The Challenges of Free Trade - Law In Action



The Economic Relationship between Korea and the US:

Implications for Lawyers and Law Students

December 2006

By Charles R. Irish, Director

East Asian Legal Studies Center

Volkman-Bascom Professor of Law

University of Wisconsin

Madison, USA

The economic relationship between Korea and the US for the next two or three years will be significantly affected by three factors:

• The first is the maturing of the economic relationship between the two countries.

• The second is the November, 2006 elections in the US which has softened the US Congress’s commitment to free trade and created the possibility of a rise of “economic populism” as an important component of the US government trade policies.

• The third is Kim Jung Il.

Let me talk about each of these three factors and then conclude with some comments on how they will affect lawyers and law students.

1. The Maturing Economic Relationship between Korea and the US.

For the last six decades, Korea and the US have been tightly bound together in a close political and economic partnership. For much of this period, the US was very much the dominant partner, perhaps even like a parent and child. Now, however, there is strong evidence that the economic relationship between Korea and the US is maturing, with Korea increasingly becoming a more equal partner.

The maturing of the Korea/US economic relationship is due principally to extraordinary economic growth Korea has experienced in the last five decades. During that period, Korea has grown from one of the poorest and least developed countries in the world to become the one of the most economically powerful. In the late 1950s, Korea was the third poorest country in Asia and its per capita GDP was less than that of Brazil or Mexico. Now Korea has one of the largest economies in the world and its per capita GDP is over $20,000, which is two and a half times greater than Brazil's and more than double Mexico's. The latest edition of US CIA's Fact Book concludes: "Moderate inflation, low unemployment, an export surplus, and fairly equal distribution of income characterize [Korea’s] solid economy." While many Koreans take great pride in their economic (and political) accomplishments, and such pride is certainly justified, quite often they have not absorbed the consequences of Korea's emergence into the first tier of economically developed countries. Korea is, and has been for several years, a developed country, but still too often protectionist trade policies or outmoded regulations are justified by Korea's status as a less developed country – a condition that disappeared quite some time ago.

The Context of Korea/US Economic Relations.

Before considering the consequences of the maturing economic relationship between Korea and the US, it is useful to look at the context of Korean/US relations. In fact, while modern Korean society is now much more like the US than it has been in the past, there still are a number of significant contrasts.

• The Korea economy is about $1 trillion and forecast to grow at about 5.5 percent for 2006. The US economy is $12 trillion and, while the US economy seems to have slowed somewhat, latest projections put economic growth at 2.2 percent. At the broadest level, both economies have troublesome spots, but they still are among the richest in the world.

• The Korean household savings is the highest in the OECD countries at about 20 percent, but the US household savings rate is actually negative and among the lowest in the OECD.

• The Korean Government now estimates that the 2006 trade surplus will be $16 billion, up from earlier estimates of $12 billion. Korea also has substantial foreign exchange reserves of $230 billion.

• In contrast, the US has a massive trade deficit now in excess of about $850 billion. Japan, Korea, Taiwan and China together hold more than $1 trillion in debt obligations of the US Government and US corporations. The US now is the largest net debtor in the world.

• The comparative household savings rates and trade accounts make it apparent that while Korea’s economic growth is driven by production and exports, US economic growth is consumption driven – Korea and the other Asian economies export to the US and the US consumes more than it produces.

• Americans now are preoccupied with the loss of manufacturing jobs, the stagnation of wages for blue collar workers, and rapid growth in wage inequality, with the rich getting much richer while the poor remain trapped in poverty. While the November, 2006 elections were largely a rejection of US policies in Iraq, they also reflected domestic concerns about declining competitiveness and an erosion of the comfortable American life style. If the US economy continues to slow, as many expect it will, American concerns with global competitiveness and the sense that the current free trade system is not fair to the American economy trade will intensify.

• In contrast, Korea’s rapid recovery from the 1997 IMF financial crisis and its relatively equal distribution of wealth have been sources of pride and optimism about the future of the Korean economy.

• Since 9/11/2001, the US has turned inward and become preoccupied with national security. In Seoul, however, the very real and substantial threats from North Korea have been a reality for many decades. Koreans have long known what the Americans were surprised to learn on 9/11: the world is a dangerous place. The October, 2006 nuclear test in North Korea oddly seems to have had a bigger impact in the US than in Korea.

• American politicians continue to use “national security” as pretexts for conduct that many throughout the world (including many Americans) regard as inconsistent with America’s place as a bright light for liberty and justice. The detentions at Guantanamo Bay and the secret wiretaps by US intelligence services are just two examples. As the November elections made clear, many Americans now think that the government and the economy are not headed in the right direction. Americans have lost some of their confidence, while many Koreans feel more optimistic about the future.

• Finally, US policy makers are obsessed with the rise of China’s political and economic power. The massive bilateral trade imbalance between China and US, with China showing a trade surplus (by American accounting standards) in excess of $200 billion, for example, has made it easy for US political leaders to characterize China as the villain in international trade. Never mind that China’s trade surplus with the US is largely the result of “outsourcing” by US industries and Korean, Japanese and Taiwanese companies shifting their production facilities to China, the US is preoccupied with China’s political and economic emergence and that means less critical attention is focused on Korea.

The Consequences of Maturity.

The maturing of the economic relationship between Korea and the US is changing the way in which the two countries interact. Some of the major changes are as follows.

Currency exchange rates. In moving from a poor, underdeveloped country to an economic powerhouse, Korea has done many things right. It should be understood, however, that external circumstances also have played a role in Korea's march to prosperity. One of the most important external circumstances is the open access to the US economy for Korean goods that has enabled Korea to pursue export oriented growth policies. In addition in recent years, Korean exports and the exports of China, Taiwan, Japan, Thailand, and Malaysia all have benefited from undervalued currencies relative to the dollar.

It appears that the era of undervalued Asian currencies is coming to an end. Quietly, so as to not disrupt foreign exchange markets where a massive overhang of US dollar denominated securities has accumulated, central banks around the world now seem content to let the dollar slide against the Korean won, other Asian currencies, the Euro and the British pound.. This action is designed to reduce the massive US current account deficit, which is seen as a threat to global economic stability, but there also will be significant collateral consequences.

• The decline in the relative value of the dollar will diminish consumption in the US and thereby increase the US savings rate. This may already be happening and most would agree that these changes are very welcome. But because the US economic growth is consumption driven, the decline in consumption also may result in lower growth in the US.

• Additionally, diminished consumption in the US will result in lower demand for Korean and other Asian exports, which now will become relatively more expensive. Because economic growth in Korea and other Asian economies (especially China) is heavily dependent on exports, the currency adjustments will put downward pressures on the economic growth rates in Korea and the other Asian economies.

• The currency realignments also may make it necessary for Korea and other Asian governments to look more to increased domestic consumption or regional trade as stimuli to economic growth. Again, these changes may be overdue and helpful for longer term economic health, but in the short term, they will be disruptive and painful.

Carl Icahn, Lonestar, Samsung and Hyundai. Corporate mergers and acquisitions have long been a regular feature of the US and other industrialized economies. Even hostile acquisitions by foreign investors are commonplace and usually pass without much attention. Where foreign governments are involved, however, the US government makes it clear that heightened scrutiny is appropriate. Thus, CNOOC’s attempted purchase of Unocal and Dubai Ports World aborted effort to acquire P&O ran into Congressional opposition principally because the acquirers were owned by the Chinese government and the United Arab Emirates Government. Still, the US and other industrialized economies are relatively open to market based mergers and acquisitions involving foreign direct investment.

Now, the market for corporate control is moving to Korea and other Asian countries. Of course, Carl Icahn’s attempted take-over of KT&G ran into intense local opposition and Lonestar’s sale of its stake in the Korea Exchange Bank would have received less attention from the Korean tax collector if Lonestar had not purchased its interest when the Korea Exchange Bank was financially distressed, but it seems inevitable that over the next several years Korean enterprises are going to attract more attention from foreign investors and that cross-border mergers and acquisitions will increase.

The financial and tax scandals at Samsung and Hyundai and efforts by the founding families to atone for their errant behavior through contributions to Korean society may be regarded as a return to the old days when the Korean economy was dominated by the chaebols and they could buy their way out of any problems. Today’s environment is markedly different than pre-1997, however, as corporate governance and corporate transparency now get much greater attention among investors. And Korea is one of Asia’s leaders in promoting good corporate governance practices. As a consequence, even the major scandals at Samsung and Hyundai are likely to only slow, not completely cut-off foreign investor interest in Korean enterprises.

Hyundai Motor vs. General Motors. Fifty years ago, General Motors, Ford Motor Company and the other American automakers were powerful and largely unchallenged in the world. Since the 1970s, the Japanese and European manufacturers have eroded the American dominance in auto manufacturing. Now, as Toyota moves past GM to become the world’s largest auto-maker, Hyundai Motors stands as the seventh largest auto-maker in the world. The relative decline in US dominance in auto-making, steel, electronics, and many other products is more because of the economic successes of Korea and other American competitors than a real decline in US competitiveness, but the consequences are apparent. American business people are acutely aware that the enormous size of the American economy and the overwhelming superiority of military power do not translate into an advantage in international commerce for individual US enterprises. The economic powers of Korean and other US trading partners now are too great to ignore. Korean enterprises have become much larger and more technologically advanced and at the same time US businesses and workers have become more vulnerable to competition from Korean and other foreign producers.

One consequence of the greater economic parity among US and Korean business enterprises is that there is considerable pressure on the US government to resist unilateral market opening concessions. More widespread economic equality means that the US is less likely to lead by example; instead, the US is inclined to stress reciprocity in market opening measures as a condition to obtaining or maintaining access to the US economy.

2. The November, 2006 Elections and the Rise of Economic Populism in the US.

The November, 2006 elections resulted in the Republican Party losing control to the Democrats in both houses of Congress. The shift in political power in Congress is notable as a repudiation of President Bush’s handling of the war in Iraq, but it is also important because of the very considerable power Congress has to influence US international economic policies. Unlike most countries where power to negotiate international agreements rest largely with the leader of the government, in the US, the President and USTR’s powers to influence international economic policies is heavily dependent on a delegation of authority from Congress to the President. Congress, in other words, has very substantial power to affect international trade policies.

The current delegation of authority is referred to as Trade Promotion Authority (“TPA”). Under the current version of TPA, the President and the USTR are authorized to continue the Doha Round of Multilateral negotiations, but they also are empowered to negotiate bilateral trade agreements, such as the agreements recently concluded with Chile and Singapore and the proposed agreements under negotiation with Korea and Thailand.

Korea/US Free Trade Agreement. Partly in response to the lack of progress in the Doha Round of multilateral trade talks, many countries have shifted attention to regional and bilateral trade agreements. Among the most economically significant potential new agreements is the free trade agreement between Korea and the US. From an American perspective, Korea is by far the largest trading partner to enter into bilateral negotiations since the establishment of the North American Free Trade Agreement with Canada and Mexico on January 1, 1994. For Korea, a free trade agreement with the US will be much more important than the free trade agreements with Chile and Singapore that already are in effect and the free trade agreement with the European Free Trade Association that came into effect, but was largely unnoticed in July, 2006.

Bilateral free trade agreements have been criticized as being more political than economic documents. The US recent experience with free trade agreements seems to support this criticism as the US negotiators have focused their attention on such small economies as Jordan, Morocco, Central America and the Dominican Republic, and Thailand. Even the proposed free trade agreement with Korea is criticized as being prompted more by concerns about containing China than stimulating economic activity between Korea and the US. Still, if the negotiations are successful, a Korea/US free trade agreement is expected to benefit important sectors of the Korean economy, such as motor vehicles, and may have a positive impact on US agriculture and service industries, including legal services.

The November, 2006 elections, however, raise serious questions about the prospects of a Korea/US free trade agreement. The elections moved several economic populists into powerful positions in Congress. These economic populists, such as incoming House Speaker Nancy Pelosi, are focused on appealing to their local constituents on economic issues and they tend to view free trade with considerable skepticism. Even though the new Congress will not come into power until January, 2007, one of the most immediate examples of the growing hostility to international trade was the failure of Congress to pass a relatively non-controversial bill to approve permanent normal trade relations with Vietnam in time for President Bush’s visit to Hanoi in mid-November. Another longer term consequence is that TPA, which is set to expire on July 1, 2007, will not be renewed anytime during Bush’s remaining two years in office. This means that unless the Korea/US free trade negotiations are concluded in the very near future, the President and USTR will be without meaningful powers to continue the negotiations. In the meantime, however, the economic populists will be calling on the Bush administration for greater protections for US industries from Korean products and at the same time for improved access to the Korean markets, including in the agricultural sectors. It also is highly unlikely that the USTR now has the ability to agree to include the KaeSong Industrial District as part of the South Korean territory for purposes of the free trade agreement. Susan Schwab, the current USTR, was recently quoted as saying that she thought the existing free trade negotiations would not be affected by the November elections. In fact, it is very likely that she was perfectly wrong and that the recent elections have had the effect of killing the likelihood of any meaningful agreement being concluded between Korea and the US (and, by the way, between Thailand and the US).

3. Kim Jung Il.

South Korea and the US have disagreed much more than they agreed on how to deal with the threat of North Korea. It may be that the November elections will actually have a positive impact on both the hardliners in the Bush Administration and Kim Jung Il. The Bush advisors may now recognize that their hard line approach has been a significant impediment to meaningful discussions about making the Korean Peninsula a nuclear free zone. On the part of Kim Jung Il, he may be more comfortable knowing that two years from now he will be dealing with people who are very different from President George Bush and his hard headed advisors. There may be a softening of attitudes on among both the Americans and Kim Jung Il. Based on Kim Jung Il’s past record in negotiations, however, it seems unlikely that Kim Jung Il will actually make any meaningful concessions before the presidential elections in South Korea in December, 2007, and the US in November, 2008. So, don’t hold your breath in waiting for a lessening of tensions on the Korean Peninsula. Still, the hope with all of us is that the next two years will be relatively quiet on South Korea’s northern border.

4. The Effects on Korean Lawyers and Law Students.

The November elections in the US and the continuing presence of Kim Jung Il in the north may have little direct effect on South Korean lawyers and law students. The maturing of the Korean/US economic relationship, and more generally, Korea’s emergence as a modern and more industrialized country, however, will have implications for Korean lawyers and law students. Some of the major effects are as follows.

Competition. For many years, Korean lawyers have resisted pressures to open the market for legal services. The Korean legal services market is often cited as the most protected and the least competitive in Northeast Asia. But a protected legal services market is inconsistent with Korea’s efforts to promote itself as a logistics and financial hub for Northeast Asia. The protected legal services market also cannot provide the kind of sophisticated legal services needed by Korean enterprises as they become more integrated into the global economy. The pressure to allow foreigners into the Korean legal services market is very considerable, but most importantly it now is coming from within Korea rather than from the US and Korea’s other trading partners. It seems likely, therefore, that there will be some new openness in Korean legal services. New openness translates into a more competitive environment for Korean lawyers, but it also means many new opportunities for Korean and other lawyers trained to offer the sophisticated legal services required in developed economies. Some lawyers will prosper, but some will see an erosion of their protected practice. Whatever the positive or negative effects on individuals, Korean businesses and the Korean economy will benefit.

The local demand for better legal services is becoming so great that continued efforts by the Korean Bar to limit competition in legal services may result in an expansion of services closely related to legal services – such as financial and tax consulting. These accounting and consultancy firms will supply high end services often provided by the legal industry in other economies. The position of the current bar thus may be hampering the prospects for future Korean lawyers.

Increased sophistication in legal services. Korean enterprises already need sophisticated legal services in a number of areas. International business law now means much more than an understanding of the legal documentation necessary to support an international sale of goods. In addition to sales of goods, international business now encompasses inbound and outbound, direct and portfolio investment, equipment leases, cross-border financing, and international service agreements. Direct investment typically also implicates licensing agreements to support and protect transfers of technology and management service contracts to establish the framework for interaction between the foreign investor and any local partners. Portfolio investment and direct investment may require advice on the rights of minority shareholders and directors and officers liability, And all of these may involve various forms of alternative dispute resolution.

New areas of business also will open new needs for legal services. The market for corporate control, for example, supports very robust legal practices in New York, London, Hong Kong, Tokyo and just a few other places in the world. It is expected that soon legal services supporting friendly and hostile cross-border mergers and acquisition will be more widely available in East Asia, but will such services be available in Seoul, or will the parties have to go to Hong Kong for assistance (which by the way is very, very well compensated)?

If the Korea/US Free Trade Agreement eventually becomes a reality, it will bring new legal issues to Korea. Lawyers in Korea are going to have to special attention to new rules of origin under the free trade agreement if their clients are to gain the benefits of the agreement. Rules of origin also will be implicated whenever Korean enterprises are contemplating foreign direct investment, especially in the US. The question then will be: how much of the manufacturing process must be shifted to the US to have the resulting products characterized as US made rather than Korean or Chinese products? If the Korean negotiators secure favorable treatment for products manufactured in the KaeSong Industrial District there then will be the question of what manufacturing processes will be necessary to have the goods characterized as KaeSong products?

A Korea/US Free Trade Agreement is likely to establish a new forum for the resolution of disputes arising under the agreement. Because of the high level of economic activity between Korea and the US and the probable breadth of a free trade agreement to include trade in goods and services, direct and portfolio investment, and protection of intellectual property rights, the dispute resolution process may affect a large number and wide variety of transactions. When the Korean Government agreed to relax the screen quota system protecting the Korean film industry from 146 days to 73 days per year, it removed a major impediment to concluding a free trade agreement. It also raised the possibility that some fortunate lawyer one day will represent actress Jeon Ji-hyun in the dispute settlement process of the Korea/US Free Trade Agreement!

Legal education and law students. The maturing of the Korean economy and its relationship with the US also has at least four implications for Korean law students.

• First, graduates of Korean law schools are likely to find a more competitive market for legal services than now exists. This may mean that jobs will be more competitive, but it also means that Korean lawyers a few years from now will be asked to provide a broader range of legal services than now. The opportunities for those that are well prepared will be greater; but the risk of failure for the unprepared will be higher.

• Second, Korean legal practice in the future probably will pay a premium for lawyers with an interdisciplinary education. The sophisticated nature of current and future legal practice provides good rewards for lawyers conversant in the underlying transaction. Increasingly, it is not enough to know the relevant rules; now to prosper, lawyers will need to know the social and commercial environment in which the rules are to be applied. An MBA in international finance, for example, may be a fine supplement to a law degree. Undergraduate degrees in science and engineering also may become an excellent complement for a graduate law degree and subsequent work in intellectual property rights.

• Third, Korean lawyers will have to be comfortable offering advice on not just the law, but on how the law really applies. The success of mergers and acquisitions, for example, may depend greatly on the interaction of the principals, not just on the supposed synergies of the two companies. Memorization of the law will no longer be a guarantee of success. Lawyers will have to be conversant with the social and economic context of the law. Students thus should not be satisfied with the law on the books, but they will need to understand how the law is applied in real life. In other words, they will need to be schooled in law in action.

• To be competitive in the new era of a more open legal services market, law graduates will have to master a range of skills from rigorous analytical thinking, to improved written and oral communication skills, and greater cross-cultural awareness. The role of the modern day lawyer will be broader, not narrower.

Finally, a concluding thought on the reformation of legal education. The reformation of legal education is an important topic throughout East and Southeast Asia. Japan is undergoing massive reforms in its system of legal education and China, Taiwan and Thailand are studying reforms. Korea has been debating the reformation of legal education, but to enhance its competitiveness in legal services, it is critical that Korea pay particular attention to legal education reforms aimed at increasing the basic competency of law graduates through interdisciplinary education using multiple pedagogical techniques. Failure to do so will mean that very attractive, and lucrative areas of professional services will be taken over by foreign lawyers, not in Korea, but in Hong Kong, the US, UK, or some other jurisdiction. Within South Korea, the failure of legal education to keep pace with the maturing Korean economy will enable accountants and other professionals to provide sophisticated services typically provided by lawyers in other jurisdictions.

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