Korea's active free trade agreements cover a total of 16 countries in four regions, and the country has also signed FTAs with the United States and the European Union and a comprehensive economic partnership agreement with India, which are expected to come into force sooner or later. It is also negotiating FTAs with Australia, New Zealand, Peru and the GCC, and there are calls for similar deals with China and Japan.
The FTAs in effect are designed as bridgeheads to major market zones. The strategy has been successful, but it is questionable if Korean businesses are prepared to take full advantage of it. According to a recent survey, the degree Korean businesses use the FTAs for goods exported is surprisingly low. Major reasons are that country-of-origin criteria differ from country to country in the FTAs, and that Korean businesses have yet to work out what the criteria are.
A free trade agreement is the beginning of new rules as well as privileges. If a business makes good use of the accord, it can advance in the world market on the strength of price competitiveness, but it is liable for enormous penalties if it mislabels the country of origin.
Under NAFTA, U.S. Customs investigates goods imported from partner countries in terms of country-of-origin labeling through records or on-the-spot inspections. Honda Motors was charged $17 million in additional duties in 1991 for failing to meet country-of-origin criteria for cars manufactured in Canada, and Ford was charged $41 million in 2001 for failing to certify car parts produced in Mexico. Pioneer had to pay $37 million in 2006 for not fully meeting the criteria for speakers produced in Mexico.
What should Korean businesses do? First is the training of manpower. Expertise on country-of-origin regulations, item classification and cost accounting as well as trading experiences and foreign language efficiency are needed.
Second, businesses seeking FTA privileges should confirm country-of-origin criteria for export items at the stage of concluding export contracts and prepare to meet the requirements.
Third, companies need to establish their own system to check the criteria and carefully file the documents for verification. Of course there are no problems if only one raw material is needed, but in reality production processes require a range of materials from all kinds of sources. And they, too, must be checked.
Fourth, the duty of cooperation on ex post facto verification and the right to claim losses arising from errors must be stipulated in trade contracts. Korea's volume of trade with new partners will expand, so firms have to prepare for inspections and local importers demanding country-of-origin conformation data. At the same time, domestic importers who will sustain damage from errors made by their trade partners abroad must be protected.
Fifth, rights to claim losses from errors must be stipulated in purchase contracts between local exporters and their raw materials or parts suppliers. Suppliers need to cooperate on a specified portion of goods final producers export, because final producers may commit errors based on wrong information from suppliers.
If the government offers effective policies, free trade agreements provide a great opportunity to enrich not only businesses but the entire nation.
By Lee Gang-yeon, a consultant of Deutsche Bank