"How strange the final legacy of the East Asian financial crisis should be a protectionist America protesting against a current account deficit."
Ten years after the East Asian financial crisis, congressional Democrats are poised to veto President George W. Bush’s proposed free trade agreement with South Korea.
The new protectionism in the US Congress is an indirect legacy of the East Asian crisis. The financial shocks of 1997-98 were the greatest to rock the region since the Great Depression. They plunged several countries into severe recession and forced three, including South Korea, to seek International Monetary Fund programs in order to restore confidence.
East Asia recovered from the crisis by 2004, but its investment share of gross domestic product is still 10-15 per cent below the levels of the mid-1990s in countries excluding China and Vietnam. As a result, most East Asian countries have been running current account surpluses and accumulating large foreign exchange reserves. The region excluding Japan now has more than Dollars 2,400bnof reserves, while China alone has Dollars 1.2bn of reserves.
It is East Asia’s large accumulation of foreign exchange reserves that has been funding the US budget deficit and housing boom since 2002. Members of Congress do not recognize the role the East Asian crisis played in making it so easy for the US to finance its budget deficit and current account deficits after 2002. They instead allege that East Asia has maintained undervalued currencies in order to promote export growth.
The Democrats cannot criticize South Korea for having an undervalued currency. The won has appreciated at double-digit rates during the past year despite the concern of South Korean companies about competing with Japan’s undervalued yen.
The Democrats intend to reject the South Korean FTA because of allegations that it will not provide an effective market opening for the US auto industry. They want the South Korean government to offer the US auto industry a managed trade agreement guaranteeing it a share of the market.
General Motors is not opposing the FTA because it has a large market share in South Korea. It was able to take over the Korean auto company Daewoo five years ago because of East Asia’s financial crisis. Daewoo has an 11 per cent market share, compared with 4.7 per cent for South Korean companies in the US. It is curious Ford and Chrysler are so apprehensive about the FTA, seeing that South Korean workers staged a brief strike last week to protest against the agreement.
The rejection of the South Korean FTA will have profound consequences for US foreign policy. South Korea has been a close US ally since 1948. President Roh Moo-Hyun has invested great political capital in promoting the FTA over the protests of farmers and industrial workers. The FTA is the culmination of a trade liberalization process that has faced great domestic opposition and taken several years to achieve.
The loss of the South Korean FTA will also undermine the ability of the US to play a leadership role elsewhere in Asia. China is now busily promoting regional free-trade agreements with other Asian countries, regarding trade as an important diplomatic tool for projecting its soft power. South Korea had Dollars 134.3bn of trade with China last year. Korean economists are projecting it could grow to Dollars 200bn by 2012. The rapid growth of trade can only bolster China’s political influence throughout East Asia, at the expense of the US.
The Democrats have turned protectionist because they regard trade as an opportunity to exploit domestic concerns about issues such as income inequality and manufacturing job losses. Their strategy is extremely risky, because trade policy has long been one of the most important pillars of US foreign policy. It played an important role in cementing alliances during the cold war. The US will find it difficult to compete with China for influence in East Asia if it cannot use trade as an instrument of foreign policy.
How strange that the final legacy of the East Asian financial crisis should be a protectionist America protesting against a current account deficit made possible by the ease of US access to the region’s surplus liquidity. South Korea was once a protectionist country closed to many imports, but it is using the pending FTA to accelerate its transition to an open free-market economy. The US should be encouraging this development rather than letting two sick auto companies in Detroit derail it. The price of defeating the South Korean FTA will be a significant erosion of US influence in East Asia.
The writer is chairman of David Hale Global Economics