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Canada - Korea

Preliminary Assessment of the Economic Impacts of a Canada-Korea FTA

APPENDIX 1: SECTORAL INTERVENTIONS

This appendix sets out the analytical basis for adjustments to the simulations to take into account structural or institutional developments that have implications for the response of two sectors in the economy—automotive and dairy—to a CKFTA.

Automobiles and Auto Parts

(Trade data for this category of products are under HS8407-8409, HS860900, HS87)

Since 2001, the base year for the GTAP model, Korean auto assemblers have greatly expanded their sales in North America, including in Canada, and as a result two Korean firms have made the strategic decision to begin production in North America to serve the North American market. As noted in a study on the auto sector commissioned by the Department of Foreign Affairs and International Trade, “…[t]he next investor in North American assembly plants will be Hyundai, which recently opened a plant in Alabama. Early 2006 it decided on a site in Georgia for its Kia subsidiary, nearby its Hyundai plant in Montgomery, AL so it can share suppliers for its two plants. Further capacity expansions are highly uncertain; the viability of the Kia plant already relies on a very ambitious sales projection and the Alabama plant will take some time to ramp up its production to its full capacity of 300,000 vehicles per year.”²⁸

As background, Canada’s imports of automotive products from Korea totalled $1.7 billion in 2005 up by about 55% from $1.1 billion five years ago. Imports of assembled vehicles (almost entirely passenger automobiles) rose by about 50% in this period while imports of automobile parts grew even faster, by 174%, albeit from a relatively low base. Table A1 breaks down the growth in vehicle imports from Korea by firm.

Table A1. Sales of Korean Light Vehicle Imports in Canada

Source: Industry Canada, “Partial Equilibrium Analysis of the Impact of a Canada–Korea FTA on the Canadian Automotive Industry”; citing information obtained from Ward’s AutoInfoBank.

Insofar as Canadian demand for particular models is satisfied from these new U.S. plants, this market segment would not be impacted by the CKFTA. The best information available at the present time to assess the implications of the Korean “transplants” on vehicle sourcing is the prior experience of the most comparable suppliers, namely the Japanese auto firms. The following figure describes the sourcing patterns for Canadian sales of Japanese transplants in North America.

Source: Ward’s AutoInfoBank . Trend line is an exponential trend fitted using Excel spreadsheet.

As shown, Japanese firms that established plants in North America progressively shifted the bulk of their assembly of units for sale in Canada to their North American operations. Note that the “undershoot” from 1994 to 1997 coincided with a period of very high values for the yen and sharply lower volumes of imports from Japan as well as of total sales of Japanese brands in Canada; subsequently, as volumes picked up as the extent of yen over-valuation eased, the share sourced from Japan resumed a more gradual decline. The trend appears to be flattening out in the 30% to 40% range. This result does not appear to depend upon where in North America the plants are located: the pattern of sourcing of Toyota, which has capacity in Canada, is similar to that of Nissan, which does not.²⁹

The early results from the Hyundai plant in Montgomery, Alabama are consistent with the Japanese patterns: within the first year and half of production, the share of Canadian sales accounted for by North American assembled units has risen to over one quarter and is on a steeply rising trend from month to month. A private-sector forecast projects this share to rise to about 65% by 2012³⁰.

The advent of Korean transplants in North America raises a number of issues for the analysis of a CKFTA. Insofar as Korean transplants do not satisfy NAFTA rules of origin, their importation into Canada from the United States attracts the MFN tariff. However, such a state of affairs is likely to be transitional, with the transplants organizing their production to meet NAFTA rules of origin, just as the Japanese firms have done. Importantly, this means that automotive parts production for Hyundai and Kia North American vehicles is likely to shift to their North American production centres³¹. Once that happens, the impact of tariff elimination on Korean-brand auto sales in Canada would be limited to models shipped from Korea.

Based on the average Japanese transplant experience and forecast data for Hyundai-Kia North American production, we assume that only 35% of the units sold in Canada would be shipped from Korea; the rest would be assembled in North America. Since Hyundai and Kia account for only 71.6% of assembled vehicles imported into Canada and assembled vehicles account for only 92% of the value of Korean imports, this implies that only 57.2% of the Korean export base to Canada benefits from tariff elimination³³. To reflect the impact of tariff elimination in the presence of Korean transplant operations in North America, we therefore reduce the effective protection rate in the GTAP database by 57.2%, from 5.8% to 2.5%.

Dairy Products

(Trade data for this category of products are under HS40, HS170211, HS170219, HS210500 and HS350110)

Both Canada and Korea impose high tariffs on the imports of dairy products. The GTAP 6.0 database reports 113.9% for the weighted Canadian import tariff on dairy products and 47.7% for Korea, after taking into account the conventional ad valorem tariffs, ad valorem equivalents of specific rates, mixed and compound rates, as well as the effective protection provided by tariff rate quotas (TRQs). A simulation of tariff elimination in this sector would result in very large boosts to bilateral trade, as shown in Table A2.

Table A2. CKFTA Impact on Trade in Dairy Products

Neither estimated effect appears to be credible. While Canada has the export capacity to fill the simulated growth in demand from Korea and some established presence in the Korean market³³, Canada’s exports of dairy products are subject to WTO constraints. In a WTO challenge to Canada’s exports of dairy products under the system of supply management, New Zealand and the United States successfully argued that exports of dairy products from Canada were subsidized and should count against Canada’s WTO commitments to reduce subsidized agricultural exports³⁴. In response to the original Canada-Dairy panel and Appellate Body reports, the Canadian supply-management system was modified to exclude export milk from the domestic management scheme. However, in a subsequent challenge to this regime, the WTO determined that this scheme did not bring Canada into compliance with its obligations under the Agreement on Agriculture; even exports based on milk excluded from the domestic management system were deemed to benefit from subsidies, and thus must count against Canada’s allowed amount of subsidized exports³⁵. This ruling effectively constrains Canada’s exports of dairy products outside of the allocated quotas, restricting any response to a CKFTA.

With regard to Canadian imports, imports of fluid milk are restricted under Canada’s negotiated Uruguay Round commitments to milk for household use and subject to a tariff rate quota. Since fluid milk is not traded over large distances because of its weight, for practical purposes the tariff rate quota on fluid milk applies only to the United States for cross-border purchases of milk. Otherwise, imports of dairy products are in the form of constituent milk components and processed foods such as cheese, yoghurt, ice cream, etc. Any Korean expansion of exports to Canada would have to be in these categories.

As shown in Table A3 below, Korea is a major net importer of most dairy products and has minimal exports in any dairy category save for a handful of speciality products in the category of “buttermilk, yogurt, kephir etc, flavoured etc or not,” in which in fact it is a small net exporter. Shipments to Canada are minimal. The 15-fold expansion of Korea’s worldwide dairy exports implied by the GTAP simulation would appear to require unrealistic supply-side responses in Korea.

Without pre-judging what might be negotiated in a CKFTA with regard to trade in dairy products, for the purposes of the present assessment this sector is excluded on the basis that the GTAP estimates indicate an implausibly large effect and there is no information on hand on which otherwise to base an assessment of dairy trade as it might be affected by a CKFTA.

Table A3: Korea’s Trade in Dairy Products with the World, US$ millions

APPENDIX 2: GLOSSARY

Aggregate utility function: A measure of satisfaction. Underlying most economic theory is the assumption that people do things because doing so gives them utility. People want as much utility as they can get. Aggregate utility function is an aggregation of each individual’s satisfaction.

Allocative efficiency: Allocative efficiency is improved if production is shifted to lower-cost producers and/or if consumers gain access to lower-cost goods.

Armington elasticity: The degree of substitution between domestic and imported products, or between different sources of imports. It is a major behavioural parameter that determines the quantitative results in the policy simulation.

Caribbean Community and Common Market (CARICOM): Originally the Caribbean Community and Common Market, CARICOM was established by the Treaty of Chaguaramas, which came into effect on August 1, 1973. The first four signatories were Barbados, Jamaica, Guyana and Trinidad and Tobago. A Revised Treaty of Chaguaramas establishing the Caribbean Community including the CARICOM Single Market and Economy came into force on July 5, 2001.

Cobb-Douglas production function: A mapping from quantities of inputs to quantities of an output as generated by a production process. The Cobb-Douglas functional form of production function shows that the shares of labour and of capital and of others within the economy are relatively constant over time. This function is widely used in policy simulation.

Computable general equilibrium (CGE): A class of economic model that seeks to explain the economic-wide changes in production, consumption, and price. It uses actual economic data to estimate how an economy might react to changes in policy or other external factors. It is widely used to analyze the aggregate welfare and distributional impacts of policies whose effects may be transmitted through multiple markets, or different policy instruments. A CGE model usually consists of equations describing economic behaviour of economic agents and a database that is consistent with the model equations.

Constant elasticity of substitution (CES) production function: A function describing production often with two inputs that are usually capital and labour. In this function form, the elasticity of substitution between capital and labour is constant.

Elasticity (supply-side): Measures how much the quantity of supply of a good changes if its price changes. If the percentage change in quantity is more than the percentage change in price, the good is price elastic; if it is less, the good is inelastic.

Endogenous variables: The variables that are solved inside the economic model.

Exogenous variables: The variables that are given outside the economic model.

Foreign direct investment: Investing directly in production in another country, either by establishing an enterprise, expanding operation of its existing business, or acquiring ownership or control of an existing enterprise.

General Agreement on Trade in Services (GATS): The creation of the GATS was one of the landmark achievements of the Uruguay Round, whose results entered into force in January 1995. The GATS was inspired by essentially the same objectives as its counterpart in merchandise trade, the General Agreement on Tariffs and Trade (GATT): creating a credible and reliable system of international trade rules; ensuring fair and equitable treatment of all participants (principle of non-discrimination); stimulating economic activity through guaranteed policy bindings; and promoting trade and development through progressive liberalization.

Global Trade Analysis Project (GTAP): A global network of researchers and policy makers conducting quantitative analysis of international policy issues using a CGE model developed by Purdue University.

Gravity model: Predicts bilateral trade flows based on the economic sizes of (often using GDP measurements), distance, and other variables between countries. The model has often been used to test the effectiveness of trade agreements and organizations such as NAFTA and the WTO.

Gross national income (GNI): A term now used instead of GNP (see below).

Gross national product (GNP): A measure of a country’s economic performance that is calculated by adding to Gross Domestic Products (GDP) the income earned by residents from investments abroad, less the corresponding income sent home by foreigners who are living in the country.

Input-output table: A matrix representation of a nation’s economy. It depicts how the output of one industry goes to another industry where it serves as an input, and thereby makes one industry dependent on other both as customer of output and as supplier of inputs. It could be used to predict the effect of changes in one industry on others and by consumers, government, and foreign suppliers on the economy.

Intermediate inputs: Goods or services used as inputs in the production of other goods, such as partly finished goods or raw materials. A firm may make then use intermediate inputs, or make then sell, or buy then use them.

International Trade Centre (ITC): Originally established by the GATT and now operated jointly by the WTO and the UN, the latter acting through the UN Conference on Trade and Development (UNCTAD). The focal point of ITC is for technical cooperation on trade promotion of developing countries.

South African Customs Union (SACU): Comprises Botswana, Lesotho, Namibia, South Africa and Swaziland.

Tariff rate quota (TRQ): Combines two policy instruments that nations have used to restrict imports: quotas and tariffs. Imports entering under the quota portion of a TRQ are usually subject to a lower, or sometimes a zero, tariff rate. Imports above the quota’s quantitative threshold face a much higher tariff.

World Trade Organization (WTO): The only global international organization dealing with the rules of trade between nations. At its heart are the WTO agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. The goal is to help producers of goods and services, exporters, and importers conduct their business. The WTO began life on January 1, 1995, but its trading system is half a century older. Since 1948, the General Agreement on Tariffs and Trade (GATT) had provided the rules for the system. Over the years GATT evolved through several rounds of negotiations. The last and largest GATT round was the Uruguay Round, which lasted from 1986 to 1994 and led to the WTO’s creation.

WTO Agreement on Textiles and Clothing (ATC): Since January 1, 1995, international textiles and clothing trade has been going through fundamental change under the 10-year transitional program of the WTO’s Agreement on Textiles and Clothing (ATC). Before the Agreement took effect, a large portion of textiles and clothing exports from developing countries to the industrial countries was subject to quotas under a special regime outside normal GATT rules. Under the Agreement, WTO members have committed themselves to remove the quotas by January 1, 2005 by integrating the sector fully into GATT rules.

APPENDIX 3: ACRONYMS

ASEAN- Association of Southeast Asian Nations
ATC - WTO Agreement on Textiles and Clothing
CA4 - Central American Four
CARICOM - Caribbean Community and Common Market
CDE - Constant difference of elasticities
CEPII - Centre d’Etudes Prospectives et d’Informations Internationales
CES - Constant elasticity of substitution
CGE - Computable general equilibrium
CKFTA - Canada-Korea Free Trade Agreement
DFAIT - Foreign Affairs and International Trade Canada
EFTA - European Free Trade Association
FDI - Foreign direct investment
FTA - Free trade agreement
GATS - General Agreement on Trade in Services
GDP - Gross domestic product
GNI - Gross national income
GTAP - Global trade analysis project
IMF - International Monetary Fund
ITC - International Trade Centre
MERCOSUR - Southern Cone Common Market
NAFTA - North American Free Trade Agreement
OECD - Organisation for Economic Co-operation and Development
ROW - Rest of world
SACU - South African Customs Union
TRQ - Tariff rate quota
WTO - World Trade Organization

28. Johannes Van Biesebroeck, “The Canadian Automotive Market,” May 20, 2006; p 75. According to up-dated information, Hyundai production in North America is slated to grow from 91,218 units in 2005 to the 450,000 range by 2012. The Kia plant has since been confirmed, with production slated to start in 2010 building to about 250,000 units by 2012. Source: Ward’s AutoInfoBank.

29. According to Ward’s AutoInfoBank, the share of Nissan automobiles sold in Canada directly imported from Japan declined from 99.9% in 1990 to 33.2% in 2005.

30. Source: Wards Automotive Infobank.

31. A number of major Korean suppliers have already located near the Alabama plant, following the pattern of the Japanese suppliers.

32. The calculation is as follows: Hyundai and Kia accounted for 71.5% of Korean auto imports into Can-ada in 2005 by number of units. Assuming the non-Hyundai-Kia production destined for Canada (which ac-counted for 28.5% of Korean auto imports in 2005) remains in Korea, the level of Korean-sourced units sold in Canada in the post-transplant “equilibrium” as a share of the pre-transplant level is then .716*.35 +.284 = .535. Autos account for 92% of Korean shipments to Canada and parts 8%; accordingly the value of Korean total automotive shipments in the post-transplant “equilibrium” as a share of the pre-transplant automotive shipments = .535*.92 plus .08 = .572. In the GTAP 6.0 database, the trade weighted tariff rate for Canada’s imports of Korean automobile products was 5.8%. The FTA impact is then calculated by reducing the level of border pro-tection by 57.2% from 5.8% to 2.5%.

33. In 2005, Canada exported $279 million worth of dairy products, of which $149 million went to the U.S. Exports to Korea amounted to only $9 million, or about 3.5% of total Canadian exports of dairy products; of this total, $7.9 million were products consisting of natural milk constituents, and the remaining $1 million were cheese and ice cream.

34. For a review of the case history, see Report of the Panel, Canada – Measures Affecting the Importation of Milk and the Exportation of Dairy Products, WT/DS103/RW, WT/DS113/RW, 11 July 2001, p. 11, para 3.2.

35. Ibid,, p. 66, para 7.2.

36. Not elsewhere specified or included

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Date Modified:

2009-01-05