prospects for product diversification in agricultural exports to Korea are minimal. In fact only coffee exports may have some prospects but this is a traditional export of Vietnam. In minerals however, there is a much greater scope for increasing exports both of raw materials and refined minerals. The tables in Annex 4 on comparative advantages and disadvantages of Vietnam versus Korea and ASEAN which is based on the current trade profile of the two countries also does not show a major advantage for Vietnam in primary products. On the other hands both the GTAP analysis and tables in Annex 4 show some advantage in textiles and clothing and in other manufacturing. GTAP analysis also shows some advantages in transportation and other sectors. GTAP analysis also shows some comparative disadvantage for Vietnam in the services sector. Moreover, both in terms of investment and in terms of mode 4, there has been some progress in trade between the two countries as shown by chapter IV. There is concern that Vietnam's exports to Korea are only processed products whose imported content is high. This on one hand, has lowered the added value, on the other hand enlarged the dependence on Korea, causing trade deficit to increase, and the economy to be easily affected when there are instabilities in the overseas markets. Further the techonological content of exports and production in general is low. In spite of being considered as a driving force of growth, and a key factor to improve the quality of growth, technological science activities only account for 0.62 to 0.63 percent of GDP. Further the product content of export and imports from Korea is indicative of another factor. Korea is perhaps able to use Vietnam as a base to export to third countries. This could be explained by the investment profile of Korea which shows investment in products which may not have a large market in Korea. This includes products such as iron and steel, aluminium and other such industries. AKFTA should not only result in trade creation and higher growth rates for Vietnam, but it must also change the composition of its trade through product diversification. In the face of intense competition in global markets especially from China, a considerable potential for upgrading Vietnam's export performance through product diversification and quality improvement remains. In a longer-term perspective, Vietnam should think of expanding capital-intensive and more sophisticated products. In sum, opportunities of Vietnam's trade export growth depend on how the government succeeds in changing its industrial structure and the related export pattern towards higher value-added products. The contribution of AKFTA must be examined in this context. 8

9 INTRODUCTION Vietnam has a robust economy. Vietnam is one of the brightest emerging markets in Southeast Asia. Its economy remained sturdy with 5.3% growth in 2009 despite the financial tsunami. Key drivers of the country s economic growth include a strong export engine supported by the abundance of young labour at relatively low-cost, growing buying power of consumers, and geographic advantage with proximity to China. As Vietnam gradually opens its economy according to its WTO commitments, new business opportunities emerge. While most other Asian nations recorded double-digit decline in their external trade amid the global economic crisis in 2009, Vietnam s trade performance was comparatively healthy, with exports and imports falling 9.7% and 14.7% respectively from the 2008 levels, an indication of the competitiveness of many Vietnamese products in the international market. As such, the plunge in external demand also dealt a lesser blow to Vietnam compared to other export-oriented Southeast Asian countries, even though its export sector accounts for some 60% of GDP. With a fast growing economy and gradual liberalisation of the retail market following World Trade Organisation (WTO) accession in 2007, Vietnam has been experiencing rapid retail market growth, with an average annual growth rate of more than 8% from , outpacing the country s economic growth. As a retail market, Vietnam is attractive given many positive fundamental factors, which include a young population, accelerating urbanisation, increasing brand awareness and demand for better-quality products. Modern retail channels now account for 20% of the market, with the share expected to keep rising rapidly to drive Vietnam s overall retail industry growth. This is expected to give a further boost to trade. Vietnam is one of the major exporters of footwear and garments for the global supply chain. Its strengths as a production base lies in its relatively cheaper labour cost and low cost of land use. With 60% of the 87 million population under the age of 25, Vietnam has a large pool of young workers to give it an advantage as a base for labour-intensive production. In recent years, Vietnam s legal system has greatly improved to create a more favourable and open investment environment. Many laws and regulations regarding investment and enterprises have been enacted to establish a more mature legal framework for foreign investment. These changes have helped create more opportunities for foreign investors, as more favourable forms of direct investment and capital structures are allowed. In addition, better protection for business contracts and intellectual property rights is seen after the country s legal reform, with the latest laws better complying with international standards and in accordance with the WTO s commitment. Hong Kong companies have been taking advantage of the trend. For instance, Hong Kong-listed automobile equipment manufacturer Zhongda International Holdings established its first overseas plant in 2007 in Vietnam for the production of truck chassis and special purpose vehicles in a US$60 million joint venture with the state-owned vehicle manufacturer, Vietnam Motors Industry. With manufacturing costs surging on the Chinese mainland in recent years, many multinational enterprises regard Vietnam as an alternative location for diversifying their production bases. For example, Japanese camera maker Canon has shifted some of its production from the Chinese mainland to Vietnam. In this background the possibilities for the ASEAN Korea Free trade agreement (AKFTA) have improved significantly. This report evaluates the effects of the AKFTA on Vietnam by quanitative and qualitative means. Section A, lays out the setting for the AKFTA along with the details of the agreement and the implications of the current financial and economic crisis on Vietnam. Section B examines trade and investment flows into Vietnam consequent to 9

10 signing of AKFTA. It also analyses the changes in tariffs as well as the effective rates of protection offered to Vietnamese products. Section C is a quantitative and predictive analysis of the effects of the AKFTA both in the short run and long run. The macroeconomic variables analysed here not just focus on trade, but also output, wages and employment. A Computable general equilibrium (CGE) framework is used for this analysis. However, given the limitations of a CGE framework, the results obtained are tallied with micro level information obtained from various reports on Vietnam. Finally section D draws up conclusions and some lessons learnt from the AKFTA. It also draws up some recommendations for future FTAs that Vietnam may negotiate. 10

11 PART A. THE SETTING CHAPTER I - KEY FEATURES OF AKFTA I.1BACKGROUND The ASEAN-Korea Free Trade Area (AKFTA) is a major concrete manifestation of both ASEAN s pivotal role in the Asia-Pacific region and the trend towards regionalism that has characterized ASEAN s outward-looking trade policies since the late 1990s. Building on the Joint Statement on East Asia Cooperation of 1999, cooperation between the Southeast and Northeast Asian countries has accelerated with the holding of an annual summit among the leaders of ASEAN, China, Japan, and the Republic of Korea (ROK) within the ASEAN Plus Three (APT) process. In 2001, Korea s former President Kim Dae-jung proposed a free-trade area that would include all APT members, but this was considered somewhat premature. Subsequently, when the first East Asia Summit was convened in Kuala Lumpur in December 2005, Australia, India and New Zealand were also included in the grouping, thereby initiating the ASEAN Plus Six (APS) process. Starting in 2002, ASEAN Member Countries have collectively concluded FTAs with all Plus Six countries: China (November 2002), Japan (October 2003), Korea (December 2005), Australia and New Zealand (February 2009), India (August 2009). Furthermore, Vietnam has concluded an Economic Partnership Agreement with Japan (December 2008). These agreements will serve as the building blocks of an East Asian Free Trade Area as a long term goal. By concluding FTAs with individual Dialogue Partners (the so-called ASEAN+1 FTA approach), ASEAN has become, in effect, a hub, with the 6 Dialogue Partners being the spokes. The impact assessment of AKFTA cannot be conducted in isolation. To be meaningful, particularly from a policy recommendations viewpoint, such an assessment has necessarily to take into account the other ASEAN FTAs, including AFTA, although they are all at different stages of implementation. The ASEAN FTAs share many provisions, as they have been heavily influenced in their making by the WTO disciplines, by AFTA itself and by the requests and negotiating power of the various Dialogue Partners individually involved in each of such FTAs. A major purpose of this Chapter is to highlight not only the key characteristics of AKFTA but also its distinctive features. I.2 THE ARCHITECTURE OF AKFTA Box 1. The architecture of AKFTA Agreement Date of signature Date of entry into force Framework Agreement on 13 December July Comprehensive Economic Cooperation Trade in Goods (AKTIG) Annex 1. Normal Track Annex 2. Sensitive Track Annex 3. Rules of Origin (ROO) 26 August 2006 (except Thailand)* 1 June 2007 (except Thailand)* Trade in Services (AKTIS) Annexes on schedules of specific commitments 21 November 2007 (except Thailand)* 1 May

12 by individual Parties Investment 2 June 2009 Dispute Settlement Mechanism (DSM) 13 December July 2006 (to check) * The Protocols on the accession of Thailand to the Agreements on TIG and TIS were signed on 27 February 2009 The agreements underpinning AKFTA fall into a simple legal structure: an umbrella agreement (The Framework Agreement on Comprehensive Economic Cooperation); agreements for each of three broad areas that AKFTA covers (goods, services and investment); and an agreement on dispute settlement which applies to the three areas. Box 1 describes this basic structure, showing the dates of signature and entry into force of each agreement. As with other ASEAN FTAs, the ASEAN-Korea FTA (AKFTA) is characterized by a sectoral approach to negotiations. First an agreement was reached on trade in goods. It was followed by agreements on trade in services and on investment. It is worth noting that the Agreement on Trade in Goods (AKTIG) entered into force only 2 ½ years ago and the Agreement on Trade in Services (AKTIS) as recently as six months ago, while that on investment was just signed. Because of the very short track record of AKFTA, this impact assessment study has to be, necessarily, forward-looking, rather than stock-taking, I.3 FRAMEWORK AGREEMENT ON COMPREHENSIVE ECONOMIC COOPERATION The Framework Agreement established AKFTA and laid down the scope and timing of the Agreements on TIG, TIS and Investment. It also called for the implementation of specific economic cooperation measures in a number of FTA-related areas (Box 2) as well as capacity-building programmes and technical assistance, particularly for the new ASEAN Member Countries, based on the experiences and expertise of Korea in development. For this purpose, the ASEAN-Korea Economic Cooperation Fund, financed only by Korea, was created. Box 2 Areas for economic cooperation The Framework Agreement urges the Parties to explore and undertake cooperation projects in the following areas: (a) customs procedures; (b) trade and investment promotion; (c) small and medium enterprises; (d) human resource management and development; (e) tourism; (f) science and technology; (g) financial services; (h) information and communication technology; (i) agriculture, fisheries, livestock, plantation commodities and forestry; (j) intellectual property; (k) environmental industry; (l) broadcasting; (m) construction technology; (n) standards and conformity assessment and sanitary and phytosanitary measures; (o) mining; (p) energy; (q) natural resources; (r) shipbuilding and maritime transport; and (s) film. 12

13 [ Details of such cooperation are specified in the Annex on Economic Cooperation. As an example, for trade and investment promotion (see b) above), the Annex calls for launching a feasibility study on the establishment of an ASEAN-Korea Centre based in Korea. The Centre, modelled after the ASEAN-Japan Centre, was established in Seoul. It is financed exclusively by the Korean Government. Reportedly, this is the only area of cooperation where significant progress has been made so far. I.4 TRADE IN GOODS AGREEMENT Unlike AFTA, the TIG Agreement deals exclusively with tariff dismantling and related rules of origin (ROO), leaving aside non-tariff barriers, apart from reiterating the relevant WTO disciplines. The Agreement, in fact states that The Parties shall identify non-tariff barriers other than quantitative restrictions for elimination as soon as possible after the entry into force of this Agreement. This means that quantitative restrictions, such as Korea s quota on rice, will not be covered by future negotiations. This provision limits the positive effects of AKFTA on Vietnam, a major rice exporter. Rice remains subject to import quota restrictions under Korea's WTO minimum market access (MMA) commitments until Furthermore, negotiations on other non-tariff barriers, such as scientifically unjustifiable sanitary and phytosanitary measures (SPS) and technical barriers to trade (TBT) have not yet started. All tariff lines are subject to the tariff reduction or elimination programme, based on applied MFN rates, rather than bound rates, thus resulting in a higher effective preferential margin until tariffs are eliminated. The tariff lines are grouped into two categories: 1) The Normal Track, which covers at least 90 % of all tariff lines of each Party and at least 90 % of the total value of imports for ASEAN-6 and Korea, and 75% for Vietnam (based on 2004 trade statistics). With regard to the timing of the dismantling, the principle of special and differential treatment has also been applied and additional flexibility has been granted to the newer ASEAN members. Thus, Korea will eliminate all tariffs for products listed in the Normal Track by 1 January For ASEAN-6 the deadline is 1 January 2012, while Vietnam was given an additional 6 years (up to 1 January 2018) and Cambodia, Lao PDR and Myanmar received an additional 8 years (up to 1 January 2020). For details, see Box 3. In fact, the TIG Agreement adopts the negative listing approach. Those products which are not listed under the Sensitive Track (see below) are automatically subject to the tariff reduction and elimination modality of the Normal Track. The principle of reciprocity is also applied: If an exporting Party places a tariff line in the Normal Track, that exporting Party shall enjoy the tariff concessions which an importing Party has made for that tariff line. This clause is meant to avoid free rides. Box 3 - Normal Track Korea will eliminate tariffs on at least 70% of its products listed in Normal Track upon the entry into force of the Agreement, i.e., 1 June All tariffs for products listed in Normal Track will be eliminated by 1 January 2010; For ASEAN-6, tariffs will be eliminated in 4 phases beginning July 2006 and concluded by 2012: tariffs for at least 50% of products listed in Normal Track will be reduced to 0-5% by 1 January 2007; tariffs for at least 90% of products listed in Normal Track to be eliminated by 1 January 2009; 13

14 all tariffs for products listed in Normal Track to be eliminated by 1 January 2010, with flexibility to eliminate maximum 5% of products listed in Normal Track by 1 January 2012; and all tariffs for products listed in Normal Track will be eliminated by 1 January Vietnam is given an additional 6 years while Cambodia, Lao PDR and Myanmar are given an additional 8 years. 2) The Sensitive Track provides a mechanism for the Parties to protect a limited amount of traded goods, which, according to their own perception, need to be dealt with greater care because of the possible adverse impact of tariff dismantling on the production of import-competing firms and related employment. Under this track, the principle of special and differential treatment is also applied in favour of ASEAN new Member Countries, with regard to coverage and timing (for details, see Box 4). The product composition of Vietnam s Sensitive Track is virtually identical to that in the ASEAN-China FTA, although the structure of Vietnam s current and future imports from Korea is substantially different from those from China. Box 4 - Sensitive Track For ASEAN 6 and Korea, maximum ceiling for Sensitive Track is 10 per cent of all tariff lines and 10 per cent of the total value of imports based on 2004 trade statistics; For Vietnam, this ceiling is 10% of all tariff lines and 25% of the total value of imports from Korea; and for Cambodia, Lao PDR and Myanmar, 10% of all tariff lines. Products in the Sensitive Track are divided into Sensitive List (SL) and Highly Sensitive List (HSL); HSL is limited to 200 tariff lines at the HS 6-digit level or 3 per cent of all the tariff lines and 3 per cent of the total value of imports (the latter ceiling does not apply to CLMV countries) Duties for products under the SL will be reduced to 20 per cent by 1 January 2012 and subsequently to 0-5 per cent by 1 January Vietnam is given an additional 5 years while Cambodia, Lao PDR and Myanmar are given an additional 8 years. Products under HSL are subjected to five methods of tariff reduction: o tariffs to be reduced to 50% by 1 January 2016; o tariffs to be reduced by 20% by 1 January 2016; o tariffs to be reduced by 50% by 1 January 2016; o products subjected to Tariff Rate Quotas (TRQs); and o products exempted from tariff reduction. A maximum of 40 tariff lines at six digit level can be placed under this category. For the first three methods of tariff reduction mentioned above, Vietnam is given an additional 5 years while Cambodia, Lao PDR and Myanmar are given an additional 8 years. Table I.1 shows average tariff rates for major product categories at the full implementation of tariff dismantling under AKFTA as well as under WTO, AFTA, and ASEAN-China FTA (ACFTA). With regard to AFTA, the deepest tariff cuts (20 percentage points and above) will occur in agriculture, fish and fishery products, and textiles and garments. Conversely, cars and transportation equipment will remain heavily protected with tariff rates hovering around 36%, or as high as MFN rates, but much higher than those that will prevail under ACFTA and, particularly, under AFTA. Table I.1 Vietnam s average tariff rates in major trade agreements 14

15 Figure 1 shows the differential impact of the future tariff cuts under various FTAs. By 2015, against MFN rates, preferential margins under AFTA will average about 14%, compared to 10% under ACFTA and 6% under AKFTA. By 2023, however, the gap between the different preferential margins is expected to narrow considerably. Figure I.1 Average tariff rates imposed by Vietnam to key trading partners Rules of Origin Box 5 The economics of the rules of origin 15

16 Rules of origin (ROO) are essential in FTAs to determine the eligibility of imported goods for preferential tariffs. In the absence of ROO, it would be extremely difficult to prevent trade deflection, which occurs when imports from non-member countries enter the FTA via the member country with the lowest tariff on non-member trade. An FTA without ROO would be tantamount to a customs union with a common external tariff equivalent that of the member country with the lowest MFN tariff. This situation would reduce import duty collection in the members with higher MFN tariffs. ROO are not only a technical tool to enforce FTAs but also a trade policy instrument. There is, in fact a trade-off between avoidance of trade deflection and trade creation. The more restrictive the ROO, the less is the risk of trade deflection. There is, however, a cost of compliance with ROO, to be borne by firms, in terms of documentation and accounting expenses. Such expenses can vary, according to the literature, from 1.5% to 6% of ex-factory price. If the difference between the MFN rates and the preferential rates (i.e. the margin of preference) is lower than the cost of compliance, firms will not use the preferential track and keep on paying the MFN tariff. Thus, the FTA will not be instrumental in enhancing intra-fta trade. A key indicator of the effectiveness of an FTA is or the utilization ratios, namely the value of preferential trade divided by total intra-fta trade. As shown in Annex Table 1, in 2006, AFTA utilization ratios for Malaysia and Thailand were 9% and 20%, respectively. However, excluding trade with Singapore, a country with very low MFN rates, these ratios would jump to 18% for Malaysia and 28% for Thailand. Interestingly, in exporting to Vietnam, a partner with relatively high MFN rates, Malaysia s utilization ratio was as high as 47% and that of Thailand reached 40%. Source: ADB (2008); Hiratsuka (2008) Rules of origin (ROO) play a key role in ensuring a proper functioning of an FTA and can significantly affect its effectiveness, by influencing intra-fta trade (see Box 5). Unsurprisingly, AKFTA s ROO reflect those that are found in AFTA and ACFTA, which, in turn, are largely inspired by international rules, such as those enshrined in the Kyoto Convention. However, AKFTA s ROO are also shaped by the results of the negotiations with Korea. The main criteria used in AKFTA to determine the origin of goods are described in Box 6. Box 6- AKFTA - Criteria for determining the origin of goods 1. Wholly obtained (WO) criterion : a good is deemed as originating from a particular country if a good is wholly obtained or produced entirely in the territory of that country. This criterion applies mainly to products which have been entirely grown, extracted from the soil, harvested within the country of export, obtained by maritime fishing or manufactured there from any of these products. Therefore it applies when only one country enters into consideration in attributing origin. 2.Regional value content (RVC) criterion requiring that 40% of the value of the final product must originate from AKFTA Parties. This criterion is used in combination with diagonal cumulation, under which a good originating in the territory of a Party, which is used in the territory of another Party as material for a finished good eligible for preferential tariff treatment, shall be considered to be originating in the territory of the latter Party where working or processing of the finished good has taken place. Diagonal cumulation is more generous than bilateral cumulation, which takes into account only the value added generated in the two trading Parties. 3. Change in Tariff Classification (CTC) criterion, requiring the product to belong to a tariff classification different from that of its imported inputs. The change of tariff classification can be expressed at various levels of aggregation: from broader to narrower, chapter (HS 2 digits), heading (HS 4 digits), subheading (HS 6 digits). Changes of classification expressed at broader levels of aggregation are, in principle, more constraining. 16

17 4. Technical test, requiring a specific product to undergo certain manufacturing operations in the exporting country or within AKFTA, such as the provision under which garments should be both cut and sewn in the territory of any Party. In comparing ROO in selected ASEAN FTAs (Table 1.2), it is interesting to note that AKFTA appears to be the most liberal as the change in tariff classification (CTC), as an alternative rule to the 40% regional value content (RVC) criterion, is applicable to a greater number of products. This outcome reflects Korea s preference for CTC over RVC, because of difficulties in calculating the value added. 1 AKFTA is further characterized by a much greater use of the wholly obtained (WO) criterion and by the introduction of the back-to-back Certificate of Origin (CO), which allows the granting of preferences to the re-exports of partner A into partner B of products first exported by partner C into A. This provision is particularly beneficial to countries, such as Singapore, with significant entrepot trade, i.e. exporting imported goods which receive no further processing. With regard to product-specific ROO, as with the other ASEAN FTA, AKFTA is generally liberal even in the sensitive sectors, although in varying degrees. For details of product specific ROO see Annex 1. The RVC requirement is 40 percent except for a few cases in the automotive sector where it is 45 percent. Moreover, co-equal rules (CTC or RVC) are usually allowed. However, the predominance of WO criterion for food and agricultural products seems, prima facie, more restrictive than the RVC requirement prevailing in the other FTAs 2. Annex 1, Tables 1 to 4, provide some information on the ROO for iron and steel, textiles and garments, and food and agricultural products. Table I.2 Rules of origin in ASEAN FTA: a comparative analysis Source: ASEAN secretariat I.5 SERVICES AGREEMENT During trade negotiations, services are usually the most difficult sectors for liberalization because of the regulatory and legislative implications. However, this did not occur in the framework of AKFTA negotiations. Under the ASEAN-Korea Agreement on Trade in Services (AKTIS), which 1 See Expert Group Report on the Feasibility of an ASEAN-ROK FTA, Chapter 5, para.11 2 This was a preliminary finding from the first mission. 17

18 entered into force in May 2009, Vietnam concluded the first package of commitments, which correspond broadly to the same level of commitments as those made in the context of WTO accession and the ASEAN-China Agreement on Trade in Services (ACTIS). Conversely, Korea s commitments were more generous, as they went beyond those it had made under GATS by containing the revised offer it had tabled at the Doha Round negotiations in This disparity is the result of several factors: a) the special and differential treatment granted to new ASEAN Member Countries, in terms of flexibility for opening fewer sectors, liberalising fewer types of transactions and progressively extending market access in line with their respective development situation. b) Vietnam s defensive negotiating posture, in which protection of domestic services firms prevailed over the country s interest in penetrating Korea's services market c) Vietnam s weaknesses in several services sectors d) Korea s vision of liberalization of services trade as an instrument to facilitate domestic reform and deregulation and thereby raise efficiency in the overall economy. As in the case of GATS, under AKTIS the positive list approach was followed. 3 Vietnam made substantial commitments to liberalize access to 110 service subsectors included in 11 overall service sectors, out of 155 service subsectors identified by the WTO. For most of these services, Vietnam will allow 100% foreign ownership but restrictions limiting foreign ownership to percent will be maintained for several other sectors, such as telecommunications. Table I.3 lists those 11 sectors and shows the percentage share of sub-sectors for each category of commitments (full, partial, or no commitment) according to the mode of delivery and whether it concerns market access or national treatment. This characterization of commitments is important for assessing the nature and extent of liberalization in various services sectors. As an example, within the financial services sector, in its market access schedule, of the sub-sectors committed under mode 1, Vietnam maintains no restrictions in 15% of those, while there are bound, i.e. partial commitments for 20% and no (unbound) commitments for the remaining 65%. It is noteworthy that construction, education, health and financial services maintain a high degree of protectionism, as shown by the high share of unbound commitments, compared with other sectors, such as business and tourism services, which are basically all bound or have no restrictions. Table I. 3 Vietnam s commitments under AKTIS 3 A positive list approach is one where countries specify sectors which are covered or offered for commitments. In other words, countries list national treatment and market access commitments specifying the type of conditions under which foreign service suppliers can enter a given market or the type of treatment that will be granted to services or service suppliers in sectors included in the schedules of commitments. 18

19 Note: a: due to lack of feasibility; N: No restrictions (full commitment); B: Bound (partial commitment); U: Unbound (no commitment). The numbers correspond to the percentage of sub-sectors in each category. Source: Ministry of Industry and Trade By contrast, Vietnam has agreed to a much larger and deeper level of commitments within the ASEAN Framework Agreement on Services (AFAS), which has expanded the scope of liberalization in services among ASEAN members beyond those already undertaken under the GATS (GATS plus). To date, ASEAN has concluded five packages of commitments through successive rounds of negotiations that started in The progress made so far under AFAS can give some indication about the content of future packages of commitments in the context of AKTIS. In any case, the nature of service regulations is such that it is difficult to differentiate standards and conditions between AFAS partners and third party countries. Korea, therefore, may also reap the benefits of liberalization in services under AFAS. I.6 INVESTMENT AGREEMENT The Agreement on Investment is the latest addition in AKFTA architecture, as it was signed in June 2009, after three years of protracted negotiations. This is a legal framework to expand investment between the two parties. Among the three areas usually covered by investment agreements, namely protection, liberalization and facilitation, this instrument focuses particularly on protection. It is expected, in fact, to afford better protection for both Korean and ASEAN investors by granting national treatment and most favoured-nation treatment, which will guarantee protection from discriminative measures by local governments. In terms of investment protection, this Agreement is, reportedly, even more comprehensive than the ASEAN Comprehensive Investment Agreement (ACIA) signed in December

20 Plans for the liberalisation of investment for individual industries will, however, be completed within five years of the agreement taking effect. Furthermore, the Agreement is weak on investment facilitation, apart from the special and differential treatment for the new ASEAN Member Countries, which calls for: a) access to information on the investment policies of other Parties, business information, relevant databases and contact point for investment promotion; b) technical assistance to strengthen their capacity in relation to investment policies and promotion including in areas such as human resource development. The Agreement also emphasizes bilateral efforts to enhance fair and equal treatment of both sides, including in the cases of investment-related financial transfers and of expropriation and compensation, to improve investment-related transparency, and to better cope with investment disputes. I.7 DISPUTE SETTLEMENT AGREEMENT Being an international treaty, AKFTA is a legal system of rights and obligations for the Parties. The enforcement of any trade agreement entails the translation of legal provisions into effective results. This depends both on the implementation of the obligations and the resolution of disputes related to such implementation. The AKFTA Agreement on Dispute Settlement Mechanism (DSM) applies to all disputes on trade and economic cooperation that might arise between two Parties in connection with AKFTA implementation. This Agreement is broadly similar to the ACFTA Agreement on DSM. The dispute settlement consists of three stages that are outlined in Box 7. Box 7 - Dispute settlement procedures Consultations: A party complained against shall accord due consideration to and afford adequate opportunity for consultations regarding a request for consultations made by a complaining party Conciliation or mediation: These procedures, which are undertaken voluntarily if the parties to the dispute so agree, may be requested, and terminated, at any time by any party to a dispute. Arbitration: This formal and last stage is used if the parties cannot settle the dispute within 60 days after the request for consultations, or within 20 days in cases of urgency, such as those involving perishable goods. An arbitral panel, consisting of three members, would be established. Each party would appoint a member and the two parties together would try to appoint a third member, who would act as the chair. If they fail to do so, the chair is appointed by the Director General of WTO. Unlike NAFTA, AKFTA does not provide a roster of arbitrators but specifies only their qualifications. The litmus test of the effectiveness of any DSM is the implementation and enforcement of the decision of the arbitral panel. Under AKFTA, The final report of an arbitral panel shall be binding on the parties to the dispute and shall not be subject to appeal. In addition, Compensation [which is voluntary] and the suspension of concessions or benefits are temporary measures available in the event that the recommendations are not implemented within a reasonable 20

21 period of time. However, neither compensation nor the suspension of concessions or benefits is preferred to full implementation of the recommendations to bring a measure into conformity with the covered agreements. It should also be stressed, however, that, although AKFTA s DSM has several points in common with the WTO system, it lacks a standing body. Furthermore, AKFTA does not have a permanent secretariat. In addition ASEAN itself is an institution which has not yet acquired full international legal personality nor treaty making powers. As a result, AKFTA is not, as its title connotes, a bilateral accord between ASEAN as an entity and Korea, such as those concluded by the European Union with individual countries. AKFTA is rather a trade agreement with eleven Parties, i.e. Korea and the ten ASEAN Member Countries that participate in AKFTA as individual sovereign states. AKFTA s bilateral legal nature might have profound implications on the implementation of AKFTA obligations and the functioning of the DSM. The latter will basically be a mechanism for resolving disputes between Korea and individual ASEAN countries. The DSM cannot be used to settle disputes between Korea and ASEAN as a collectivity. Korea would have to pursue each ASEAN member individually to enforce its rights. ASEAN could at most provide help in the form of political goodwill and moral suasion but it is not in a legal position to force the individual member countries to perform their obligations. CHAPTER II IMPLICATIONS OF THE GLOBAL ECONOMIC CRISIS FOR AKFTA AKFTA II.1: IMPLICATIONS OF THE CRISIS ON VIET NAM 21

22 The main effects of the global economic crisis on Viet Nam was felt on its trade deficit and on inflows of foreign exchange. Viet Nam has traditionally (over the last twenty years or so) run large fiscal and trade deficits financed by foreign inflows, but there are growing signs that the imbalances are no longer sustainable. The country saw trade surplus in only one year (at $41 million, in 1992). The scale of trade deficit was rather high, $18 billion in 2008, and in the last four years, the country ran double digit trade deficit if calculated in billion US dollars. If compared to export turnover, and to GDP, trade deficit exceeded the safety level of 20 percent. This is because value added in exports is low which increased dependence on foreign countries, causing trade deficit to increase, and the economy to be easily affected when there are instabilities in the overseas markets. 4 However, for the first time in about fifteen years, Vietnam's trade deficit in the first eight months of 2009 fell an estimated 68 percent year on year to $6.22 billion in the first nine months of Trade deficits have increased in 2010, amounting to $8.58 billion during the first nine months. 5 The country's main sources of foreign exchange are exports, foreign direct investment, remittances from overseas Vietnamese and donor aid. With the global downturn, all of these income sources - with the notable exception of donor flows - have drastically fallen off. Foreign exchange reserves had fallen to $17.6 billion by June 2009 from $23 billion at the end of Foreign exchange reserves were expected to fall further in 2010 knocking the import cover by another 2.5 weeks. 6 All of these factors - unsustainable government deficit, reduced foreign inflows, have led to a steady fall in the dong. A persistent trade deficit has prompted Vietnam to devalue its dong currency three times since November 2009, most recently in August Effects on economic growth Viet Nam s performance in 2008 reflected both fiscal tightening and the slowdown of the global economy. After three years of real GDP growth above 8.5 per cent, the pace of GDP growth slowed to 6.2 per cent in 2008 (GSO, 2009), of which agriculture, aquaculture and forestry grew at 3.8 per cent; industry and construction grew at 6.3 per cent and services at 7.2 per cent. 8 According to the World Bank (2008) 9, the slowdown of GDP growth largely reflected the impact of the government s stabilization package announced in March The economy grew 6.52 percent in the first nine months of 2010 compared with a year earlier. A full- year gain of more than 6.2 percent would be the fastest since 2007 s 8.5 percent. Growth was stimulated by industrial production and exports which went up by nearly 14% and 20% respectively as compared to the same period in Export increase was mainly contributed by the foreign direct investment in export sectors and the rising prices of primary commodities such as rubber, pepper, cassava, cashew nuts, tea, rice and seafood in the global market. Industry and construction, which accounted for 41 percent of GDP, grew 7.29 percent in the first three quarters. Construction by itself expanded percent during the nine-month period. Services, which comprised 38 percent of the economy, grew 7.24 percent in the first nine months. Hotels and restaurants expanded 8.28 percent, as the number Central Institute for Economic Management (CIEM) (2008): Vietnam Economy in 2008 and 2009: Country Forecast, CIEM, (2009a): Jobs, income down in industrial zones, 20 January 2009, Vietnam Economic Portal, (CIEM) (2009b): A lot of garment companies face shut down, 6 February 2009, Vietnam Economic Portal, 9 World Bank (2008): East Asia & Pacific Update: Navigating the Perfect Storm. 22

23 of foreign visitors to Vietnam advanced 34.2 percent from the same time a year earlier. Financial services gained 7.94 percent. Agriculture, forestry and fisheries, which made up the remaining 21 percent of the economy, expanded 2.89 percent in the first three quarters. Vietnam is the world s second-biggest exporter of both rice and coffee. 10 In the past nine months, retail and service sales also went up by 25 percent more than a year earlier in value terms. Despite gains, the national economy still faced a high trade deficit as its imports rose by 22.7 percent in value terms compared to the corresponding period last year. The MPI predicted that the prices of consumer goods would go up in tandem with those of input materials and commodities in the world market. 11 Effects on FDI Despite some concerns over the worsening of Viet Nam s economic environment, foreign direct investment (FDI) have remained robust so far. FDI approval reached a record level of USD 64billion, equivalent to more than triple the FDI approval amount in Disbursements in 2008, due to the fact that foreign investors remain confident about Viet Nam s long-term prospects, was USD 10.5 billion, up from USD 8.1 billion in However, following recent trends, the gap between registered FDI and implemented FDI was increasing. 12 The share of FDI contribution to GDP went up from 13.3 per cent in 2000 to nearly 17.7 per cent in Since 2003, the FDI sector has contributed more than 50 per cent of the total export value. 13 Inflationary effects High inflation resulted from a combination of the impact of high fuel and food prices and strong domestic demand for both intermediate and final goods. Food price inflation peaked in June 2008 at around 32 per cent compared to January 2008, and year-on-year food price inflation peaked at 74.3 per cent. 14 This hike was largely caused by the sharp increase in rice prices which were forecast to rise by 108 percent in In addition, transportation costs also escalated rapidly. Trade effects The opening of the US market since 2001, together with the benefits of having joined the WTO for four years, increased Vietnamese exports rapidly. The Vietnamese economy has become more and more dependent on global trade, with exports accounting for nearly 70 per cent of GDP. However, the current recession in industrialized economies, particularly the US, EU and Japan, has adversely affected Viet Nam s exports as these countries have become leading markets for Vietnamese exporters. Growth in exports fell in every month since August 2008 and decreased nearly 25 per cent in January It was estimated that exports of garment products would contract per cent in 2009 as Vietnamese exporters lost their traditional customers from their leading markets in 10 Vietnam s GDP grows by 6.52 percent in nine months, Source: english.vovnews.vn 11 Ibid 12 Impact of the Global Financial and Economic Crisis on Viet Nam, A RAPID ASSESSMENT, Prepared for the ILO, by Ngoc Q. Pham, Research Director Development and Policies Research Center, Viet Nam ILO Regional Office for Asia and the Pacific, Bangkok ILO Policy Integration and Statistics Department, Geneva. 13 ibid 14 Nghieu, B. D. (2009): Viet Nam s inflation and its solution, The Economic Studies, Vol. 1 (368), pp The Economic Intelligence Unit (EIU) (2008): Country Forecast: Vietnam, 23

24 the US and EU. Even if garment exporters can remain competitive, they will face difficulties when restrictions on China s garment exports to the EU and US are lowered within the next few years. 16 The decline in the world price of various goods in the last 4 months of 2008, along with the timing of some key policy decisions on rice exports, was another factor contributing to the continuous contraction of Vietnamese exports in With the depreciation of the dong against the US dollar in late 2008, it was expected that exporters would be given a competitive boost when global demand picks up. In 2008, the US market accounted for 21.5 per cent of total Vietnamese exports, followed by Japan and Australia for 10.8 per cent and 7.0 per cent respectively. 17 The Government decided to halt signing rice export contracts from the end of March 2007 to the end of May 2008, when the global rice price was very high at over USD 1,000 per ton, after considering inaccurate forecasts by the Ministry of Industry and Trade and the Ministry of Agriculture and Rural Development. As a result, millions of tons of paddies from summer-autumn and autumn-winter crops in Cuu Long River Delta could not find outlets. The Government then lifted the ban on rice exports in July However, at that time, the rice price dropped dramatically in the world market. Viet Nam s 25 per cent broken rice could be sold only at approximately USD 300 per ton. 18 Imports meanwhile contracted every month since May 2008 reflecting the impact of the government stabilization package to counter inflation and the slowdown in demand. Declining import volumes, of which many were important industrial inputs, also indicated that firms were expecting to reduce their output. According to EIU, there was a slowdown in the volume of imports of key manufacturing inputs: imports of steel (in year-on-year terms) contracted in every month since June 2007; imports of primary plastics and textile yarn had also fallen. 19 This indicated the interdependent causal effects that: (i) high prices of many intermediate inputs indeed impact the rising cost ofmanufacturing production and (ii) the large increase in interest rates in the first half of 2008 had led to many firms in manufacturing sectors to reduce their output. 20 In 2008, due to falling market share and pressure from traditional customers to reduce prices, many foreign investors in garment and textile manufacturing had withdrawn their investment capital from Viet Nam altogether. Moreover, the danger that exports of garment and textile products would contract had led firms to reduce their output. Falling domestic consumption together with less competitiveness in comparison with Chinese-made products (which often have soft prices and diversified designs) were the main reasons for a number of garment companies to shut down in the beginning of Being a labour-intensive sector with more than two million contract workers, there was a danger that many workers in this sector would lose their job. 21 In addition to the manufacturing sectors, aquaculture was also suffering declining demand from traditional markets and falling world prices for Tra and basa catfish. In June 2008, there were more than 1,200 tons of Tra and basa fish ready for export (GSO, 2009). 22 In August 2008, the Government provided assistance on access to capital to catfish processing firms to encourage them to buy Mekong catfish to help farmers. Despite this effort, there was inadequate demand for the 16 Ibid. 17 Central Institute for Economic Management (CIEM) (2009a): A lot of garment companies face shut down, 6 February 2009, Vietnam Economic Portal, 18 Central Institute for Economic Management (CIEM) (2009b): Jobs, income down in industrial zones, 20 January 2009, Vietnam Economic Portal, 19 EIU, 2008, op.cit. 20 General Statistics Office of Viet Nam (GSO) (2009): Monthly statistical report, May 2008 to January 2009, Government Office (2009): USD 1 billion stimulus package for supporting consumption and investment, VN Express, 3 December 2008, 21 Ibid 22 ibid 24

25 large supply of catfish grown in the Mekong River, including 28,000 tons in An Giang, 14,000 tons in Can Tho, 12,000 tons in Vinh Long and 6,300 tons in Tien Giang (GSO, 2009). 23 This created difficulties for thousands of catfish farmers and workers, as well as the catfish industry as a whole. In particular, it pushed down prices in An Giang province the biggest producer of catfish in the delta and threatened the livelihoods of thousands of farmers. The global economic crisis has had an impact on both export- and import-dependent industries. According to CIEM (2009a) these sectors include textile and garments, leather shoes, wood processing, seafood processing, electronic components and tourism. 24 II.2 THE AKFTA IN THIS GLOBAL CRISIS Despite the financial and fiscal crisis, according to ASEAN, trade relations between ASEAN and Korea was still growing robustly in Total trade between ASEAN and Korea in 2008 grew 23.4 percent compared to 9.5 percent in 2007, reaching the level of USD 75.5 billion from USD 61.2 billion in Exports of ASEAN to Korea increased from USD 29.5 billion in 2007 to USD 34.9 billion in 2008, or a growth of 18.5 percent. Imports of ASEAN from Korea grew by 27.9 percent, from USD 31.7 billion in 2007 to USD 40.5 billion in ASEAN was the third largest trading partner of Korea in 2008 and conversely, Korea was the 5th largest trading partner of ASEAN. Vietnam was by far the star ASEAN performer in its trade with Korea. 23 Ibid 24 CIEM, 2009b, op.cit 25 THE SIXTH AEM ROK CONSULTATION 15 August 2009, Bangkok, Thailand, JOINT MEDIA STATEMENT, 25

26 SECTION B: TRADE OF VIETNAM WITH KOREA CHAPTER III. TRADE AND INVESTMENT FLOWS BETWEEN VIETNAM AND KOREA III.1 EVOLUTION AND STRUCTURE OF VIETNAM S TRADE WITH KOREA The agreement between Korea and ASEAN members took effect for goods in 2007 and services and investment in ASEAN, as the Association of Southeast Asian Nations is often known, comprises ten countries: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam. Korea eliminated 70 percent tariffs in 2007 and completed its committed tariff reductions early in 2010 for the ten members, while Vietnam aims to complete its commitments by reducing tariffs from the current 7 to 20 percent to between 5 and zero percent by This reduction will be effected on half the tariff lines by Vietnam ran huge trade deficits with Korea. However, it was hoped that the FTA would bring investments into Korea which would contribute both to reducing its deficits and increase its exports. Bilateral trade between the Republic of Korea (ROK) and Vietnam jumped to US$9 billion in 2009 from $490 million in 1992, while South Korea's accumulated investment in Vietnam reached over $11 billion as of October (See tables in Annex). By end 2010 bilateral trade was expected to increase to over US$10billion and is expected to rise to US$20bn by Following the FTA there has been a big jump in trade values with both exports and imports increasing exponentially. According to data released by customs authorities, the bilateral trade value was US$4.2 billion in 2005, US$4.7 billion in 2006, US$6.6 billion in 2007 and US$9.9 billion in 2008 despite difficulties triggered by the global economic crisis. (see Table III.1 below). In 2009, the two-side trade turnover sank 8.5 % to US$9 billion because of direct effects of the global economic downturn. 26 Table III.1: Two-way trade between Viet Nam and Korea (in US$millions) Exports Imports Total trade Deficit Rate Rate CY Value Rate (%) Value (%) Value (%) Value Rate (%) % % Source: General Statistics Office of Viet Nam 26 Expanidng Exports to South Korea, Viet Nam Business News, July 2nd 2010, Report provided by the Vietnam Chamber of Commerce and Industries 26

27 Vietnam had a deficit in merchandise trade with South Korea to the tune of US$4.8 billion in 2009, which was higher than total exports of Vietnam to South Korea through the period. In 2009, South Korea was the seventh largest importer of Vietnam s goods, it was however the largest exporter to Vietnam. South Korea was the fourth largest trade partner of Vietnam in In 2009, nearly 9,800 Vietnamese companies had trade revenues with South Korea and the figure was already 7,250 companies in just the first five months of According to the latest statistics from the General Department of Customs, the two-way trade turnover totalled US$4.3 billion from the start of 2010 to the end of May, up 41.2 % over the same period in Specifically, Vietnam spent US$3.4 billion on imports from South Korea, accounting for 10.8 % of its total import expenditure, while it earned US$900 million from exports to Korea, up 32.4 % from year on year and accounting for 3.6 % of Vietnam s total export value. 28 Vietnam s export earnings from Korea was roughly equal to nearly 26 % of its imports from South Korea in Vietnam s exports increased 32.5 percent in the first seven months of 2010 while average export growth in ASEAN members was about 24 percent during the same period. The country s exports to South Korea grew 16.3 percent in Product profile of Vietnam s trade and investment with Korea after the FTA Vietnam s main exports to South Korea in the first five months of 2010 included seafood, apparel, crude oil, coal, timber and wooden products. The top 10 exports made up over 62% of Vietnam s export earnings to South Korea in the January-May period of The top ten exports account for over 60% of the total exports in terms of value through the three years, Table III.2 : Merchandise Exports of Vietnam to Korean Republic, Exports of Top ten products by Viet Nam to Korea in 2008 (in Thousand USD) Exports to Korea 2008 Fishery Products 301,832 Crude oil 172,244 Textile products 139,337 Wood and products of wood 101,521 Coal 91,362 Coffee 82,915 Footwear products 64,283 Rubber 63,187 Electronic parts (including TV 51,453 parts), computer and their parts 49,821 Total exports 1,794,442 Source: General Customs of Viet Nam, data provided by MOIT 27 Ibid 28 Ibid 29 ibid 27

28 Exports to Korea 2009 Crude oil 389,096 Fishery Products 312,844 Textile products 242,486 Coal 98,412 Wood and products of wood 95,130 Footwear products 61,819 Machinery, tools 59,778 Coffee 46,400 Computers, electric products and its spare parts 45,787 Other means of transportation and its spare parts 44,482 Rubber 40,831 Total exports 2,065,491 Source: General Customs of Viet Nam, Data provided by MOIT Table 5 above shows the list of top ten products exported from Viet Nam to Korea in 2008 and This list has not changed in 2010, though the ranking of products has changed with electronic products exports reaching the top position in The change in ranking between products between 2008 and 2009 could be in part attributed to FDI from Korea. See Table III.4 below. The highest investment by Korea in Vietnam is in manufacturing perhaps accounting for the increase in exports of apparel, mining products and electronics. Several services such as transport and warehousing where investment by Korea has been high could have also increased exports from Vietnam. Table III.3 : Imports of Top ten products of Viet Nam from Korea in 2008 Thousand USD Imports from Korea 2008 Petroleum 1,339,803 Machinery, tools 1,023,488 Clothing materials 892,065 Iron and Steel 623,484 Plastics material 477,978 Materials for textiles, footwear 402,150 Chemical products 280,108 Metals 277,542 Automobiles 248,406 Spareparts of automobile 188,155 Total imports 7,255,318 28

29 Imports from Korea 2009 Clothing materials 938,116 Machinery, tools 808,211 Petroleum 684,027 Iron and Steel 673,159 Plastics material 511,572 Automobiles 460,816 Materials for textiles, footwear 383,701 Computers, electric products and spareparts 307,582 Spareparts of automobile 287,461 Chemical products 277,467 Total imports 6,976,362 Source: Ministry of Industry and Trade, Vietnam Meanwhile, Vietnam s key imports from South Korea consisted of fabric, steel, machinery, equipment, tools, parts, petroleum, plastic materials, computers, electronic products and parts, textile materials, leather shoes, ordinary metal, automotive parts and ships. The top 10 imports accounted for nearly 72 % of Vietnam s spending on imports from South Korea. Apart from Capital goods imports which is used to fuel the industrial process of Vietnam the product profile of Vietnam s exports also indicate another important point. There is concern in Vietnam that exports are only processed and the imported content of exports is very high. This on one hand, has lowered the added value, on the other hand enlarged the dependence on Korea, causing trade deficit to increase, and the economy to be easily affected when there are instabilities in the overseas markets. Further the techonological content of exports and production in general is low. In spite of being considered as a driving force of growth, and a key factor to improve the quality of growth, technological science activities only account for 0.62 to 0.63 percent of GDP. 30 Further the product content of export and imports from Korea is indicative of another factor. Korea is perhaps able to use Vietnam as a base to export to third countries. This could be explained by the investment profile of Korea which is analysed below. III. 2 : TRENDS IN AND COMPOSITION OF KOREA S FDI FLOWS TO VIETNAM According to the Ministry of Planning and Investment, South Korea is Vietnam's second largest foreign investor after Taiwan as Korean companies had registered $20.15 billion for more than 2,200 projects from 1988 to July Despite the economic crisis, global investment flows into Vietnam increased albeit slower than before from 2007 onwards. The order of sectors in which investment flows came into Vietnam were different from investments from Korea. Most of the FDI into Vietnam was in the oil and gas sector and the heavy industry sector. (see tables in Annex II). However investments from Korea into Vietnam varied over the years. According to a report of KOTRA more than 1,000 Korean enterprises are actively seeking business and investment opportunities in Vietnam and creating over 200,000 jobs. More than 500,000 South Koreans are staying in Vietnam. About 430,000 South Korean tourists visited the country in 2006 alone. 32 Both countries are increasing cooperation in areas of information-technology and other

30 high-tech industries. Vietnam has also been keen on increasing cooperation in Korea's key sectors of shipbuilding, steel, chemicals, automobiles, infrastructure development and construction. 33 The Vietnamese government also places importance on strengthening cooperation in labor-intensive small and medium-sized enterprises in Korea, since Vietnam has a competitive labor force and offers low-priced raw materials. The two countries have been actively engaged in economic activities through various channels, including the Asia-Pacific Economic Cooperation forum. According to KOTRA, Retail and franchise trade were among the attractive business sectors to Korean investors as consumer spending was expected to grow some 20 percent a year. 34 Vietnam is comparable to other emerging markets like China and Russia in attracting international retailers including those from Korea. In addition Vietnam was ranked 13th of the world in terms of population. Korean companies could use Vietnam to expand their investment to neighbouring countries Laos and Cambodia. 35 While there have been complaints about barriers to Korean retailers in terms of licensing procedures in Vietnam, the figures of Korean FDI in Vietnam in this sector shows that these barriers have not prevented the Koreans from investing in Vietnam. 36 (see table III.4 below) Table III.4: KOREAN FDI TO VIETNAM IN DIFFERENT SECTORS Only projects that are valid until 3/11/2010 Nr 1 Sector Processing an Manufacturing industry Number of projects Registered capital (USD) Chartered capital (USD) Real Estate Construction Lodging and catering services Transport and Warehousing Art and entertainment Healthcare and social security Whole sale, retail sale and repair Mining industry Finance, Bank and Insurance Information and Communication Agriculture, forestry and fishery Science and technology Production, electricity, air, water, conditioner Other services Administration and supporting services Water supply and Waste treatment Education and training Total 2,610 22,906,516,205 7,795,075, ibid Ibid 36 Ibid 30

31 Real Estate has been by far the largest sector in which Korea has invested in Vietnam. This must have generated a lot of investment in the construction sector. In 2006, RoK textile companies boosted investment in Vietnam by 53.7% over the previous year. This makes Vietnam the second-largest investment destination for the RoK textile industry, after China. Among the top 20 textile exporters in Vietnam six are from the RoK. The surge in investment in Vietnam s textile industry can be attributed to low-cost labour, Vietnam s skilled workforce, various incentives for foreign investment and the Vietnamese government s strong will to attract foreign investors. 37 In 2008, South Korea was the second largest investor in Vietnam s clothing sector after Taiwan with an investment of US $737 million. South Korea was the sixth largest garment importer from Vietnam in 2008 with turnover reaching $139 million. In the first half of 2009, despite economic crisis, imports amounted to $77 million, up 43% over the same period last year 38.. Box 8 ASEAN Korea FTA has brought opportunities for Vietnam to export more telephone set parts and wood chips, products that have also brought in investments from Korea. Kotra said Vietnam s export to Korea in the sectors grew respectively by 98.6 and 600 percent from January to July 2010 while that of traditional goods like seafood, shoes and agricultural products increased stably. Korean electronic giant Samsung has exported US$1 billion worth of products so far from its $670 million mobile phone factory that it opened in September 2009 in the northern province of Bac Ninh in Vietnam. Vietnam was considered Korea s best partner in the Southeast Asian bloc. Source: There was a significant increase in investment in electronics in 2008 and This is shown in Box 8 above. Investments in one single plant can change investment significantly as a Billion dollar investment in a total of 7 billion overall inflow from Korea is a significant proportion of total investment from Korea. Hence yearly figures may be susceptible to changes in single investments. 39 III. 3 EVOLUTION AND STRUCTURE OF TRADE IN SERVICES WITH KOREA The services sector is integral to a country s overall competitiveness. This is because infrastructure services such as finance, telecommunications and information processing permeate the entire economic structure. The share of the services sector in ASEAN and Korea is 55.8% and % of GDP, respectively, with the total trade volume in the services sector amounting to $61 billion and 151 billion in ASEAN and Korea, respectively. 40 The service sector of today is also becoming increasingly sophisticated with strong links to the manufacturing sector. Services provide the connections, the coordination and the support for the manufacturing process and often generate demands for new industrial products MOU singed with Vietnamese Clothing Sector, September 10, 2009, reported in. Korea Times, August 20,

32 In addition, the potential in services is huge, with technology rendering more and more services exportable. Many of the services spawned by technological advances have high value-added and knowledge content. Considering the geographical proximity and cultural similarity between Vietnam and Korea, there is a great potential of expanding trade in services between the two sides through various facilitation and liberalization measures. In this regard, the importance of MRAs for qualification in professional services cannot be overstressed. Korean exports of services to Vietnam have been climbing in recent years, but their market share has been declining, signaling a need to increase the competitiveness of domestic products. From construction to financial companies, Korean businesses are poised to further expand their presence in Vietnam. Faced with intense competition in the domestic market, Korean financial services companies, including Kookmin Bank, have been tapping emerging markets including Vietnam for expansion. They are focusing more on high value-added services, such as investment banking, as a new growth area. 41 Since a 2001 summit in which the two countries agreed to forge a comprehensive 21st century partnership, they have concluded a set of agreements to promote trade and investment, prevent double taxation, and increase cooperation in the airline and shipping sectors. As for tourism, Seoul and Hanoi signed an accord in 2007 on working closely to establish tourism offices in each country. 42 As far as Mode 4 is concerned, South Korea is a higher-level market, attracting well-trained workers from Vietnam to electronics, fisheries, food processing, and shipbuilding. Salaries are also higher, averaging US$ per month, equal to the average annual income in Vietnam. In 2003 the South Korean government ratified the Employment Permit System (EPS), which places a range of strict requirements on both labor exporters and workers. There is an annual labor quota, limiting the opportunities for employment. 43 Since the end of 2006, more than 20,000 Vietnamese workers have been employed in South Korea. However, the strict, employer-oriented regulations, which prevent migrant workers from changing their workplace and employer and give them no avenue to lodge claims against their employer, have seen working conditions deteriorate. As a result, a large number of Vietnamese employees have terminated their contracts and begun to work illegally. Unofficial figures put the number at some 14, Korea will pick 5,000 out of 12,500 Vietnamese workers who applied for the EPS in Of the applicants, 8,000 candidates seek to work in the manufacturing industry, 2,000 in construction, and the rest in the agriculture-aquaculture sector. Tests were held in the Korean language. The quota of 12,500 allocated to Vietnam in 2010 is the largest for any country under the EPS. Vietnam has been the biggest supplier of guest workers to Korea, sending 70,000 since the start of the EPS system in In 2009, the MoU on cooperation in vocational training, social insurance and labor safety that was extended for a further two years. The MOU laid down the legal foundations and created 41 The Korea Times Special, Labour Exports: Dreams Unfulfilled, Saturday 9 October 2010, Vietnam Financial Review, Ministry of Finance 43 Korea to take 5,000 Vietnamese guest workers, March 3, 2010 Compiled by Quoc Thoai, 44 Labour Exports: Dreams Unfulfilled, Saturday 9 October 2010, Vietnam Financial Review, Ministry of Finance 32

33 conditions for a large number of Vietnamese workers to work in South Korea, thus further boosting the two countries labor cooperation. 45 South Korea s labor market is considered an important market for Vietnamese workers. Vietnam is planning to set up a vocational training school for Vietnamese workers before sending them to South Korea. Vietnam hoped that the South Korean government and its Labor Ministry would join in training Vietnamese workers to help them get familiar with the lifestyle and daily activities in South Korea. Vietnam tops the list of 15 nations in South Korea s EPS program. The Vietnamese Government also held a job festival in October 2009 where South Korean businesses and Vietnamese workers met one another Korea to take 5,000 Vietnamese guest workers, March 3, 2010 Compiled by Quoc Thoai, 46 Ibid 33

34 CHAPTER IV: STYLIZED FACTS ABOUT KOREA AND VIETNAM S TARIFF STRUCTURE BEFORE AND AFTER AKFTA IV.1: EVOLUTION AND STRUCTURE OF VIETNAM AND KOREA'S TARIFFS Most studies attribute Vietnam's export performance to a great deal of continuing effort to improve trade policies through trade liberalization and strengthened international economic integration. However, some others argue rather that, although there has been considerable liberalization of trade, Vietnam still needs to meet its external commitments otherwise the emerging industries or productive sectors will not expand. This section reviews these aspects as a prelude to an empirical investigation of Vietnam's economic performance in the ASEAN Korea FTA. 47 Since the start of transition, the timing and sequencing of trade reform in Vietnam has been as gradual as in China. Although Doi Moi ('Renovation' in Vietnamese) was officially announced in 1986, trade reforms were only initiated in Vietnam's law on export-import tariffs was first launched on 1 January 1988 along with a Foreign Investment Law promulgated in The trade reform process was strongly supported between 1989 and the early years of the 1990s; it then suffered a standstill during the mid-1990s, but was resumed after As pointed out by Vo (2005), trade reforms in Vietnam that are closely connected with export performance largely refer to trading rights, import protection and export promotion. 49 Over the past 15 years or more, there has been significant liberalization of the foreign trade regime in Vietnam. Non-tariff import restrictions that create trade distortions have been abolished gradually, while voluntary reductions in tariff rates have promoted economic efficiency, productivity and competitiveness. Recent accession to the WTO and commitments in the formation of an ASEAN Free Trade Area mean that the Most Favored Nation (MFN) and preferential tariff schedules have replaced the much higher previous tariff rates. Also, a great harmonization in the legal framework and policies has been made for consistency with international norms and practices. Trade promotion activities have become more diversified; management of export and import policies has been made more flexible and predictable. In view of these achievements, some commentators were judging Vietnam's trade regime to be quite open compared to its Asian neighbors. 50 By contrast, others argued that Vietnam's present trade regime is characterized by a 'dual' approach that the country has been pursuing for a number of years. On the one hand, the government promotes export-oriented sectors in which private firms, especially the foreign-owned firms are fully integrated into cross-border production networks, play the leading roles. In doing so, trade reform has helped the private sector by enhancing its access to imported inputs and to export outlets. According to Athukorala (2006), 51 the share of foreign-owned firms in Vietnam's total manufacturing exports increased from about 20% in the mid-1990s to over 70% by The private sector is mostly labor-intensive, and exports on average are three-quarters of its production; this contrasts sharply with the state sector that is mainly capital-intensive and inward-looking, but still dominates the economy (Ngo, 2005). 52 However, considerable bias against exports still exists in several sub-sectors, in which Vietnam has an ample scope for achieving export success such as 47VIETNAM'S EXPORT PERFORMANCE IN THE FACE OF CHINA'S COMPETITIVE CHALLENGE, 48 IBID 49 Vo, TT. 2005: Vietnam's trade liberalization and international economic integration: Evolution, problems and challenges. Asian Economic Bulletin 22(1): Ibid 51 Athukorala, P. 2006: Trade policy reforms and the structure of protection in Vietnam. The World Economy 29(2): Ngo, TH. 2005: Catching-up industrial development of East Asian economies and its application to Vietnam. The Journal of Developing Areas 39(1):

35 labor-intensive or primary processing industries. The antiexport bias in the incentive structure is creating a major constraint for a sound development of the private sector, especially with regard to small- and medium-sized enterprises that are considered to be a driving force for export growth (Athukorala, 2006) 53. This anti-export bias results from the central government's objective, on the other hand, to structure the foreign trade regime in order to protect some of its large import-substituting industries and related State-Owned Enterprises (SOEs). In the face of increased competition from abroad, the trade regime is still considered to be restrictive by maintaining controls in key imported commodities such as oil and gas, mining, transport equipment, cement and steel, petrochemicals. In fact, the Vietnamese government maintains protection of capital intensive SOEs that are dominant in importsubstituting sectors but remain generally weak, although they benefit from FDI. Such issues reflect Vietnam's rather special circumstances as an Asian transition economy, where the SOEs still enjoy rents from existing barriers to trade because of their leading role in policymaking, revenue collection and distribution. To remove these weaknesses, Vietnam needs to conduct trade reforms in connection with a wide range of macroeconomic and structural reforms of SOEs, state-owned commercial banks and tax administration (Auffret, 2003; Vo, 2005) 54. As the country has achieved rapid export growth in recent years, an antiexport bias in certain sectors did not inhibit its strong export performance. First, Vietnam's case is similar to the early industrialization experiences of South Korea and Taiwan outlined by Amsden (1989) 55 and Wade (1990). 56 Strong evidence is given that the two East Asian 'Dragons' pursued import substitution policies that had significant distorting effects, but still maintained remarkable rates of growth of exports, GDP and employment. Second, the Vietnamese government has helped to reduce the antiexport bias by introducing export subsidies and tariff exemptions for imported inputs used in the production of export goods, as well as tax incentives, and the expansion of export processing zones (Chaponniere et al., 2009). 57 Third, the SOEs have played a key role in the export-led growth strategy. Involved in many joint-ventures with foreign investors, the state-owned sector is reinforcing its leading role in upstream industries, either for export or for import substitution of inputs used in the production of export goods (Cao and Tran, 2005). 58 The equitization process (that is, the transformation of SOEs into joint stock companies) goes hand in hand with this trade strategy, as State capital in relatively small export-oriented SOEs has effectively passed into private hands (Commercial Counsellors, 2006). 59 These strategies had much in common with Korea and hence the level of comfort of Korean FDI in Vietnam. All in all, combination of import substitution measures (favorable to large SOEs in specific industries) and incentives to exports has characterized Vietnam's trade policy on the eve of its WTO 53 Athukorala, 2006, op.cit 54 Auffret, P. 2003: Trade reform in Vietnam: Opportunities and emerging challenges. World Bank Policy Research Working Paper, No 3076, World Bank: Washington D.C., June.Vo, 2005, op.cit 55 Amsden, A. 1989: Asia's next giant: South Korea and late industrialization. Oxford University Press: New York 56 Wade, R. 1990: Governing the market. Economic theory and the role of government in East Asian industrialization. Princeton University Press: New Jersey. 57 Chaponniere, JR, Cling, JP and Zhou, B. 2009: Vietnam following China's footsteps: The third wave of emerging Asian economies. In: Santos-Paulino, A.U. and Wan, G. (eds). Southern Engines of Global Growth and the role of FDI. Oxford University Press: New York. 58 Cao, XD and Tran, TAD. 2005: Transition et onverture economique au Vietnam: une differenciation sectorielle (in French), Economie Internationale 104(4th Quarter): Commercial Counsellors. 2006: Report on Vietnam. European Union Economic and Commercial Counsellors: Hanoi, July. 35

36 accession. This strategy of Vietnam is also reflected in its tariff structure vis a vis Korea and other ASEAN countries. See Table 8 below. While Vietnam's tariff is generally higher than the ASEAN 6, its export performance is far better. It is also interesting to note that prior to the FTA, tariffs in Vietnam and Korea Table IV.1: Nominal rate of Protection before AKFTA in ASEAN and Korea Tariff lines with tariff: Higher Korea Indonesia Malaysia Thailand Philippines Singapore Vietnam than 20% 10-20% Lower than 10% % Total * Source APEC E-IAP in the middle range, i.e 10-20% were almost the same. Further Vietnam had far more tariff lines with 0% tariff than Korea, though the overall level of liberalisation of Korea was much higher. IV.2 MAJOR CHANGES IN VIETNAM S AND KOREA S TARIFF PROFILES AFTER FULL IMPLEMENTATION OF AKFTA Post AKFTA however, the scenario changes considerably. Korea will continue to maintain high tariffs for agricultural products, even though these products are of vital export interest to Vietnam. On the other hand, motor vehicles and parts and transport equipment which is of export interest to Korea will continue to enjoy higher rate of tariff in Vietnam. Another area of concern to Vietnam would be the tariff on processed food. Post AKFTA also these would be continue to be high. The overall levels of liberalisation of the two countries would be roughly similar though on critical products of export interest to Vietnam tariffs would continue to be significant. 36

37 Table IV.2: Post AKFTA Tariff schedules for Korea and Vietnam Tariff schedule of Vietnam for Tariff schedule of Korea in AKFTA Korea in AKFTA Agriculture Forestry Fishing Coal Oil and Petrolium Gas and other mineral Processed Food Beverages and tobacco products Textiles and wearing apparel Leather products Wood products Paper products, publishing Chemical,rubber,plastic prods Metals Motor vehicles and parts Transport equipment nec Electronic equipment Machinery and equipment nec Manufactures nec Electricity, Gas, and Water Source: GTAP The advantage to Vietnam because of its high tariffs in some areas would be the tariff jumping investment from Korea. Evidence from the previous section shows that such investments in manufacturing and electronics in already coming to Vietnam from Korea. Furthermore it is likely that investment in motor vehicles and transport equipment may also come to Vietnam. Investment in these sectors will also be sensitive to non-tariff barriers and it is important to examine these to determine whether such investments will actually take place. See tables IV.3 and IV.4. IV.3 NON-TARIFF MEASURES IN VIETNAM AND KOREA While non-tariff barriers may be important in the overall trade scenario of Vietnam and Kora, in the short term they have not deterred trade expansion. The number of C/O (certificate of origin) forms used for the ASEAN Korea FTA by Vietnamese exporters has increased (exporters using C/O form AK can enjoy preferential tariff when exporting goods to South Korea). In 2009, Vietnamese enterprises used 33,479 C/Os form AK to export $1.66 billion worth of goods to South Korea, accounting for 86 percent of Vietnam s total export revenue to the country ASEAN-ROK FTA helps Vietnam boost exports to ROK, , 37

38 Table IV.3 : NTMs imposed by Korea on products of export interest to Vietnam Category Generic Measure Product Comments Anti-competitive Pricing Rice, garlic, onions, sesame, groundnuts State Trading Enterprises impose additional markups on top of in quota tariffs Customs Procedure Classification Wood and wood products European exports of paper affected by Korean Classification of 2004 Import related measures Quota Rice Ten year extension negotiated in Import related measures Tariff rate quotas Several agricultural products Horizontal SPS Delays Food Time required for detailed quarantine inspection appears excessive at 28 days. Standards, testing and certification Certification Organic foods General non-recognition of international standards Table IV.4: NTBs in Vietnam on products of export interest to Korea Category Generic Measure product Comments Corruption Corruption Horizontal Import related measures Licensing consumer products Import related measures prohibited Horizontal cultural products, firecrackers, children's toys, second-hand consumer goods, right-hand drive motor vehicles, used spare parts Investment related measures Regulations Services and Telecommunication Investment related measures Restrictions Horizontal audiovisual, express delivery, telecommunications, distribution, banking, securities, insurance State Trading State trading Horizontal cigars, cigarettes, crude oil, newspapers, journals, periodicals, recorded media Source: CORE NTMs database The number of C/Os form AK to be used in 2010 is forecast to be much higher than in According to the Ministry of Industry and Trade (MOIT), in the first half of the year, $842 million worth of goods were exported to South Korea with C/O form AK out of the total export revenue of 38

39 $1.2 billion worth of exports to the country. As such, the number of C/O form AK has increased by 70 percent over the same period of the last year. 61 According to Bui Huy Son, Director of the Asia-Pacific Department under MOIT, a lot of export items have seen the export revenue increasing sharply thanks to the FTA. These include seafood exports (the seafood export revenue to South Korea in the first seven months of the year reached $179 million, an increase of 11.7 percent over the same period of the last year), garment products ($155.2 million; 64.2 percent), crude oil and coal. 62 Why do Vietnamese enterprises take full advantage of the ASEAN-ROK FTA better than other FTAs? According to analysts, there are many reasons. However, the most important reason is that the current characteristics of South Korean market allow Vietnamese enterprises to penetrate the market more easily. Meanwhile, South Korean invested enterprises in Vietnam have been very interested in using C/O form AK to export goods to South Korea. 63 However, future trade between the two countries and the dynamic evolving potential for trade will also be determined by the effective rate of protection offered by Vietnam for products of export interest. (see Table IV.5 below) Tariff jumping investment and the import regime in Korea will also be of vital importance in determining evolving patterns of trade. IV.4 EFFECTIVE RATES OF PROTECTION IN VIETNAM Table IV.5: Effective Rate of Protection by industry (%) in Viet Nam Rice Coffee bean Tea Other agricultural products Forestry products Fish and other fishery products Aquaculture Coal Heavy metal Crude oil, natural gas (excluding survey) Processed or preserved fruit and vegetable Ibid 62 Ibid 63 Ibid 39

40 Processed coffee Processed tea Processed seafood and other seafood products Processed rice Other processed food Cement Wood and processed wood products Basic organic chemicals Basic inorganic chemicals Fertilizer Other fertilizer (not chemicals) Pesticide Rubber and processed rubber products Plastic products Paint Houseware products Motorbike and parts Bicycle and bike parts Machine tool Other machine for various purposes Specialised machine Car Other transport vehicles Textiles

41 Garment Woven carpet Embroidery products (excluding coover materials) Leather Leather articles Source: MOIT, tables provided by local team Table IV.5 above shows the effective rate of protection (ERP) in Vietnam in sectors of export and domestic interest to it. ERPs for agricultural primary products will be very low particularly in This would help exports and also shows that Vietnam has full confidence in its capacity to compete effectively in global markets for these products. Indeed it is not surprising that the ERP for rice is negative, as Vietnam is already the second largest exporter of rice globally. However, as Table IV.2 shows the post AKFTA tariff for agriculture will continue to be around 33% in Korea, while that for processed food would be around 18%. Moreover, Table IV.3 shows that quotas, pricing, as well as SPS related standards are non-tariff barriers that Korea uses to restrict imports of food, particularly rice. Vietnam also has relatively high ERP for processed food, post AKFTA, which may create an anti-export bias. So all in all the potential for expanding trade in agricultural and food products between the two countries is not likely to be very high. Indeed the trade patterns between the two countries reflect this. Except for coffee, agricultural products do not figure among the top ten export products accounting for 70% of total export value from Vietnam to Korea. (See Table III.2). For coffee beans the ERP post AKFTA implementation will be low as will be the ERP for processed coffee. Thus the potential for coffee exports from Vietnam to Korea will continue to be high. Regarding other non-agricultural exports, textiles and garments will continue to have a high ERP post AKFTA in Vietnam. This may create an anti-export bias. However, tariff jumping investments from Korea may be encouraged by these high ERP. Given that import tariffs in Korea for these products are negligible, especially post AKFTA (See Table IV.2), Vietnam may be well advised to put some investment measures in place to encourage Korean investments in textiles and garments. However, progressively reducing the ERP on these products would improve the competitiveness of Vietnam's textiles and garments industry, as these products also constitute an important import item from Korea into Vietnam. The same arguments apply to leather articles, plastics and rubber, all of which are important export items by Vietnam to Korea. Another interesting category of items are machinery and transport items. Machinery of various forms has low or negative ERPs especially post AKFTA. This would indeed be in Vietnam's interest as these will fuel its industrial development. Indeed these items constitute a top import item from Korea. It is in transport items where Korea has an export interest, but Vietnam has high ERPs that there may be a potential for clash of economic interests between the two countries. On the other hand if Korea invests in these sectors for production for the Vietnamese market only then Vietnam may be able to gain. All in all, high ERPs are unlikely to make these industries globally competitive in Vietnam, even if labour costs are low. 41

42 PART C. ECONOMY-WIDE & SECTORAL ASSESSMENT:A QUANTITATIVE APPROACH CHAPTER V: THE METHODOLOGICAL APPROACH V.1 THE ECONOMIC MODEL Trade liberalization in an FTA will have systematic effects on the economy in general, and the CGE model can analyze changes in macro variables such as GDP, welfare level, prices of goods, as well as the interaction between economic agents such as producers, consumers, and the government. The general equilibrium approach allows factor prices to vary. Thus, the relative price changes between the intermediate inputs and primary inputs would presumably affect the ratios of a firm s material components and the amount of value added to the primary production factors in each equilibrium. It provides a framework through which different and diverse policies can be examined. Once the basic model has been specified and applied with actual data, various policies can be studied with minor modifications. The model used here is a static, Walrasian general equilibrium model that endogenously determines quantities and prices by using a descendant of the Johansen-style simulation approach. 64 The CGE model assumes a simple structure of production by assuming perfectly competitive technology. Therefore, the perfectly-competitive firms operate with constant-returns-to-scale technologies in their production process, where the producer s prices are equal to the marginal costs of production. All firms use primary production factors and intermediate goods as their production inputs. Firms employ labor and capital as primary production factors. In addition to labor and capital, land is one of the primary production factors in the production of agricultural products. Both labor and capital are assumed to be perfectly mobile within the region, but immobile between regions. The goods and services can be used for final consumption and as intermediate goods. Primary production factors will be aggregated into an added value, once again using a Constant Elasticity of Substitution (CES). equation. In addition, the top of the production structure combines the added value and the composite intermediate goods by using a fixed-coefficient (Leontief) technology. 65 Besides trade liberalization, an FTA will lead to the enhanced advancement and transparency of trade regulations and the trade system, inducing the inflow of capital from both within and outside the region. That is, as trade, investment and economic growth have interactive and dynamic synergy effects, the effects of concluding an FTA could be amplified. Levine and Renelt (1992) 66 assert that there is a positive relation between economic growth and investment ratio to GDP, and also that the investment ratio to GDP is positively related to the trade ratio to GDP. Baldwin and Venables (1995) 67 state that trade liberalization will bring investment incentives besides the static effects, and the accumulation of such investment will provide motives for new economic growth. They dubbed this phenomenon capital accumulation effects. Such investment accumulation effects could be an important factor in estimating the economic impact of an FTA. 64 Levine, R. and D. Renelt "A sensitivity analysis of cross-country growth regressions." The American Economic Review. Vol. 82(4), Ibid 66 Ibid 67 Baldwin, R.E. and A.J. Venables "Regional economic integration." In Handbook of International Economics, Vol., edited by G.M. Grossman and K. Rogoff. Amsterdam: North-Holland/Elsevier. 42

43 Recently, some CGE researchers have endeavored to reflect such relations to the model. The most representative literature in the field is by Francois, McDonald and Nordstrom (1997). 68 When estimating the effects of an FTA, they try to model the positive aspects of an FTA by taking into account its capital accumulation effects. In contrast to static factors, dynamic factors do not pertain to one-off changes in welfare but gradually emerge over time. For example, firms and industries of a country more exposed to competition from its neighbors after the formation of a customs union tend to become more efficient. But those efficiency gains will not be realized overnight. The main dynamic benefits are improvements in efficiency due to greater competition and gains from greater specialization, economies of scale, and learning-by-doing. Other dynamic benefits include reduction in intra-regional transactions costs, some protection from adverse developments in world markets, and bargaining power vis-à-vis industrialized countries. Against these potential dynamic benefits, dynamic costs of polarization would also accrue. Integration among countries with different levels of income and economic integration may disproportionately fall upon one country and may produce a backlash which will threaten the viability of the union over time. Other Factors which are important in FTAs (1) Trade creation versus trade diversion The trade creation effect is stronger the greater the size of pre-fta trade. The underlying intuition is simple: countries that trade heavily with each other stand to gain the most from eliminating impediments to trade. By the same token, removing trade impediments will no longer matter to those who trade little with each other. Vietnam and Korea were already important export and import markets for each other. (see Table III.1). The level and growth of trade between Vietnam and Korea was such that the removal of trade barriers were likely to yield substantial benefits. (see Table III.1). (2) Substitutability of Products Substitutability refers to the production of similar but differentiated products. For example, Vietnam can theoretically substitute semi-conductors from Taipei, China with similar but slightly different semi-conductors from Korea. While Vietnam s trade with Korea is large and growing, most of its exports go to other markets and most of its imports come from other markets. Vietnam s biggest trading partners are also Korea s biggest trading partners, namely, the PRC, EU, Japan, and the US. Such a trade pattern provides stylized evidence of the limited substitutability of products. The extent to which Vietnam and Korea can substitute imports from external markets with imports from each other is likely to be limited. This is borne by the fact that Vietnam and Korea only trade in some 2000 tariff lines of the 6,000 tariff lines at the HS 6 digit level Francois, J.F., B. McDonald, and H. Nordström "Assessing the Uruguay Round." In The Uruguay Round and the Developing Countries, edcited by W. Martin and A. Winters. World Bank Discussion Paper Data given by MOIT. 43

44 (3) Disparity in Pre-FTA Level of Development If pre FTA income levels are similar among members, integration will be more beneficial. A major reason for the EU s success is that all its countries are developed market economies with relatively small disparities in income levels and other structural characteristics. In AKFTA, Korean per capita income is significantly ahead of the ASEAN countries. Korea s 2006 per capita GNI was $17,690 compared with ASEAN s $1,881 (excluding Brunei and Singapore). In purchasing power parity terms, Korea s 2006 per capita GNI was $22,990 and Vietnam s $1,100 making Korea about twenty times richer. 70 Whether the members economic structures are complementary or competitive influences the success or failure of a free trade area. The insights of Meade (1955) suggest that the trade creation effect will be stronger if pre-fta economic structures are competitive but post-fta economic structures are complementary. 71 High tariffs and non-tariff barriers may induce FTA members to produce similar goods before the FTA. Afterwards, more efficient producers replace less efficient ones and the number of similar goods produced falls, resulting in welfare gains associated with specialization and economies of scale. That is, the removal of trade barriers within an FTA allows member countries to take better advantage of their comparative advantage. Vietnam and the ASEAN economies are competitive to some extent now, but trade barriers are high enough ( see table IV.1) to protect inefficient domestic producers from effective competition in selected high-priority sectors such as Korea s agriculture and certain manufacturing sectors in Vietnam. The more significant question is whether Vietnam and Korea will become complementary after AKFTA so that they produce less similar goods than before the FTA, but the answer to this is unclear. Although the rapid growth of Vietnam- Korean trade in recent years does provide some indirect evidence of potential complementarities (See Kwon 2004), such evidence is far from conclusive. 72 V.2 LITERATURE SURVEY OF MAIN RESULTS FROM ECONOMIC MODELS Several studies have investigated the impact of AKFTA using CGE models. These have mostly relied on the model and data base of the Global Trade Analysis Project (GTAP) and differ mainly in their assumptions. 73 For the most part, these studies look at all the proliferating proposals for free trade agreements in East Asia rather than only AKFTA, and compare the welfare implications of various alternative scenarios of FTAs. While these studies tend to show AKFTA s impact on Korea, they do not always show its effect on individual ASEAN countries. A common finding across several CGE-based studies is that AKFTA can benefit the ASEAN region as a whole. However, they are divided in terms of (1) the impact on Korea, (2) which countries are likely to benefit the most, or (3) whether Korea or ASEAN is likely to gain more from AKFTA. 70 Park,D., Park.I., and Gemma Ester V. Estrada, 2008, Is the ASEAN Korea Free Trade Area (AKFTA) an Optimal Free Trade Area, Asian Development bank Working Paper Series on Regional Economic Integration Number 21. Pk, 71 Meade, J., 1955, The Theory of Customs Union, North Hollan, Amsterdam, The Netherlands 72 Kwon, Y., 2004, Toward a Comprehensive Partnership, ASEAN-Korea Economic Cooperation. East Asian Review, Vol(16 (4).pp Park et al, 2008, op.cit 44

45 A study by Choi, Park, and Lee (2003) indicates that both Korea and ASEAN will experience welfare gains, but Korea will gain more than ASEAN. 74 In contrast, simulations by Cheong (2003) show that ASEAN will benefit but Korea is likely to suffer welfare and output losses. 75 Ando and Urata (2006) incorporate trade liberalization, capital accumulation, and trade facilitation into their model, and found that individual ASEAN countries, in particular Thailand and Singapore, will benefit from AKFTA. 76 More recent studies based on CGE modeling takes into account countries commitments to trade agreements as well as expected trade liberalizations over several years. Kawai and Wignaraja (2008) found that AKFTA generated positive income effects for Korea and individual ASEAN countries relative to their baseline scenario. 77 Based on deviations in equivalent variations, the highest gains accrued to Viet Nam, Korea and Thailand while the lowest gains accrued to the CLM countries. Lee and van der Mensbrugghe (2007) examined AKFTA s welfare effects relative to a baseline scenario of no FTAs over the period They found that AKFTA raised the welfare of Korea and ASEAN as a whole, but did not analyze the welfare effects for individual ASEAN countries. For the free trade area as a whole, trade among member-economies will rise by 18.1% while trade with non-members will fall by only 2.2%. 79 AKFTA will accelerate trade between ASEAN and Korea. Viet Nam will see a decrease in the trade deficit. While Korea s trade with Viet Nam was expected to expand by only 2%, its actual trade following the AKFTA was over 100%. 80 Viet Nam s trade deficit with Korea is predicted to decrease, however it still continues to be high. 81 Finally, Viet Nam will experience the highest net trade creation among all member-countries. 82 Overall, AKFTA is expected to have a favorable impact on Vietnam s trade flows. 74 Choi, N., S. C. Park and C. Lee Analysis of the Trade Negotiation Options in the East Asian Context. KIEP Policy Analyses Seoul. 75 Cheong, I Regionalism and Free Trade Agreements in Asia. Asian Economic Papers. Vol.2 (2). pp Ando, M. and S. Urata Emerging Developments in East Asia FTA/EPAs. Paper presented at the JSPS (Kyoto University)-NRCT (Thammasat University) Core University Program Conference. October Kawai, M. and G. Wignaraja Regionalism as an Engine of Multilarelism: A Case for a Single East Asia FTA. ADB Working Paper Series on Regional Economic Integration No Lee, H. and D. van der Mensbrugghe Regional Integration, Sectoral Adjustments and National Groupings in East Asia. Osaka School of International Public Policy (OSIPP) Discussion Paper DP-2007-E Park, et al, 2008, op.cit 80 See Table III.1 and Park etal, 2008, opcit 81 See table III.1 82 Park et al, 2008, opcit 45

46 CHAPTER VI: ECONOMY WIDE IMPACT Having reviewed the existing quantitative studies of AKFTA, we are now ready to perform our own quantitative analysis of AKFTA. More precisely, we apply the CGE model to quantify the gains and losses for Vietnam and Korea. The complete methodology, aggregation of sectors and the data for shocks are explained in Annex 3. VI.1 WELFARE AND OUTPUT EFFECTS The formation of AKFTA will increase aggregate welfare. The short run increase in welfare is less than that in the long run. Terms of trade are likely to become adverse in the long run for Vietnam. This is because labour and wage costs are likely to rise with free trade agreements and labour intensive exports may thus suffer an adverse terms of trade. However, AKFTA may lead to a decrease in the costs of capital goods to the Vietnamese economy as cheaper capital goods imports from Korea and other FTA members will become available. The most important gains would however accrue from better allocation of resources consequent to trade liberalisation. These efficiency gains would be highest through import increases and greater in the long rather than the short run. (see Table VI.1 below) Table VI.1: Welfare measure results in the short and the long run: Total Equivalent Variation and decomposition for Viet Nam Welfare measure: Total and decomposition Change in Welfare in US$ Millions Change in the short-run Change in the long-run Total EV Contribution of Capital goods prices Contribution of Terms of Trade Contribution of Allocative Efficiency (AE) AE gains due to import changes AE gains due to output changes AE gains due to export changes Broadly speaking, real output effects more or less correspond to welfare effects so that increases in welfare correspond to gains in real output. Output losses can be partly traced to total imports rising faster than total exports. Viet Nam will enjoy welfare and output gains under AKFTA. In fact, Viet Nam s output gains will be greater than those of higher income countries such as Indonesia, Thailand, or Philippines. This is mainly because Viet Nam s total exports will grow rapidly, the fastest among member-economies. Viet Nam s total export growth will be much higher than its total import growth. Table VI.2: Results for Output quantity changes in Viet Nam in the short and the long run Change in the quantity of sectoral output % Change in the shortrun % Change in the long-run Agriculture Forestry Fishery Coal Oil/Petroleum Minerals

47 Processed food Beverages and Tobacco Textiles and Apparel Leather Products Wood Products Paper printing and publishing Chemicals, rubber and plastics Metals Motor Vehicles and Equipments Other Transport Equipments Electronic Equipments Other Machine Equipments Other Manufacturing Electricity and gas Construction Other Services The sectors that are likely to grow the fastest in the long run are typically those that have a comparative advantage because of cheap labour costs in Vietnam, i.e textiles and apparel, leather products, electronics, machinery and most importantly construction. The high growth in construction would be a consequence of increased investment by Korea in Vietnam. Primary products are likely to decline slightly perhaps as there will be natural limits to their increase in trade. New sectors which are likely to emerge consequent to Korean Investment on account of the FTA are electronics and other manufacturing. Domestic prices of all products are expected to rise marginally in the long run, except for the heavily traded items which are likely to fall. This is because the import content of textiles and apparel, leather products, electronics and light manufacturing is very high. Hence with a reduction in tariffs intermediate products would become cheaper leading to a long run fall in prices. For other sectors where the import content is lower, wage rise effects would lead to a small increase in prices. (See Table VI.5 below). Table VI.5 : Results for Output price changes in Viet Nam in the short and the long run Change in the price of sectoral output % Change in the shortrun % Change in the long-run Agriculture Forestry Fishery Coal Oil/Petroleum Minerals Processed food Beverages and Tobacco Textiles and Apparel Leather Products

48 Wood Products Paper printing and publishing Chemicals, rubber and plastics Metals Motor Vehicles and Equipments Other Transport Equipments Electronic Equipments Other Machine Equipments Other Manufacturing Electricity and gas Construction Other Services Dynamic considerations are likewise important for Vietnam. In addition to productivity gains from greater competition, transfer of technology through trade e.g. imports of capital goods can benefit Vietnam, which lags substantially behind Korea in terms of technological capabilities. IV.2 TRADE FLOWS AKFTA is not only likely to affect Vietnam's trade with Korea but also with other partners of FTA as well as the rest of the world. This is because the FTA would affect investment in Vietnam by Korea. Korea is likely to use Vietnam as a base to export to other FTA partners such as China and Japan as well as the rest of the world. While aggregate exports on account of the FTA will increase, exports to Korea will increase by a much higher proportion than that to the rest of the world. This points to the complementarities of trade between Vietnam and Korea and minimum levels of trade diversion. (see Table VI.6) Table VI.6: % Changes in Viet Nam s sectoral Exports to different countries/regions China Japan Korea Rest of the World Aggregate Exports Importing Region: from Viet Nam Sector Short-run Longrurururururun Short- Long-run Short- Long- Short- Long-run Short- Long-run Agriculture Forestry Fishery Coal Oil/Petroleum Minerals Processed food Beverages and Tobacco Textiles and Apparel Leather Products Wood Products Paper printing and publishing Chemicals, rubber and plastics

49 Metals Motor Vehicles and Equipments Other Transport Equipments Electronic Equipments Other Machine Equipments Other Manufacturing Electricity and gas Construction Other Services Almost all imports are likely to increase in the long run, with imports from Korea rising very rapidly in almost all sectors. This is consistent with Vietnam's stage of economic development where intermediate inputs and primary products would be imported to fuel its industrialisation processes. Apart from China, imports from Korea would rise faster than aggregate level of imports by Vietnam. The fact that imports from the rest of the world is falling while imports from Korea are rising points to some diversion of the sources of imports. However, this may arise in part from the aggregation of sectors which was aimed at capturing most of the traded products between Vietnam and Korea. Another factor which may explain higher levels of imports from China and Korea is the product composition of Vietnam's exports which are mostly labour intensive products whose intermediate products are more likely to be manufactured cheaply in China and Korea. (see Table VI.7 below). Table VI.7: % Changes in Viet Nam s sectoral Imports from different countries Exporting Region: Sector China Japan Korea Rest of the World Aggregate Imports by Viet Nam Shortrun Longrun Shortrun Longrun Shortrun Longrun Shortrun Longrun Shortrun Longrun Agriculture Forestry Fishery Coal Oil/Petroleum Minerals Processed food Beverages and Tobacco 0.69 Textiles and Apparel 1.86 Leather Products Wood Products Paper printing and publishing 1.23 Chemicals, rubber and plastics 1.11 Metals

50 Motor Vehicles and Equipments 1.49 Other Transport Equipments 3.39 Electronic Equipments 2.29 Other Machine Equipments 1.44 Other Manufacturing 6.55 Electricity and gas Construction Other Services VI.3 WAGES Openness of trade is likely to change wages in the short and long-run. See table VI.8 below. It is interesting to note that the increase in wages on account of the AKFTA is likely to be higher for unskilled labour in the lon-run than that for skilled labour. This points to the fact that most of the gains in exports is likely to arise in labour intensive products which will open demand for unskilled labour. TableVI.8 : % Changes in wages in short and long run Type of labor % Change in Short-run % Change in Long-run Skilled Labor Unskilled Labor VI.4 CHANGES IN SKILLED AND UNSKILLED EMPLOYMENT Changes in employment (see table VI.9 below) are completely consistent with output and export increases with most of the increase in employment occurring in sectors such textiles and apparel, footware, electronics and light manufacturing. These emerge clearly as sectors which would gain from AKFTA. Table VI.9: % Changes in employment in short and long run Labor type Unskilled Labor Skilled Labor Sector Short-run Longrun Shortrun Longrun Agriculture Forestry Fishery Coal Oil/Petroleum Minerals Processed food Beverages and Tobacco Textiles and Apparel Leather Products Wood Products

51 Paper printing and publishing Chemicals, rubber and plastics Metals Motor Vehicles and Equipments Other Transport Equipments Electronic Equipments Other Machine Equipments Other Manufacturing Electricity and gas Construction Other Services All the sectoral differences and changes are consistent with the model and equations explained in the methodology. For example, exports from all regions to Viet Nam increase due to tariff-cuts, while exports from Viet Nam to Korea increase in many sectors. Viet Nam manages to increase exports in some sectors mainly because the corresponding tariff-cuts are not too high. This is also because of the cheaper imported intermediate inputs to such sectors, as implied by the Input-Output structure of the data and underlying model. Changes in exports and imports affect those in output as implied by equation 1. (See Annex III on Methodology). Output growth or decline has an impact on labor demand and price. For example, fall in agricultural output results in fall in agricultural employment of both skilled and unskilled labor, as equation 3 suggests. (see Annex III on methodology). Wages increase because of increase in output and hence labor demand in many other sectors. As expected, the long-run results are far more pronounced because their corresponding tariff-cuts were far higher than the short-run counterparts. Welfare results are mostly driven by the tariff-cuts and hence the international trade part of the economy, mostly in terms of allocative efficiency, but also partly due to terms-of-trade changes. 51

52 CHAPTER VII. IDENTIFICATION OF WINNING AND LOSING PRODUCTS Vietnam made impressive progress towards opening its trade system during the 1990s, enabling the country to become the latest emerging Asian economy. Empirical results suggest that Vietnam's strong export performance is mainly attributed to a 'competitiveness' effect. 83 This result attests to the successful implementation of trade reforms since However, majority of Vietnam's exports remain traditional and labor-intensive products and, in fact, world demand for those commodities tends to grow slowly. 84 Vietnam has been climbing up the ladder of world trade despite increased competition from China. But although the country achieved high rates of export-led economic growth, there is no guarantee that it will be able to sustain such high growth in the future, unless it adjusts to the Chinese challenge and improves its export structure as international integration proceeds. In the face of intense competition in global markets, a considerable potential for upgrading Vietnam's export performance through product diversification and quality improvement remains. In a longer-term perspective, Vietnam should think of expanding capital-intensive and more sophisticated products. In sum, opportunities of Vietnam's trade export growth depend on how the government succeeds in changing its industrial structure and the related export pattern towards higher value-added products. The contribution of AKFTA must be examined in this context. GTAP analysis in the last chapter showed that the gaining sectors with respect to Korea and the rest of the world were different. For example, while agricultural exports to Korea is likely to increase significantly in the long run, that to the rest of the world is likely to decline. The same logic applies to fishery, processed food, beverages and tobacco, coal and petroleum. This trend points to trade diversion from the rest of the world to Korea. However, for a number of manufacturing products such as textiles and apparel, leather products, electronics, transport equipment and other manufacturing, exports to both Korea and the rest of the world shows rising. In the services sector, GTAP analysis shows that Vietnam would continue to be a net importer for the foreseeable future. This trend points to trade creation in both manufacturing and services sector. The composition of exports to Korea and the consequent generation of exports to the rest of the world points to some product diversification especially in manufacturing in Vietnam. The next section examines the supply capacities of Vietnam in key export and import competing sectors in its trade with Korea. VII.1 SELECTED EXPORT AND IMPORT COMPETING PRODUCTS IN THE PRIMARY SECTOR From the GTAP analysis in the previous chapter, minerals appeared to be the only primary sector where Vietnam's exports are likely to decrease to Korea and the rest of the world in the long run. Hence it would be one among the losing sectors. Whether this decrease in exports is attributed to Vietnam building its own refininf capacities for minerals remains to be seen. Furthermore, Korean investment may help Vietnam to build such capacities. One important example of this possibility is to be found in bauxite or aluminium ore. Dongyang Gangchul, South Korea's No 1 aluminium extruding firm with an annual production capacity of 54,000 tonnes, will import 600,000 tonnes of alumina or 25% of South Korea annual use from Vietnam as it plans to build a USD 350 million aluminium refinery. 85 However, Dongyang Gangchul, has agreed with Vietnam National Coal, Mineral Industries Holding Corp to proceed with building the aluminium refinery in Vietnam, the world's No.4 bauxite producer. 86 The ministry of knowledge economy said in a statement While South Korea sees 83 Vietnam's export performance in the face of China's competitive challenge, 84 Ibid ibid 52

53 its aluminium demand rising, all of the demand is met by imports. If this project was successfully conducted, it would contribute to stabilizing the metal supply. The ministry added that on top of the aluminium refinery project, state entities of the two countries have agreed to widen cooperation in developing energy and resources, such as oil, gas, coal and rare earth in Vietnam. 87 While this is just one example of possibilities of investment by Korea in the minerals sector, undoubtedly other such projects would develop. The percentage of foreign direct investment (FDI) in Vietnam's agricultural sector has fallen from 8 per cent in 2001 to only 1 per cent in 2009, with a large share of FDI having shifted towards the services sector in recent years. 88 Untapped opportunities in the agriculture, forestry and fisheries sectors were awaiting Korean enterprises as Viet Nam was offering incentives for investment in these sectors, including reduced land rental fees and assistance in human resources training, transportation and market development. More effective measures were needed to boost investment in the agricultural sector. Consistent economic growth have led to double-digit consumption growth forecasts across all agricultural sectors in Vietnam. However, the industry will continue to produce surpluses in coffee and rice - but few other commodities. Indeed, with a rising population and incomes, the country will remain a net importer of all livestock and dairy goods over the forecast period. Although the Vietnamese government is investing in several sectors to increase production, most of the industry, barring rice, will remain import-dependent and vulnerable to changes in global agricultural prices. 89 Vietnam's coffee sector has grown significantly over the last 20 years, with yields doubling over that time, while the area planted has expanded from 42,000 hectares to over 509,000 over that time. Out to 2013/14, it is expected that production will grow by 23% annually, as the Vietnamese government is aiming to increase replanting of coffee trees. 90 Work on replacing trees, many of which are more than 20 years old, will improve disease resistance and thus yields in the long term. Another growth driver will be export opportunities, given that Vietnam is the world's largest exporter of robusta coffee. 91 However, Vietnam's export opportunities in Korea will be tempered by the NTMs used, of which as table IV.3 shows several are applied to food products. Despite virtually flat production growth in recent years and even a slight decrease in 2009/10, Vietnam's rice sector will experience considerable growth by 2013/14, because of improvements in infrastructure, higher yields and increased domestic demand. 92 Compared with many of its agricultural sub-sectors, Vietnamese rice is actually very competitive relative to many of its regional peers and is well positioned to ensure the country remains a net exporter. 93 Indeed, it will continue to be one of the world's few rice exporters, the second largest in 2009/10. However, significant NTMs (see table IV.3) in Korea's import market for rice will prevent it from becoming a significant importer of rice from Vietnam. Vietnamese dairy consumption has expanded significantly in the last 15 years, driven by relatively large increases in domestic consumption and rising incomes, which have fostered 87 Ibid 88 balita.ph/2010/09/10/agriculture-fisheries-seek-korean-investors ibid 91 ibid 92 ibid 93 ibid 53

54 increased milk consumption. To 2013/14, a 40.9% growth in Vietnamese fluid milk production to 400,000 tonnes is forecasted. 94 Dramatic increases in cattle numbers and increased public and private sector investment, in an effort to reduce the country's growing import dependency, will support the strong growth. Commercialisation will also play a key role as larger, more efficient farms begin to play a greater part in total milk production. While Vietnam has started important import substitution projects in this sector, it is unlikely that Korea would be a major investor as it is not a major producer of either milk or milk products. VII.2 SELECTED MANUFACTURING EXPORT AND IMPORT COMPETING PRODUCTS From the GTAP analysis above, textiles and apparel emerged as a major sector where Vietnam would gain in terms of exports. However, imports were also expected to be high in this sector. These predictions have to be tallied with realities in Vietnam. South Korea was the second largest investor in Vietnam s garment sector with US$737 million, after China. 95 The country ranked sixth among importers of Vietnam's garments. However, the attractive image of Vietnam s apparel sector maybe fading in the eyes of foreign investors and importers. 96 Previously, Vietnam s garment-textile sector stood out globally with its abundant workforce who accepted lower wages and were eager to improve their performance at work. However, recent estimates show that Vietnamese labour productivity is only equivalent to 70%-80% of that of China. 97 Vietnamese workers tend to pick strike as their first choice when they want to negotiate for higher wages and proper benefits. Cheaper land leasing costs and the availability of local fabric producers give Indonesia an advantage over Vietnam. Hence Indonesia has established more knitware plants to enrich local fabric sources and offered more training courses to sharpen the skills of their laborers. 98 The AKFTA may go some way towards establishing its trade links but export increases such as those forecasted by the GTAP model will need to be tempered by the disadvantages of Vietnam as outlined above. The transport sector was identified by GTAP as another winner for Vietnam in terms of substituting imports through the AKFTA. Vietnam's automotive industry is very sensitive to tariff and tax cuts. For example, tax cuts towards the end of 2009 invreased passenger car sales by 125%. 99 Signs that the after-effects of the tariff changes are kicking in are evident as sales for Q are down by 2%, despite an 80% increase in passenger car sales. Again it is the MPV/SUV segment dragging on growth, with sales down 39% y-o-y, while commercial vehicle sales are down 2% y-o-y. Fluctuating tariffs are a factor in Vietnam's 12th position out of 14 markets in BMI's Business Environment Ratings for the autos sector in Asia Pacific. However, the market has witnessed stellar growth, and according to the above-average rating for its potential over the next five years, sales growth should be maintained. 100 The AKFTA with eventually lower tariffs, though this is one of the sensitive sectors in Vietnam's offer list, would lead to a growth in this industry, both through imports and through FDI by Korea. Initially, tariff jumping investment in these sectors should be expected by Vietnam. 94 ibid Vietnam s apparel losing competitive edge: AmCham, 97 Ibid 98 Ibid 99 MARKET SNAPSHOT: Good growth prospects for Vietnam car market: Business Monitor International 12 May Ibid 54

55 VII.3 SELECTED EXPORT AND IMPORT COMPETING SERVICES The Ministry of Information and Communications reported Vietnam s ICT sector is growing fast with over 22 million Internet users and a penetration rate of over 25%. In 2009, the sector generated US$6.26 billion in revenue, 7% of Vietnam s GDP. The digital content industry registered a dramatic growth rate of 50% with revenue reaching US$700 million. 101 The software industry gained an impressive 40% growth rate and revenue of US$880 million. World-known ICT companies like Intel, Compal, Foxconn, Olympus and Samsung are present in Vietnam. This is an area of cooperation which this report has not explored but could be one of Vietnam's competitive advantages. However, telecommunications which forms the backbone of this sector has been criticised as indulging in predatory competitive behaviour. 102 Other service sectors like aviation, banking, insurance, petroleum distribution were also criticized for unhealthy competitive behaviors such as abuse of advertisements and discounts to gain market share. 103 Vietnam's petroleum and gas sector were identified as another winner by the GTAP analysis in terms of output. Vietnam s natural gas sector is set to triple in size over the next fifteen years, according to a World Bank report Vietnam Gas Sector Development Framework. 104 The report presents a vision of the infrastructure and institutions needed to overcome the challenges and realize these objectives. According to the report, the gas sector is facing multiple challenges, including greater demand for gas; and a potential gas shortage, which may become worse if a few key decisions for change are not made soon. The report recommends that from now until 2025, Vietnam should apply various measures to address the uncertainty in the pricing methodology, the weakness in converting resources into reserve and to attract more investment in the sector. Specifically, Vietnam needs to create a competitive gas pricing methodology, as well as eventually a wholesale competitive gas market. It also suggests the Ministry of Industry and Trade set up an advisory unit on gas policy development, adjusting PetroVietnam s role and establish a modern regulatory structure. Vietnam s gas sector, according to the report, has tremendous potential which can be realized by 2025 with concerted and coordinated efforts by public agencies and their private partners. Gas now meets over 15% of the country s primary energy demand and 88% of the gas is currently consumed in the power sector. Gas-fired generation accounts for 40% of total electricity supply Vietnam remains attractive to IT investors, October 17, 2010, Ibid 104 World Bank, 2010, Vietnam gas sector development framework:final report, ibid 55

56 PART D-CONCLUSIONS AND RECOMMENDATIONS Vietnam is one of the brightest emerging markets in Southeast Asia. Vietnam is one of the major exporters of footwear and garments for the global supply chain. In this context, the signing of AKFTA along with its accession to the WTO in 2007 would be expected to give a big boost to its trade strategy. The impact assessment of AKFTA cannot be conducted in isolation. Such an assessment has to incorporate the effects of ASEAN+3 agreements as Vietnam's trade is composed of low value added products with a high import content. Hence the other agreements, including the AFTA are of material concern. As with other ASEAN FTAs, the ASEAN-Korea FTA (AKFTA) is characterized by a sectoral approach to negotiations. First an agreement was reached on trade in goods. It was followed by agreements on trade in services and on investment. As this agreement is only about three years old and data at this point of time is available only till the end of 2009, this impact assessment study has to be, necessarily, forward-looking, rather than stock-taking. AKFTA came at a fortuitous time for Vietnam. The global economic crisis starting in 2008 has had an impact on both export- and import-dependent industries in Vietnam. The sectors affected include textile and garments, leather shoes, wood processing, seafood processing, electronic components and tourism. The huge boost in exports to Korea in these sectors after signing the FTA would in part compensate for the decline in exports elsewhere. Trade of Vietnam with Korea almost doubled since signing the FTA in 2007, with almost a three fold increase in exports and a 50% increase in imports. That most of the increase in trade can be attributed to the FTA is shown by the huge increase in certificates of origin in Vietnam for trade with Korea. In 2009, South Korea was the seventh largest importer of Vietnam s goods, it was however the largest exporter to Vietnam. South Korea was the fourth largest trade partner of Vietnam in Vietnam s main exports to South Korea in the first five months of 2010 included seafood, apparel, crude oil, coal, timber, coffee, electronics, computer parts, transport parts and rubber. The top ten exports account for over 60% of the total exports in terms of value through the three years, Meanwhile, Vietnam s key imports from South Korea consisted of fabric, steel, machinery, equipment, tools, parts, petroleum, plastic materials, computers, electronic products and parts, textile materials, leather shoes, ordinary metal, automotive parts and ships. The top 10 imports accounted for nearly 72% of Vietnam s spending on imports from South Korea. The concentration of products in the trade profile of the two countries also reflects the investment profile of Korea into Vietnam. The export of electronics, telecommunication as well as transport equipment to Korea is a post FTA phenomenon consequent to investment in these sectors by Korea. That the increase in trade can be mainly attributed to the FTA is shown by the fact that the number of C/O (certificate of origin) forms used for the ASEAN Korea FTA by Vietnamese exporters has increased (exporters using C/O form AK can enjoy preferential tariff when exporting goods to South Korea). South Korea is Vietnam's second largest foreign investor after Taiwan as Korean companies had registered $20.15 billion for more than 2,200 projects from 1988 to July

57 In services, retail and franchise trade were among the attractive business sectors to Korean investors as consumer spending was expected to grow some 20 percent a year. In 2008, South Korea was the second largest investor in Vietnam s clothing sector after Taiwan with an investment of US $737 million. South Korea was the sixth largest garment importer from Vietnam in 2008 with turnover reaching $139 million. Investment in electronics by Korea into Vietnam has also been significant. In Mode 4 as well Vietnam is one of the major recipients of Korea's EPS scheme though supply of Vietnamese labour is far greater than that absorbed by Korea. Training schemes were also undertaken by the two countries to enable the level of skill development required for working in Korea. While the formation of AKFTA will increase aggregate welfare in the long run, this increase will only amount to about half a billion dollars. Terms of trade are likely to become adverse in the long run for Vietnam. This is because labour and wage costs are likely to rise with free trade agreements and labour intensive exports may thus suffer an adverse terms of trade. However, AKFTA may lead to a decrease in the costs of capital goods to the Vietnamese economy as cheaper capital goods imports from Korea and other FTA members will become available. Changes in exports and imports affect those in output as implied by equation 1. (See Annex IV on Methodology). Output growth or decline has an impact on labor demand and price. For example, fall in agricultural output results in fall in agricultural employment of both skilled and unskilled labor, as equation 3 suggests. (see Annex IV on methodology). Wages increase because of increase in output and hence labor demand in many other sectors. As expected, the long-run results are far more pronounced because their corresponding tariff-cuts were far higher than the short-run counterparts. Welfare results are mostly driven by the tariff-cuts and hence the international trade part of the economy, mostly in terms of allocative efficiency, but also partly due to terms-of-trade changes. There is concern that Vietnam's exports to Korea are only processed products whose imported content is high. This on one hand, has lowered the added value, on the other hand enlarged the dependence on Korea, causing trade deficit to increase, and the economy to be easily affected when there are instabilities in the overseas markets. Further the techonological content of exports and production in general is low. In spite of being considered as a driving force of growth, and a key factor to improve the quality of growth, technological science activities only account for 0.62 to 0.63 percent of GDP. Further the product content of export and imports from Korea is indicative of another factor. Korea is perhaps able to use Vietnam as a base to export to third countries. This could be explained by the investment profile of Korea which shows investment in products which may not have a large market in Korea. This includes products such as iron and steel, aluminium and other such industries. So future negotiations and liberalisation in AKFTA should move towards higher technology and higher value added products for Vietnam. Vietnam's present trade regime is characterized by a 'dual' approach. On the one hand, the government promotes export-oriented sectors in which private firms, especially the foreignowned firms are fully integrated into cross-border production networks, play the leading roles. The share of foreign-owned firms in Vietnam's total manufacturing exports increased from about 20% in the mid-1990s to over 70% by 2002 and wass about the same in The private sector is mostly labor-intensive, and exports on average are three-quarters of its production; this contrasts sharply with the state sector that is mainly capital-intensive and inward-looking, but still dominates the economy. The anti-export bias results from the central government's objective, on the other hand, to structure the foreign trade regime in order to 57

58 protect some of its large import-substituting industries and related State-Owned Enterprises (SOEs). In the face of increased competition from abroad, the trade regime is still considered to be restrictive by maintaining controls in key imported commodities such as oil and gas, mining, transport equipment, cement and steel, petrochemicals. In fact, the Vietnamese government maintains protection of capital intensive SOEs that are dominant in importsubstituting sectors but remain generally weak, although they benefit from FDI. Such issues reflect Vietnam's rather special circumstances as an Asian transition economy, where the SOEs still enjoy rents from existing barriers to trade because of their leading role in policymaking, revenue collection and distribution. Vietnam's case is similar to the early industrialization experiences of South Korea. While some tariff barriers will continue to exist post liberalisation, the huge increase in trade is a testimony to the beneficial effects of the FTA. However, future liberalisation in Vietnam would need to eliminate some of the protection accorded to SOEs or to make such SOEs more competitive. AKFTA should not only result in trade creation and higher growth rates for Vietnam, but it must also change the composition of its trade through product diversification. In the face of intense competition in global markets especially from China, a considerable potential for upgrading Vietnam's export performance through product diversification and quality improvement remains. In a longer-term perspective, Vietnam should think of expanding capital-intensive and more sophisticated products. In sum, opportunities of Vietnam's trade export growth depend on how the government succeeds in changing its industrial structure and the related export pattern towards higher value-added products. The contribution of AKFTA must be examined in this context. 58

59 ANNEX 1 Table 1 AFTA (CEPT) utilization ratios in Thailand and Malaysia 59

60 Table 2 - ROO by type : Textiles and garments Source: ASEAN secretariat 60

61 Table 3 - ROO by type : Iron and steel Source: ASEAN secretariat Table 4 - ROO by type : Food and agricultural products (Chapters 1-24) 61