European Auto Industry Set to Lose Out from South Korean Free-Trade Agreement—Analysis

The European Commission inked a free-trade agreement (FTA) with South Korea last week, following many months of negotiations. However, despite the very vocal and numerous protests from the European auto industry and its representative body, ACEA, several key provisions in the FTA were not addressed (see Europe - South Korea: 16 October 2009: ACEA Reaffirms Criticism of EU-South Korea Free-Trade Agreement). Here, IHS Global Insight assesses the possible medium and long-term impact of the deal.

Background

The automotive industry is the largest single sector in the South Korean-European Union (EU) trade relationship. For South Korea it is of utmost importance and the deal will have a significant impact, above all, on the European vehicle markets.

South Korea

• Vehicles are the most important export products of the South Korean economy.
• South Korea produced 3.8 million cars in 2008, around 2.7 million (71%) of which were exported.
• The EU is a key target market, with up to 700,000 cars per year exported there from South Korea in the past, representing 20% of all EU car imports.
• South Korea has the lowest level of import penetration of any developed country.

EU

• The EU exports only around 30,000 vehicles per year to South Korea (a market of more than 1 million new vehicle sales annually).

FTA: The Key Points

• Import tariffs will be dismantled within three (cars with an engine displacement of over 1.5 litres) to five years (cars with an engine displacement of less than 1.5 litres), as opposed to the originally proposed seven years that corresponds with the usual lead time for Organisation for Economic Co-operation and Development (OECD) countries.
• The duty drawback clause allows South Korean manufacturers to continue to reclaim import duties on imported vehicle parts from neighbouring countries. European manufacturers pay on average 4% import duty on vehicle parts from countries such as China.
• The FTA will weaken the rules of origin (from a minimum of 60% local content in vehicles to 45% to 50%).
• South Korea has signed up to the international technical standards for vehicle registration, but will be allowed to continue applying local standards on, among other things, vehicle emissions.

Outlook and Implications

The South Korean automotive industry's competitiveness is expected to increase as a result of this deal:

• European tariffs on South Korean cars will drop from 10% to 0% in 3–5 years—an expected cost advantage of 700,000 times 1,000 euro.
• South Korean imports of car parts from neighbouring low-cost countries will increase significantly: duty drawback of up to 40% (or 320 euro per car), plus a weakening of the rules of origin to 45%-plus.

The agreement in its current form will significantly boost (competitively priced) South Korean imports in the European car market in the coming years, predominantly Hyundai and Kia models. The deal will help these automakers to expand their market shares in Europe. In view of higher expected demand, South Korean vehicle manufacturers' output levels are set to increase.

However, access to the South Korean market for European manufacturers will remain severely hampered by non-tariff barriers:

• South Korean tariffs on European cars will drop from 8% to 0% in 3–5 years.
• The weakening of the rules of origin will allow South Korean manufacturers to optimise their competitiveness via increased imports of low-cost parts from neighbouring countries (especially China), plus the drawback of duties on these parts.
• South Korea does not fully acknowledge international test cycles and standards and applies its own unique rules. For example, regarding carbon dioxide (CO2) emissions, an approved and tested EU car cannot be sold in South Korea; costly modifications are required.

The agreement in its current form is unlikely to have a major impact on European vehicle imports into South Korea in the near and medium term. Imports will remain a tiny fraction of total sales in the South Korean market. All in all, the agreement gives South Korean vehicle manufacturers full market access to the European market without a tangible improvement in export conditions to South Korea. Thus, in the eyes of many European manufacturers, the current agreement is rather lopsided, handing an unfair competitive advantage to South Korean manufacturers. Moreover, such an agreement would set a precedent for EU FTAs with other countries, notably in Asia—the Association of Southeast Asian Nations (ASEAN), India, and Japan—leading to further uneven competition. In addition, the provisions on duty drawback and rules of origin have not been granted in trade arrangements with other developed countries (Mexico, South Africa, Chile) and are not covered by World Trade Organization (WTO) standards.