February 2006

Sustaining the Alliance: U.S.-Korean Relations in the New Asia

The beginning of the twenty-first century has been a troubled time for U.S.-South Korean relations. The Korean economy continues to recover from the Asian financial crisis, but has not firmly established its position within the first rank of global economies. Trade disputes continue to burden relations, and talks on a free trade agreement have not progressed significantly. On the foreign policy front, North Korea’s belligerent ways were not stemmed by the “sunshine diplomacy” of the 1990s, and the six-party talks hold little promise of resolving the security crisis on the peninsula. At a February 1 AEI conference, scholars, analysts, and government officials from both Korea and the United States gathered to discuss how Washington and Seoul can pursue their economic and security goals in the future.

Introductory Remarks

Christopher DeMuth
AEI

The relationship between the United States and Korea has differed in strength and quality, with the past few years being the most challenging. The governments of the two nations have taken differing approaches to changing dynamics in Asia, particularly with regard to North Korea. However, the relationship remains strong and important, and this conference strives to discuss both the challenges and opportunities for the alliance in the future. The timing of this conference is notable given the likelihood of a trade agreement to be reached between the two nations in the next few days.

Dae Whan Chang
Maeil Business Newspaper

The relationship between the United States and Korea is often taken for granted, but in reality, no fifty-year relationship can continue without difficulties or challenges. The State of the Union address mentioned Iran’s nuclear weapon development without discussing North Korea’s; however, with the continuation of the six-party talks, this issue will not go unaddressed. The president also discussed energy, an issue that particularly concerns Korea, a nation that must import all of its oil. The development of better sources of energy and more efficient automobiles is important to Korea’s future. The China-India relationship and their strong economic and trade capabilities when united is a concern, both in Asia and the United States. The “open market strategy” highlighted by the president can also be seen in the coming trade agreement between the United States and Korea.

Tae-Sik Lee
Embassy of the Republic of Korea

The Korean peninsula was largely not mentioned in the State of the Union address, with the president focusing primarily on Iraq, Iran, energy, and domestic issues. However, the United States and Korea continue to cooperate on many issues, and the future of the alliance will continue around such cooperation. Both countries invest a fair amount in one another, and it is important that this “silver lining” is continually highlighted. It is important not to pay too much attention to the political and military issues effecting the alliance, and in order to keep the alliance strong, it is important for the two nations to review what has made the relationship unstable.

The Nixon doctrine in the 1960s brought about a shock to the military alliance, as the United States downsized its forces in Korea, while Korea supplied forces in Vietnam. This occurred against the will of the Korean government when relations were particularly strained with North Korea. America withdrew more troops as a result of President Jimmy Carter’s campaign promises--another shock to the Korean government. Approximately 7,000 troops were withdrawn again in the early 1990s. In 2002-2003, Korea was again surprised that the United States planned to cut its troop levels in Korea down by one third, which was agreed would occur in a gradual manner.

This history has had an impact on Korean perceptions of the alliance. If the withdrawal of troops means that Korea should be self-reliant, it must possess the technology and equipment to be truly autonomous. The six-party talks thus far have produced a joint statement that demonstrates the progress the talks have made, but if North Korea fails to acknowledge and address its illicit activities, then the future of the talks is in danger. However, Korea believes that the six-party talks have the potential of solving North Korea’s nuclear ambitions and that the international community can triumph over North Korea.

Economic ties are another source of strength for U.S.-Korean relations. Current trade and investment is substantial, and it is important for governments and private businesses to look to strengthen these ties. A free trade agreement is in the interest of both nations, and despite difficulties it may have passing in Congress, it is important to the future of the alliance.

The alliance has survived the test of time, and it is important to remain optimistic about its future.

Panel I: U.S.-Korean Trade and Investment Relations

Oh-Seok Hyun
Korea International Trade Association

Mr. Hyun focused primarily on the structural changes and competitiveness of Korean industries. He presented many of Korea’s economic indicators and statistics, including GDP, trade flows, foreign reserves, technology competitiveness, and incoming and outgoing foreign direct investment (FDI). Until the 1970s, Korea’s primary sector was agriculture. However, Korea has since developed a manufacturing-based economy and, as a result, the agricultural sector has fallen as a proportion of the economy. In addition, the services sector now represents 55 percent of the Korean domestic economy.

The Korean economy is currently highly dependent on foreign trade, especially with the United States and increasingly with China. There has been a change in Korea’s export items away from textiles and towards semiconductors, computers, automobiles, and mobile phones. China has replaced the United States as the single largest market for Korea’s exports. The United States currently provides the largest source of FDI to Korea, while China is receiving an increasingly large proportion of Korean FDI.

Korea’s trade policy is based on a composite trade strategy that attempts to foster integrated competitiveness by expanding export items to include not only commodities, but also services, technology, and manpower. Korea strongly supports free trade agreements (FTAs) and has three strategies towards implementing more. First, Korea will aim to pursue several FTAs simultaneously on a multitrack basis rather than on a one-by-one approach. Second, it will establish FTAs that are consistent with the WTO and that are more comprehensive in their coverage by encompassing a wider range of areas. Third, the Korean government will try to obtain wider public support by making a wide range of outreach efforts in each step of the FTA process. The U.S.-Korea bilateral FTA faces many challenges and obstacles, but Mr. Hyun believes that the successful creation of this FTA will achieve desirable results. The likely benefits of this FTA will include an increased fostering of fair competition and an enhancement in the active cooperative relationship between the two countries.

E. M. Graham
Institute for International Economics

The recent rise of China is an important factor that needs to be fully taken into account when discussing the U.S.-Korea bilateral FTA. China has become Korea’s most important export market, and most of U.S.-Korea trade currently goes through China. Furthermore, China is a major destination of Korean FDI. This raises a much bigger set of issues concerning whether or not bilateral FTAs between countries is the most beneficial direction. Specifically, there are serious concerns among many economists that bilateral FTAs are suboptimal and that they undermine the multilateral process. This is particularly true in the case of the faltering Doha Round of trade negotiations.

Therefore, the larger issue is that the proliferation of bilateral and regional FTAs might be more of a diversion from one of the major issues in trade, that of the rise of China, rather than a help to it. Mr. Graham questions whether a bilateral FTA without China’s participation really makes sense. In addition, most of the trade between the United States and Korea is in what is often referred to as intra-industry trade. These are products, such as semiconductors, electronics, machinery, and automobiles that compete with one another in the global market. Intra-industry trade makes up a great deal of the trade that is occurring between the two countries.

There are two main issues that arise when we consider intra-industry trade. First, this type of trade is likely to make the negotiation of trade agreements much more difficult. Second, the estimated benefits of establishing such a bilateral FTA are likely to be too small relative to the actual gains. Mr. Graham explains that this problem may arise because we are using a static model, which is the wrong model to use when considering the benefits of trade. The true benefits are actually dynamic and hard to measure. Most of the main benefits are likely to accrue from the increase in competition and from the increase in the rates of technological innovation arising from such competition. This implies that the benefits might actually be substantially greater than are currently indicated by the static models.

Overall, the U.S.-Korea FTA has a unifying feature that could not have come at a better time. With the recent deterioration of U.S.-Korean relations, especially at the grass-roots level, the bilateral FTA between the two countries could provide the kind of healing and reconciliation that is necessary.

Mark Manyin
Congressional Research Service

Mark Manyin focused on the politics of and within trade. He indicated that trade tensions have not poisoned U.S.-Korean relations since the trade relationship between the two countries has been remarkably tranquil. However, there are two ways in which the FTA could change the current situation: the U.S.-Korea FTA will have the effect of politicizing economic issues, and it may provide an economic outlet in order to vent frustrations on the strategic level.

Mr. Manyin provides four reasons for why the economic relationship between the United States and Korea has been so tranquil. First, it is due to South Korea’s economic reforms since the Asian financial crises in 1997. Second, the creation of the WTO and the creation of a robust dispute resolution body have helped depoliticize many of the bilateral trade disputes. Third, there have been some elements of luck and timing, since there have not been many contentious trade issues or disputes. Finally, there has been better bilateral management of these trade disputes.

Looking to the immediate future, the FTA is likely to politicize many economic issues and magnify some of the already existing ones, including those in the pharmaceutical and automobile industries. Furthermore, the creation of a U.S.-Korea FTA may bring about new issues or cause ones that have been dormant to reemerge, such as key issues arising in the agricultural or financial services sectors.

The U.S.-Korea FTA will likely cause the political and economic worlds to collide on many fronts. Specifically, it will force the United States to examine all aspects of its relationship with South Korea, including security and strategic issues. The six-party talks will be of special concern in the immediate future and may have severe implications for the establishment of the bilateral FTA. However, these strategic issues will probably give some momentum towards the creation of the FTA and may even help to bring it to fruition. Regardless, though, the likely outcome is that these political issues are going to make economic relations between the United States and Korea much rockier in the coming years than might otherwise be the case.

Claude E. Barfield
AEI

Mr. Barfield focused on two novel trade policy doctrines that have arisen under the Bush administration. The first of these doctrines is what Ambassador Robert Zoellick has described as competitive liberalization. The second is the explicit linkage of U.S. foreign trade policy to larger political, diplomatic, and security goals around the United States. In addition, there have also been two unforeseen surprises that have developed during the same time frame that the Bush administration has had to try to adjust its foreign trade policy towards. The first is the rapid rise of China’s economy; China has become a key player in the arena of bilateral FTAs, such that countries are becoming increasingly more interested in trying to establish ties to this major economy. The second surprise has been the rise in the sense of an East Asian regionalism.

The main challenge to the United States in the immediate future will be how the country should deal with this growing East Asian regionalism and the institutional changes that are coming about as a result. Mr. Barfield points out that the United States currently has no projection into East Asia on a regional basis and that Asia-Pacific Economic Cooperation (APEC) has been moribund since 1998. Since 2001, ASEAN +3 has become the chief focus of the regional institutionalism in East Asia. However, the United States has not developed a policy towards this East Asian regionalism and has instead relied on individual bilateral agreements as its main policy within this regional framework. The question therefore becomes, with deeper regional institutionalism in the near future, will the current U.S. trade policy in this region be adequate? Mr. Barfield asserts that this administration should make clear immediately that any time there is a movement in the ASEAN +3 toward something which would become an ASEAN +3 FTA, the United States should be at the table.

Panel II: Competing in the World Economy: The United States and Korea

Phillip L. Swagel
AEI

Over the past fifty years, the Korean economy has been one of the world’s greatest success stories. Particularly during the past decade, the economy has transitioned from one based on production to one based on innovation. Today, when Americans consider their own economy, they see India and China as distant challenges. Yet for Asian countries, the presence of China and India are much greater causes for concern.

Joseph Winder
Korea Economic Institute

In considering economic competitiveness, it is helpful to consider Thomas Friedman’s book, The World is Flat. Friedman discusses how globalization has been fueled in large part by the remarkably inexpensive access to telecommunications throughout the world. Now that international, real-time communication is so cheap, many companies in the global community have changed from a horizontal to a vertical structure. In addition to companies being more competitive, virtually any fungible job can be outsourced.

This globalization is taking place just as India, China, and Eastern Europe are rising in terms of economic power, which poses a challenge to the competitiveness of the Korean economy. For example, China now produces over 350,000 new engineers per year. Also, 400 of the Fortune 500 companies have invested in over 2,000 projects in China. Private sector productivity has risen by 17 percent per year, and American companies, such as Microsoft, are using China as a place for carrying out research and development. India has world-class institutes of technology, which turn out hundreds of thousands of scientists and engineers. Likewise, investment in Poland has totaled $59 billion over the past ten years.

Korea still has an edge in its information technology. The World Competitiveness Yearbook ranks Korea first out of sixty countries in terms of broadband subscribers and fifth for Internet users. However, for a country to be competitive, more is necessary than strong technology. Other recent competitiveness surveys have noted that Korea’s macroeconomic policies have been weaker than those of other countries. Korea’s business environment, which takes into account the regulatory policies, infrastructure, education, culture, and the ease of doing business, has also been mediocre. Also, Korea has a pitiful ranking in terms of the hostility of labor relations.

Furthermore, while Korea has been a world leader in innovation, there is little cooperation between universities and the private sector in terms of investment in research and development. Moreover, in recent years, Korea has been relocating its research and development efforts to other countries. Thus, there are definite areas of Korea’s economy that need to be dealt with in order for it to remain competitive. One possible stimulus toward greater competitiveness would be the free trade agreement with the United States.

Jaewoo Lee
International Monetary Fund

There are many tools that aid in the study of competitiveness, one of which is an effective exchange rate. An effective exchange rate enables analysts to look beyond bilateral exchange rates and compare the competitiveness of multiple trading partners. Statistics demonstrate that over the past fifteen years, the direct bilateral trade relations between the United States and Korea have changed little. However, relations between Korea and Japan and China have changed a great deal. Korea’s export share to Japan has declined from 13 percent to 9 percent, and concerning China, Korea’s export share has risen from 15 percent to 27 percent. Indeed, in many respects, a strong relation with China is enticing for Korea, as Korea has gone from a $2 billion trade surplus with China in 1995 to a $20 billion surplus in 2004.

However, China might soon become a great cause for concern for Korea. This becomes apparent when one considers the product ladder, which describes how a country goes from producing simpler to more complex goods. The United States has been flexible with Korea’s rise on the product ladder and has actually encouraged Korea on that route. China, on the other hand, has developed a product mix similar to that of Korea. While some scholars argue that the unemployment of China’s central region will keep the PRC from becoming competitive with Korea in the near future, a more likely scenario is that the coastal provinces will become serious competitors with Korea in every one of its export industries.

Regarding financial relations, Asian countries are integrated better with the global financial market than they are each other. During the 1980s, few Asian countries had direct financial relations with each other, but since all had relations with the United States, the Asian countries in turn became fairly well coordinated with each other. In all likelihood, neither China nor any other Asian country will replace the United States as the main international financial center. To understand this, consider that in 1912, J. Pierpont Morgan, when asked if credit was based on money, he responded, “No, sir, none whatsoever . . . the first thing is character.” Intangibles such as character and reputation are of utmost importance in financial markets, so despite China’s $800 billion in reserves of U.S. bonds, Asian countries will probably continue to choose to process their financial transactions through America.

Joosung Jun
Ewha Womans University

Mr. Jun reviewed the competitiveness of Korea’s economy by examining numerous economic indicators.

Although the Republic of Korea has a fairly strong economy, with a per-capita income that is ranked twenty-fourth in the Organisation for Economic Co-operation and Development, certain signs indicate that it could be losing its competitive edge. Following the Asian financial crisis in 1997, Korea has become more open, disciplined, and competitive, but it still performs below its growth potential. While exports have been strong, domestic consumption and investment have been sluggish. In fact, over the past few years, its growth rate has dipped below the Asian average.

The major concerns for the long-term growth of the Korean economy are globalization, the rise of China, the aging population, and structural weaknesses.

China has been closing the competitiveness gap with Korea. For various industries, China is expected to close the gap within a matter of years. For shipbuilding, China will catch up with Korea (as of 2004) in seven years; for automobiles, four and a half; semiconductors, four; computers and telecommunications devices, two and a half; and consumer electronics within two years. One reason that China is able to close the competitiveness gap is that the hourly wage for the manufacturing sector is approximately nine times smaller than that found in Korea.

Some factors that have hindered the competitiveness of the Korean economy include labor rigidities, female unemployment, low efficiency of capital, the weak link between government and private sector research and development, and less effective government policy.

Keynote Address

Ambassador Christopher Hill
Assistant Secretary of State for East Asian and Pacific Affairs

The United States should feel fortunate that it has a good ally in the Republic of Korea (ROK). Although the two countries will not always agree on all the issues, both sides certainly have a number of shared interests.

There is compelling logic for why the Democratic People’s Republic of Korea (DPRK) should give up its nuclear weapons. Although previous negotiations to that end have failed, the current negotiations have a chance at success, primarily because they are truly multilateral in character. The United States is not interested in bilateral talks with North Korea regarding denuclearization. Rather, the United States wants to work with multiple partners through the six-party process. There is a great deal of cooperation between the members of the six-party process. China deserves a great deal of credit for the September Beijing Agreement in Principle, and there is no question that everyone wants this agreement to succeed. The six-party format is the right format. The question is whether the six-party talks offer something that a country so perversely bent on isolationism is actually seeking.

The United States needs to show a seriousness of purpose, and has done so thus far. The United States wants a diplomatic solution to this problem. However, while this is the best solution, it is probably not the only solution. The problem has to be solved, and the United States must put all the energy it can into solving it. It is important for the DPRK to understand that every serious political element in the United States supports the goals of the six-party process.

The issue of financial regulatory action is currently holding up the talks. The designation by the U.S. Treasury Department of a small bank in Macau as a “primary money laundering concern” is pursuant to Section 311 of the USA Patriot Act. This is not a part of the six-party process; rather, it is a law enforcement matter. Diplomatic negotiators thus have no authority to request the law enforcement process to be stopped. The law enforcement matter can be concluded by Banco Delta Asia doing its part to clean up its practices.

The DPRK must take a look at where its interests lie. To hold up the issue of the six-party process because of a law enforcement issue is not in the interests of the DPRK. There are numerous elements in the September agreement that would lead the DPRK down a positive route. Those issues are certainly worth pursuing, and if the DPRK follows up on its part, the other parties will follow up on their parts as well.

Panel III: Securing Peace on the Korean Peninsula

Joun-Yung Sun 
Kyungnam University

In the past three years since President Roh has taken power in the ROK, there has been insufficient dialogue between the United States and the ROK at the official and semi-official levels. There have been differences between the two governments on a number of issues, including North Korea. But as a whole, the U.S.-Korean alliance remains in good shape at this time, for several reasons: Free and fair elections have been established in South Korea as an unshakeable democratic institution. The relocation of the Second Army Division headquarters and the reduction of U.S. forces in Korea have been successfully concluded. South Korea has been the second largest troop contributor to the U.S. coalition in Iraq. The governments of the United States and ROK agreed last month to the strategy of U.S. forces in South Korea. Finally, South Korea has been brought very close to participation in the Proliferation Security Initiative.
     
In the financial realm, Korea’s financial market is now fully open and has been providing many U.S. private equity funds with an excellent market for business operations. If the U.S.-Korea FTA currently being pursued is concluded successfully, it will serve as a sort of “super glue” to the U.S.-ROK alliance in an ever-changing environment in Northeast Asia.
     
Despite seventeen rounds of ministerial level talks, things remain largely unchanged between the two Koreas. Regarding North Korea, there has also been insufficient coordination between the U.S. and ROK governments. The September 19 joint statement of the six-party talks is a very important step forward toward a diplomatic resolution of the North Korean nuclear issue. Paradoxically, the actions taken by the U.S. Treasury and Banco Delta Asia can be seen as a positive development for the six-party talks. This can serve as a precursor of “sticks” that may be applied in case there is no resolution to the nuclear issue.

Jack Pritchard
Brookings Institution

The presidencies and policies of Roh and Bush will be inevitably intertwined for at least two more years; the countries cannot afford to ignore each other, whether they want to or not. There is a perception among many, mostly in the United States, that the alliance is adrift, and that the United States and ROK have a number of incompatibilities regarding their policies toward North Korea. The reasons for this perception are many, the greatest of which is the rising sense of anti-Americanism that has been linked with Roh’s presidency.

On a more positive note, in the strategic realm, the United States and ROK share common values that transcend day-to-day differences: democracy, religious freedom, human rights, proliferation concerns, and regional stability. While the rank order of priorities on the issues may vary between the two governments, this does not diminish the fact that both sides are generally committed to the same goals.

In light of these perceptions of a drifting alliance, it is necessary to consider ways to get the alliance back on track. Each side must keep criticisms of the other private and seek opportunities to praise the other publicly. They must lay out a complete path to a diplomatic resolution of the North Korean nuclear issue and commit the resources to do so. The United States and ROK must stay the course rather than vacillating between diplomacy and some other course of action. However, should a diplomatic solution fail, it is important that the parties involved not walk away from the issue entirely. The United States cannot resort to its usual plan B, but instead should urge the South Korean government to come up with a backup plan that all parties can pursue collectively.

Byungki Kim
Korea University
 
The alliance began in 1953, when Korea, coming out of the devastation of war with a per-capita GNP of less than $15, utilized American human and financial resources to assist the rebuilding. While Korea had no real military value to the United States, Eisenhower saw the strategic need to create a regional security organization, centered on Japan, South Korea, and the United States. This concept, however, marginalized whatever minor strategic role South Korea could play in the region. In two weeks of negotiations, a bilateral agreement was established without Japan, promoting greater investment into Korea’s failing economic and political systems and providing the United States with greater access to the developments in China and the Soviet Union.

While this environment has changed as democracy and the market have flourished in Korea, it is important to actively maintain the alliance and examine the issues faced by the alliance in a comprehensive and historical manner.

Aaron Friedberg
Princeton University

There is reason to be optimistic about the future of the alliance for the long term, though there is reason to worry about its short-term status. The foundations upon which the alliance was built remain strong with important economic linkages, cultural ties, and a shared commitment to democracy. Overall, the alliance has been grounded in successful cooperation and honesty. American and Korean strategic interests are likely to remain intertwined, especially as the United States recognizes it is only an Asian power by invitation. Korea is likely to play a larger regional and global leadership role in the future, but its security can easily be challenged by the larger powers nearby, making the United States a necessary ally.

The recent relationship between the two nations has been rocky, often hurt by miscommunication. The looming issue that must be dealt with is North Korea. While the two nations agree on the end goals--denuclearization and reunification--there is much disagreement on the means and urgency by which the countries should deal with them. The Koreans wish to approach the issue with patience, using inducements to bring North Korea closer, while the American approach demands greater urgency, acknowledging that with further North Korean nuclear and military development, “time is not on our side.” The United States is only willing to give inducements when the North Koreans have stopped their nuclear development. However, both the Chinese and South Korean governments are counteracting American policy by not pressuring North Korea as much as they could.

It is unlikely that inducements will be successful, as Kim Jong-Il appears to care little about the low quality of life in North Korea and may view any inducements as a threat to his power. Ultimately, Kim Jong-Il is unlikely to end nuclear development until he feels that the program threatens his political and personal security. One way through which the United States can pressure Kim Jong-Il is to tie up his access to currency, which he uses to afford his extravagant lifestyle and buy personal security. The problem is that such actions will be largely ineffective if Kim Jong-Il is able to compensate for loses by gaining increased aid or investment through another channel.

There are five major consequences of a nuclear North Korea, which must taken into consideration in determining the best course of action: the extension of the Kim dynasty’s grip on power, the likelihood of threats to extract blackmail, proliferation to terrorists or non-nuclear rogue states, further nuclear buildup in the region for protection, and recriminations between South Korea and the United States.

David Asher
Institute for Defense Analyses

The DPRK has claimed to not be involved in any illegal counterfeiting or trafficking and has said it will not participate in the six-party talks until American Section 311 sanctions are lifted. North Korea has become a criminal state; however, in order for the six-party talks to be successful, it is important to approach North Korea as it is, not as other countries wish it to be. Crime is part of the North Korean government’s survival strategy. It is funding the regime, and criminal networks linked to North Korea are found on every continent.

The threat of North Korean proliferation is a reality. Evidence has been produced that North Korea has worked with Libya on enriching nuclear weapons grade uranium and sold missiles to Iran that can be used to launch nuclear weapons to almost every major Western European power and Israel. More aggressive measures are needed to keep the DPRK from further proliferation. Trade from the DPRK must go through ports in either the ROK or China, and it is important that Korea and China begin to inspect shipments to assure that weapons of mass destruction or contraband materials do not leave North Korea through its ports.

Crime and nuclear proliferation are not methods of long-term survival for the DPRK, as they result in sanctions and criminal prosecution. Multiple violations of international law are not sustainable. In the long term, the benefits of abandoning illicit activity, even for the leadership, should outweigh the costs.

Ultimately, the DPRK must switch to a policy of denuclearization, demobilization of the army, and political and economic opening, as other Asian countries have done in the past. This can be a transformational and soft-landing policy without forcing a regime change. It is important for other nations to support North Korea, particularly economically, in this transition. This assistance will raise the living standards of the country’s citizens without enriching the leadership.
 
There will be no diplomatic progress if the DPRK’s incentive structure does not change. Law enforcement and diplomacy must be separate tracks, holding North Korea accountable for its illegal activities while making its current means of income unsustainable. As Kim Jong-Il’s extended trip to China demonstrates, change is already happening and possibilities for reform are being considered. Combined with an effort to rejoin the six-party talks, progress appears likely in the future.
     
AEI researchers Liang Zhang, Karla Herdzik, and Anne Siarnacki, and AEI staff assistant Dan Geary prepared this summary.