News Room - Business/Economics

Posted on 19 Nov 2008

Overview of automotive clause in KORUS-FTA

The automotive clause of the Korea-United States Free Trade Agreement is but one part of a multi-faceted agreement. However, U.S. president-elect Barack Obama, along with other key U.S. lawmakers, has focused specifically on an ailing U.S. automotive industry as a crucial economic concern.

 

Couple that with slumping demand and weak profits worldwide causing problems for Korean carmakers, and the importance of the passenger vehicle section of the KORUS-FTA becomes more pronounced.

 

During the first U.S. presidential debate on Sept. 27, Obama said, "We have to ... invest in alternative energy, solar, wind, bio diesel, making sure that we're developing the fuel-efficient cars of the future right here in the United States, in Ohio and Michigan, instead of Japan and South Korea."

 

The National Assembly trade committee met on Nov. 13 to discuss the ratification of the FTA, which was first agreed upon in April 2007 under the Roh Moo-hyun administration. The committee met with intense partisan bickering, with one side suggesting a quick ratification to fend off a renegotiation demand from the coming Obama administration.

 

U.S. exports to Korea

 

As it stands now, American automobiles have been suffering from a diminished reputation in the eyes of the international community. Claims of poor fuel efficiency, lack of durability and cumbersome size have all contributed to U.S. autos' decreased appeal worldwide. While the quality of American cars is debatable, when it comes to their viability as exports, there are legislative and economic factors at play as well.

 

Lifting the existing engine-size restrictions could potentially benefit the United States, though many involved in auto production are skeptical.

 

Removing the restrictions would probably not result in Koreans buying more large American SUVs or pickup trucks. Korea's streets are already congested. Parking is scarce as is, and many streets are too narrow to support large passenger vehicles.

 

Although it is reasonable to envision a niche customer base for American trucks and SUVs, the lack of everyday practicality makes it hard to imagine them having any real impact on the market. Currently, there is an 8 percent tariff on cars and a 10 percent tariff on light trucks.

 

Nearly all U.S. car exports to Korea have engines bigger than 2,000 cubic centimeters and are assessed the higher tax.

 

U.S. car exports to Korea would likely experience a small percentage increase under the current FTA. Hyundai, Kia and Daewoo already make affordable small and mid-size cars. Factoring in Korea's national pride, even with taxes lifted American penetration into that market would be minimal. Anti-import bias may also play a role in the low import penetration in the Korean market.

 

Given the current small U.S. market share and regulatory measures in place, short- to medium-term increases would be small (by value). The long-term impact on U.S. exports of passenger vehicles to Korea depends on FTA provisions concerning standards, certification requirements, taxes and regulations.

 

The FTA clause

 

At the time of this writing, the FTA states that Korea shall amend the Special Consumption tax so that:

 

-vehicles with engines 1,000 cc or less are not taxed, vehicles with engines of between 1,001 cc and 2,000 cc are taxed at a single rate of no more than 5 percent, and vehicles with engines of more than 2,000 cc are taxed at a single rate of no more than 8 percent.

 

-within three years of the date this Agreement is signed, vehicles with engines of more than 1,000 cc are taxed at a single rate of no more than 5 percent. The tax reduction for vehicles bigger than 2,000 cc would come in three annual stages, taking effect on Jan. 1 of the relevant year.

 

The FTA also states that Korea shall amend the Annual Vehicle Tax so that vehicles with engines 1,000 cc or less are taxed at a single rate of no more than 80 won per cc, vehicles with engines between 1,001 cc and 1,600 cc are taxed at a single rate of no more than 140 won per cc, and vehicles with engines of more than 1,600 cc are taxed at a single rate of no more than 200 won per cc.

 

For Korean importers, the United States would eliminate a 2.5 tariff on passenger vehicle imports.

 

U.S. auto industry concerns

 

Ford Motor Co. is opposed to the FTA. The company has been operating in Korea since 1995, and currently maintains one dealership that sells 1,700 vehicles a year, compared to approximately 1,400 Hyundai and Kia dealers. Ford believes the 96 percent market share held by Korean carmakers is directly the result of government action. They also cite anti-American sentiment as a factor.

 

The United Auto Workers also oppose the agreement. They maintain that Korea, while it is the fifth-largest vehicle producer and third-largest vehicle exporter in the world, has the lowest level of import penetration of any major automotive producing country. The UAW believes the FTA will result in a surge of imports from Korea, a large loss of automotive jobs in an already-struggling automotive industry and an abandoning of Korean automaker plans for future manufacturing expansion in the United States.

 

GM, which has a partnership with Korean manufacturer Daewoo, is neutral on the agreement, yet believes "the benefits will skew, for the near term, to Korea."

 

The Labor Advisory Committee stated that the FTA's automotive provisions were disappointing. It pointed out that the United States had a $13.4 billion trade deficit with Korea in 2006, $11.7 billion of which was in autos and auto parts.

 

Korea's production and current environment

 

Hyundai's Alabama facility has the capacity to produce 300,000 units per year, and the Kia plan under construction in Georgia is expected to be operational in 2009, with capacity to produce 300,000 cars per year.

 

The combined U.S. sales of all Korean cars, regardless of whether they are assembled in Korea or the United States, are forecast to reach 1,007,328 vehicles in 2011, up from 749,822 vehicles in 2006.

 

In 2006, Korea exported more than 700,000 cars, vans and sport utility vehicles to the United States, while the United States exported a little more than 4,000 of the same to Korea.

 

Korean cars in the U.S. market are viewed to have improved in both quality and value.

 

The car market in Korea is dominated by the domestic industry, which accounted for greater than 95 percent of the Korean market during the 2002-06 period. Penetration by foreign automakers was 4.2 percent in 2006. European cars accounted for 60 percent, Japanese, 27 percent and U.S. cars made up 7 percent of the market.

 

The 1995 and 1998 memoranda of understanding between the United States and Korea, designed to increase market access and address barriers in the Korean market, did not help U.S. car sales in Korea. Instead, the U.S.-Korea automotive trade deficit increased from $1.3 billion in 1995, to $2.1 billion in 1998, and to $11.1 billion in 2006.

 

Korean imports

 

Korean imports of passenger cars with engines of 1,500-3,000 cc are substantially lower than imports of the same product into most other economies, relative to the size of the Korean economy. Korean imports of small cars in 2003-2005 were 0.02 vehicles per $1 million GDP, as compared to the median for 56 comparable countries of 0.45 vehicles per $1 million GDP.

 

Korea ranks 55 out of the 56 countries in imports of these cars relative to the size of its economy. Only India ranks lower.

 

Another important factor is that the Korean average import price from the world in 2004-06 was $27,160 per vehicle, which is 96.9 percent above the world average price of $13,794. The average import price in the United States is $19,754.

 

Removing the 8 percent and 10 percent tariffs would help U.S. exports, and lower the overall tax burden on the Korean consumer who buys an American car or truck. Removal of the tariff might also increase the competitiveness of U.S.-produced hybrid vehicles in the Korean market. Korea lacks a hybrid presence in their domestic market.

 

Korea's domestic stance

 

Hyundai Motor Co. has expressed support for the FTA, stating before the United States International Trade Commission that it believes the tariff reduction is fair. They stated that with the FTA U.S. automakers should be able to improve their price competitiveness and market share in Korea.

 

Hyundai sees the United States as part of its overall strategy to become one of the world's leading automakers. They added that the FTA will create further opportunities to expand market share in the United States. Hyundai noted, however, that much of what they sell in the United States is also made there.

 

During the same Commission hearing, then Korean Ambassador to the United States Lee Tae-sik addressed three issues concerning the Korean auto sector.

 

First, he said the Korean market is open to foreign automobiles. He claimed that although imported vehicles accounted for a mere 4.5 percent of the Korean market in 2006, that the foreign-market share based on value rose to 14 percent in 2006.

 

Second, he said that Korea is not the main source of the U.S. automobile deficit, as it represented only $8.5 billion, fourth behind the EU's $22.9 billion, Canada's $25.1 billion and Japan's $43.2 billion in 2006.

 

Third, Lee stated that allegations that the Korean government fosters a campaign discouraging the purchase of foreign automobiles are "groundless."

 

Today's problem

 

Both the United States and the Korean automotive industry are in trouble. International economic turmoil has forced both countries into crisis mode.

 

Hyundai's U.S. sales fell 31 percent in October from a year ago and the output at its U.S. plant will be cut by 15,000 units this year.

 

In an even direr situation, GM, Ford and Chrysler are seeking $25 billion from the U.S. government to get them through the economic crisis and the worst sales slump in 25 years.

 

It remains to be seen how this will play out, but only through careful deliberation and consideration will the best solution be reached. Both countries could benefit from a correctly composed FTA.