Comparisons of Effects after Signing of FTA by Models

Note: refer to Appendix 3 for specific values of X, Y, Z, W, and social welfare.

Figure 4-4. Comparisons of Company Profit Effects after FTA by Models ( )

원문 번역문

모형 1 기업1 이윤

Model 1 Company 1 Profit

모형 2 기업1 이윤

Model 2 Company 1 Profit

모형 3 기업1 이윤

Model 3 Company 1 Profit

However, if is larger—that is, if the production costs of intermediate goods of vertically-integrated companies in Country 2 are assumed to be much higher than other intermediate goods companies, the following equation is derived.

( )

According to the equation, in Model 2, the degree of increase in profit for companies in Country 1 with an FTA turned out to be the highest. The increase in profit in Models 1 and 3 were similar. In other words, Model 2, which most closely reflects the current status of the oil industries in Korea and China, demonstrates that when the efficiency of production costs of intermediate goods of companies in Country 2 are high, the increase in profit of Company 1 in accordance with tariff elimination is the highest. Based on the assumption that the

production costs in the upstream sector led by state-owned companies in China are high, there is an urgently needed from the position of Korean oil refinery companies for Korea and China to eliminate tariffs. Conversely, if the production costs in the upstream sector in China are not viewed as high, the FTA’s tariff elimination may have a negative impact on oil refinery companies in Korea.

Figure 4-5. Comparisons of Company Profit Effects after FTA by Models ( )

2) Comparisons of Increase and Decrease of Social Welfare in Country 1

Now, we will compare the degree of increase and decrease of social welfare in Country 1 by models. The main purpose here is to judge which oil industry structure in Country 1, which represents Korea, and Country 2, which represents China, will have a positive impact on the industry as a whole through an FTA. The degree of increase and decrease of social welfare in Country 1 by models is represented by the following equation.

Accordingly, in Model 3, the increase of social welfare in Country 1 was the highest, while the lowest was in Model 2. This condition is met when . If the government takes producer profit, consumer surplus, and government tariff income into account, the conditions of Model 3 are most suitable when signing an FTA with Country 2, whereas the conditions of Model 2 appear to be the least appealing.

Figure 4-6. Comparisons of Social Welfare Effects after FTA by Models

원문 번역문

모형 1의 사회후생 Social welfare of Model 1 모형 2의 사회후생 Social welfare of Model 2 모형 3의 사회후생 Social welfare of Model 3

3. Interpretations on the Results of Model Analysis

Based on these research findings, the following interpretations can be made. First, with Model 2, which best represents the structure of Korea’s and China’s oil industries, if is larger, the highest profit can be guaranteed for companies in Country 1. This points to the importance of identifying production efficiency among state-owned companies in China to judge the impacts of the Korea-China FTA on Korea’s oil industry.

There are several ways to gauge the production costs of crude oil in China in an indirect way. The severe plunge in oil prices in the second half of 2014 affected the production of crude oil in China, which dropped drastically at the start of 2016. In response to the worsened profitability of major state-owned oil companies in China, the International Energy Agency (IEA) ordered that China terminate the operations of its small-scale oil fields.

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We can assume, then, that the production costs of crude oil in China are relatively high—close to the marginal costs of crude oil production worldwide.

However, given that China’s production costs may improve through the development of technology in the future, assuming that is smaller, the increase in profits for companies in Country 1 through the signing of an FTA is expected to be the highest under the conditions of Model 3. Even so, as the Korea-China FTA achieves a partial opening of markets, it is difficult to compare it directly with the results of the related model.

Second, the profits of social welfare in Country 1 are the highest in Model 3 with an FTA, but are the lowest in Model 2. From Country 1’s position, under the current oil industry in China, there are no further triggers to initiate tariff elimination. In this regard, there is still room for improvement of the current incomplete FTA with China.

Lastly, in Model 3, when was low in terms of producer profit and regardless of the size of in social welfare, Country 1 received the greatest benefits. This was the result of setting vertically-integrated companies in Country 2 as private companies. To maximize social welfare and company profit in Country 1, assuming that Chinese companies may improve their production efficiency in the future, China’s price system would need to be determined by market and its state-owned oil corporations privatized.

43 Featured in the Oil Market Report 2016 (March, April, May, July, August, and October) by IEA.