Tariff Negotiations Under Free Trade Agreements: The Case of Mongolia and the Republic of Korea

1. Introduction

More than 360 regional trade agreements (RTAs) exist worldwide (World Trade Organization [WTO], 2023b). Since the 2000s, this procedure has been dynamic. It has intensified (Otgonsaikhan et al., 2014), with approximately 90 per cent of all agreements being finalised as Free Trade Agreements (FTAs) (Otgonsaikhan, 2022).

Traditional FTAs mainly focus on trade liberalisation for goods. In contrast, the new-generation agreements such as Economic Partnership Agreements (EPAs) encompass not only trade in goods, but also trade in services, intellectual property, investment and competition in all aspects of foreign economic relations.

Within the framework of the EPAs, the Customs General Administration of Mongolia (CGAM) plays a key role in tariff negotiations for the liberalisation of trade in goods in line with Mongolian law. For instance, the CGAM evaluates ‘substantially all the trade’ (SAT) as specified in Article XXIV of the General Agreement on Tariffs and Trade (GATT) 1994, develops a national schedule of tariff concession according to the classification of the Harmonized System (HS)^[1], accurately determines the classification code of goods that are of special interest for tariff negotiations in import and export, and clarifies the rules of origin of goods. In addition, as Shumba (2023) states, ‘… customs has a major role to play in the operations of an FTA, and by extension, towards the realisation of the goals of the WTO’ (p. 43).

Mongolia is a landlocked country, bordered by the Russian Federation and the People’s Republic of China (PRC). This has a major impact on the country’s foreign trade, making it heavily dependent on two neighbouring countries, and increasing trade costs. Therefore, in recent years, a great deal of attention has been paid to reducing trade costs by establishing FTAs with other countries and implementing a ‘Third Neighbour’ Foreign Policy. For instance, establishing FTAs with key trading partners is considered a priority goal of Mongolia’s foreign trade policy. Mongolia’s long-term development policy document, Vision–2050 (Government of Mongolia, 2019), states the importance of the creation of harmonised tariffs, the development of favourable terms in advance for the export of newly planned industrial products, aimed at protecting and developing domestic production, as well as increasing the export of value-added goods within the framework of foreign policy. For this reason, special attention must be paid to the issue of establishing FTAs with certain countries (Government of Mongolia, 2019).

Although FTA-like principles were initially formulated during the reign of the Mongolian Empire (Otgonsaikhan, 2023), until recently, Mongolia stood as the only member country of the WTO that had not established any FTAs. The first agreement established with Japan was an EPA, which has been in force since 2016. In recent years, there has been much activity in this area, including joint research on the possibility of establishing EPAs between the PRC, the Republic of Korea (ROK) and the Eurasian region.

An agreement was reached to launch a Joint Feasibility Study (JFS) to establish an EPA between Mongolia and the ROK during the mutual visit of their Presidents in 2016. The JFS took place in 2017 and was subsequently renewed in 2021. During the official visit of the Prime Minister of Mongolia to the ROK in February 2023, a ‘Joint Declaration on the launch of the Economic Partnership Agreement between Mongolia and the Republic of Korea’ was signed. This declaration aimed to enhance economic relations and cooperation between the two countries. In this context, the relevant officials of the parties cooperated at a working level and finalised a draft Terms of Reference (ToR), defining the scope, goals and responsibilities of the parties based on the exchange of opinions.

Subsequently, an EPA ToR between Mongolia and the ROK was signed in Ulaanbaatar on 26 September 2023 by the State Secretary of the Ministry of Economy and Development of Mongolia and the Director General for FTA Negotiations of the Ministry of Trade, Industry and Energy of the ROK. Thus, talks on the EPA have officially started, and the parties have mutually agreed to hold the first round of negotiations in December 2023 in Seoul (Ministry of Economy and Development of Mongolia, 2023) and the third round will launch in September 2024 in Ulaanbaatar.

Several studies have been conducted on the possibility of establishing an EPA between Mongolia and the ROK. However, the purpose of this study is to conduct both the qualitative and quantitative research that is necessary for successful tariff negotiations, which form a key part of negotiations.

Thus, this study includes:

• an examination of the legal aspects of tariff negotiations under FTAs and modality for tariff reduction and elimination

• an analysis of the revealed comparative advantage (RCA) index to determine goods that should be included in the interest group for tariff negotiations

• identification of the goods with the highest export potential from the ROK to Mongolia using a method from the International Trade Centre (ITC) (ITC, 2023a).

In addition, recommendations related to tariff negotiation issues within the framework of the FTA are made, based on the results of the study.

2. Legal aspects of tariff negotiations

The GATT emphasises the importance of tariff negotiations to expand international trade and raise participating parties’ economic welfare (Mayer, 1981). Kim (2017) defined negotiation of FTAs as, first, negotiation of the legal text of the agreement on trade in goods, and second, discussion of the national schedule of tariff concessions, which is an annex to the agreement. We agree with this conclusion.

In addition to the modality of tariff reduction and elimination, the text of the trade in goods section of FTAs specifically addresses sensitive sectors such as agriculture and textiles. Drawing from the experiences of countries that have signed FTAs, the contracting parties will mutually agree to trade on more preferential terms than the most-favoured nation (MFN) principle of the WTO, and the parties decide on the scope and coverage of tariff elimination, and elimination or reduction of the MFN tariff.

According to the WTO Regional Trade Agreements Database, negotiating parties use the GATT Article XXIV and the ‘Enabling Clause’ of the GATT as the legal basis for tariff negotiations (WTO, 2023b).

2.1. GATT Article XXIV

Following GATT Article XXIV, the negotiating parties must satisfy and ensure the following provisions.

First, the WTO (1994) states ‘… the duties and other restrictive regulations of commerce are eliminated on SAT between the constituent territories …’ (GATT Article XXIV:8b). Although there is no precise definition of SAT between them, the parties to the FTAs have negotiated tariffs based on the total amount of goods in the MFN tariff line and the amount of actual trade between the parties. In doing so, it was generally agreed to cover more than 90 per cent of trade between the parties This provision was followed in the Mongolia-Japan EPA. Mongolia eliminated 59 per cent of the goods on the tariff schedules and Japan, 86 per cent from the date of implementation (7 June 2016) of the Agreement. Tariffs on the remaining goods will be gradually reduced to about 96 per cent of trade between the two sides (Otgonsaikhan et al., 2022). To conclude an FTA with the ROK, the SAT must be clearly determined for the CGAM.

Second, according to the GATT Article XXIV:5c, the customs tariffs of the negotiated goods would have reduced within a reasonable length of time. Countries with FTAs show a common tendency to gradually eliminate customs tariffs for 10 years. However, since the GATT Article XXIV does not specify a specific period, the negotiating parties may mutually agree on this period. For instance, the Mongolia-Japan EPA includes a provision allowing 20 years of zeroing customs tariffs, considering the unique characteristics of the goods involved (Ministry of Foreign Affairs of Mongolia [MFA], 2015). In the case of the Regional Comprehensive Economic Partnership (RCEP), the period for tariff schedules to be fully liberalised ranges from immediate liberalisation (Year 1) to 21 years (Asia-Pacific Economic Cooperation [APEC], 2022). Third, the goods subject to the FTA tariff concession must originate from the member state of the agreement (GATT Article XXIV:8b). Previous experiences of countries with FTAs have revealed that the issue of the origin of goods is included in the text of the agreement as an independent chapter, but it is essential to coordinate this with tariff negotiation while establishing FTAs. We have carried out a separate study on this (Nomintsetseg et al., 2023).

Additionally, provisions to facilitate trade between member countries (GATT Article XXIV:4) and not to raise trade barriers with third countries (GATT Article XXIV:5) should be further emphasised.

2.2. Enabling Clause – differential and more favourable treatment, reciprocity and fuller participation of developing countries

The Enabling Clause^[2] is also the legal basis for preferential trade arrangements in trade in goods between developing country members (WTO, 2013). The GATT contracting parties may accord differential and more favourable treatment to developing countries, without according such treatment to other contracting parties (WTO, 1979). Such a decision is important for a developing country, particularly Mongolia.

WTO data indicate that 63 RTAs with the Enabling Clause have been notified (WTO, 2023c). Compared to Article XXIV of the GATT, which requires SAT between participating countries to be encompassed by the agreement and zero tariffs, an Enabling Clause is more favourable for developing countries.

Mongolia established an EPA with Japan under Article XXIV of the GATT. However, the ROK has submitted a statement that it has signed an Agreement with the Association of Southeast Asian Nations (ASEAN) and India by integrating the provision of the Enabling Clause with GATT XXIV (WTO, 2023c). As a developing country, Mongolia must determine whether it can use this experience during tariff negotiations to obtain more favourable conditions from the ROK.

In addition, Mongolia has become the seventh member of the Asia-Pacific Trade Agreement (APTA), which was implemented on 1 January 2021, and is preparing for the fifth phase of the Agreement. The Enabling Clause is used in tariff negotiations of the APTA (United Nations Economic and Social Commission for Asia and the Pacific [UNESCAP], 2020). Mongolia’s national schedule of concessions includes 366 types of goods at the six-digit level of HS classification and provides an average preference of 24 per cent from the MFN tariff rate for these goods (MFA, 2021). Furthermore, the ROK is a member of this Agreement and includes 2,797 types of goods at the six-digit level of HS classification in its national schedule of concessions, with an average preference of 33.36 per cent for these goods (UNESCAP, 2007).

2.3. Modality for tariff reduction and elimination

2.3.1. The base rate

The question arises as to how the parties will agree on the base tariff when negotiating to reduce or eliminate tariffs within the framework of the FTAs. For example, will the base tariff be the WTO bound tariff rate^[3] or the MFN applied tariff rate. In cases where these two tariffs are identical or exhibit a significant difference, the decision becomes even more complex. For example, as of 2022, Mongolia’s simple average WTO bound tariff for agricultural goods stands at 18.8 per cent, the MFN applied tariff is 6.3 per cent, the simple average WTO bound tariff for non-agricultural goods is 17.2 per cent and the MFN applied tariff is 5 per cent (WTO, 2023a). The difference between these two tariffs (WTO bound and MFN applied) is more than 10 per cent.

The negotiating parties are more likely to raise the tariff level during negotiations if the difference between the WTO bound tariff and the MFN applied tariff is high, and the WTO bound tariff is considered to be the base rate. Therefore, it is appropriate to use the MFN applied tariff as the base rate to avoid this situation.

Under the Japan-Mongolia EPA and in the case of EPAs with some other countries, the MFN applied tariff was used as the base rate for tariff negotiations. It is clear that Mongolia will also use the MFN applied tariff as the base rate with the ROK. However, Mongolia should consider whether to utilise the 2023 or 2024 MFN applied tariff as the base rate, and pay attention to the regulation of customs tariffs.

2.3.2. The schedules of preferential tariffs

As mentioned previously, Article XXIV of the GATT provides the development of a plan and schedule for tariff elimination within a reasonable length of time in line with the FTA (GATT Article XXIV:5c).

The development of a schedule of preferential tariffs raises questions regarding the inclusion of all goods or specific types of goods in the list, as well as how to represent the category and duration of the tariff reduction. Again, as mentioned previously, for countries establishing FTAs under GATT Article XXIV, it is essential to incorporate SAT in the agreement.

According to the practices of FTA members, there is a negative list approach where all goods are included in the schedule of preferential tariffs based on the six-digit level of HS classification (breakdown of national codes) of FTAs, and tariff categories are agreed upon for each product (negative list approach). In this case, approaches such as a standstill clause and the ratchet mechanism are used.

A negative list approach to tariff reductions was developed within the framework of the Mongolia-Japan EPA, and the elimination or reduction of customs duties was included in Section 2.4. The schedules of tariff reductions were approved in Appendix 1 of the EPA. These schedules include about 5,700 types of Mongolian goods and about 9,300 Japanese ones, in addition to agreeing on the tariff categories for each product and the basic tariffs and conditions of related goods.

The tariff category used in the Agreement between the two countries, its explanation and some goods for export originating from Mongolia, which are included in the tariff category in Japan’s schedule of preferential tariff rates, are summarised in Table 1.

The tariff categories in Table 1 have common purposes, as indicated below. These include:

• Category A: includes tariff-insensitive goods, domestic production inputs, or equipment

• Category B: designed to protect infant industries for a specific period and implement industry policies by gradually phasing out tariffs as the protected industry develops

• Category R: to see whether goods of highly sensitive and strategically important sectors will be further protected by tariffs and postpone tariff negotiations

• Category Q: set a quota equal to the difference between domestic market demand and the potential supply of national production, apply a tariff discount to that area, and apply a very favourable tariff to the extent that exceeds the quota

• Category X: to leave highly sensitive goods of particular importance to the national economy out of negotiations.

The FTA between the ROK and Vietnam, which entered into force on 20 December 2015, drew great attention. The types of goods included in the schedule of preferential tariff rates of the parties and the relevant rates are shown in Table 2.

Table 2 indicates that the ROK included 12,243 types of goods in the schedule of tariff concessions, and that for 92 per cent of them, the customs tariff will be reduced to zero from the date of implementation of the Agreement. It will then be reduced to 95 per cent after 15 years. However, Vietnam negotiated long-term tariff concessions. In particular, the customs tariffs of 78.7 per cent of the total 9,589 types of goods will be reduced to zero from the date the Agreement comes into force and will reach 89 per cent after 15 years. When negotiating tariffs with the ROK, Mongolia should examine Vietnam’s practice in addition to its previous negotiations experience with Japan.

3. Analysis of the identification of interest group products for tariff negotiation

3.1. Methodology

To develop a schedule of preferential tariff rates and determine the types of goods that have the highest potential for export and import from the partner country during tariff negotiations, it is essential to determine the SAT mentioned earlier.

In the theoretical framework of international trade, it is efficient for a country to specialise in producing goods that have a comparative advantage and to trade those goods. Balassa (1965) first proposed the concept of utilising a Revealed Comparative Advantage (RCA) index in international trade. He formulated the RCA index of a particular commodity by comparing the percentage of that commodity in the country’s total exports with the share of that commodity in the total world exports as follows.

Equation 1: ${RCA}_{ij}{= RXA}_{ij} = (x_{ij}/X_{it})/(x_{wj}/X_{wt})$ – RCA or revealed export advantage (RXA), where:

$x_{ij}$: the exports of $j$ of country $i$

$X_{it}$: the total exports of country $i$ in time $t$

$x_{wj}$: the total world exports of $j$

$X_{wt}$ : the total world exports of $j$ in time $t$.

The following equation defines the country’s revealed import advantage (RMA).

Equation 2: ${RMA}_{ij} = (m_{ij}/M_{it})/(m_{wj}/M_{wt})$ – revealed import advantage (RMA), where:

$m_{ij}$: the imports of $j$ of country $i$

$M_{it}$: the total imports of country $i$ in time $t$

$m_{wj}$: the total world imports of $j$

$M_{wt}$ : the total world imports of $j$ in time $t$.

The index is applied in various FTA evaluations (Plummer et al., 2011). This paper tries to determine the goods with the highest trading potential of the parties using the RXA index and the RMA index.

For certain goods, the index of export and import is high, for example,${\ RXA}_{ij} > 1$, ${RMA}_{ij} > 1$, so the possibility of trading with each other is high, but in other cases, the possibility of trading is low.

The results of the analysis can be used to develop the national tariff schedule of Mongolia, as well as to send a tariff reduction request to the ROK.

3.2. Results

3.2.1. Mongolia’s schedule of preferential tariffs

While developing Mongolia’s schedule of preferential tariff rates, it is compulsory to adhere to GATT XXIV (SAT and others) and comply with the national development policy and strategy. Additionally, it is crucial to calculate in advance on which goods the tariff will be negotiated.

Utilising Balassa’s (1965) method, the ROK’s RXA and Mongolia’s RMA were calculated (Nyamdaa et al., 2023). To examine the goods with a high potential for import from the ROK, the overlap between the RXA and RMA indices was determined. In doing so, 6,295 types of goods were analysed at the HS six-digit level by utilising ITC’s database. On the one hand, this analysis tried to identify goods of interest to the ROK and, on the other, to investigate goods that conflict with Mongolia’s domestic production sector policy, and to define Mongolia’s SAT goods.

The results of the analysis show that 919 types of goods exported from the ROK and 896 types of goods imported from Mongolia have comparative advantages. From these, the overlap of RXA and RMA was determined. 144 goods that could be imported from Korea were identified, of which the 30 goods with the highest import potential and MFN rate of Mongolia are shown in Table 3.

Table 3 illustrates that most of the ROK’s exports with comparative advantages are value-added final products. On the other hand, Mongolia tends to import automobiles, machinery, primary petrochemical products, cosmetics and noodles. The customs tariffs for cigarettes and cigars, among the goods with the highest import potential from the ROK, are set at 30 per cent, whereas for other goods, it stands at 5 per cent. Thus, it should be noted that making a profit from tariff negotiations is likely to be relatively small. In addition, when determining SAT by trade value and tariff line, it is clear that these goods will be included in the Mongolian schedule of tariff concessions and can be applied to select the tariff category.

The ITC’s method (ITC, 2023a) of calculating export potential was used to improve the precision of the above analysis. Figure 1 shows the 15 goods with the highest export potential from the ROK to the Mongolian market.

Figure 1.15 goods with the highest export potential from the ROK to Mongolia.

Source: Adapted from ITC Export Potential Map (ITC, 2023a)

Note: For each colour, the lighter shade represents export potential and the darker shade represents realised potential.

The results reveal that the export potential of motor vehicles for transport of less than 10 persons, falling under HS Heading 8703, is the most significant from the ROK to Mongolia. Surprisingly, only 8 per cent of the total potential is currently being utilised. This could be attributed to the implementation of an EPA with Japan, resulting in zero customs tariffs for new passenger cars.

Mongolia is now discussing not registering right-hand-wheel drive cars in the state registry (Bat-Erdene, 2022), so there is a high possibility of an increase in the import of passenger cars from the ROK. Further, as the ROK uses only 34 per cent of the export potential for pasta, it is possible to increase the import of this type of good to Mongolia.

The goods that could be exported from the ROK to Mongolia are classified as special interest goods, which must be considered when negotiating customs tariffs. In addition, when negotiating tariffs, it is vital to develop a list of preferential tariffs in line with Mongolia’s economic sector policy, not to compromise on customs tariffs for goods with high customs tariffs, or to include categories such as X and R.

Therefore, before defining SAT through the tariff line, Mongolia’s applied MFN tariff schedule defining SAT through the tariff line must be analysed. This schedule includes a total of 6,325 (HS eight-digit level) types of goods. Table 4 shows the number of these goods by the MFN tariffs and their share of total goods.

Table 4 reveals that 95.6 per cent of the total goods or 6,047 types of goods have a tariff of 5 per cent, and only 3.1 per cent have a tariff of more than 5 per cent. In such a situation, when determining the SAT of the GATT XXIV by tariff line, negotiations can be made to reduce the customs tariff of goods with only a 5 per cent tariff, leaving sensitive Mongolian goods with a tariff of more than 5 per cent. In line with practices in other countries, if 90 per cent of the tariff line is to be eliminated, more than 400 types of goods with a 5 per cent tariff can be excluded from the tariff negotiations or included in category X.

3.2.2. The schedule of preferential tariff rates of the Republic of Korea

During tariff negotiations with the ROK, it is imperative to not only develop a draft schedule of preferential rates for Mongolia, but also to work on the draft schedule of the ROK and submit a request for a reduction in the customs tariff of the special interest goods.

Therefore, an analysis of Mongolia’s RXA and the ROK’s RMA index was performed. The analysis used the ITC’s statistical data on 6,295 types of goods at the HS 6-digit level to define Mongolia’s interest group products in the South Korean market.

The analysis reveals that Mongolia has a comparative advantage in exporting 100 types of goods, whereas the ROK has a comparative advantage in importing 1,389 types of goods. Looking at the overlap of export and import comparative advantages, 30 types of goods have a high potential for export from Mongolia to the ROK. Table 5 presents these goods’ indices and the ROK’s MFN tariffs.

Table 5 illustrates that most of Mongolia’s exports with comparative advantages are products based on natural resources, such as mineral products and raw materials from livestock. Considering the comparative advantage of the ROK’s imports, the demand for mineral products in the fields of electronics, metallurgy, automobiles and ships is high, but the customs tariff is zero or low for most of them. Furthermore, Mongolia’s traditional export goods belonging to Chapters 61 and 62 (textile products) have a high RCA and it would be appropriate to negotiate the zero rate of these goods from the date of entry into force of the EPA or tariff category A.

As wild fruits and raw materials of animal origin are the primary materials for food and cosmetic products, there is an opportunity to export them from Mongolia to the ROK. The customs tariff of these goods is relatively high in the South Korean market, so negotiations to zero the customs tariff are necessary. It is also essential to solve the sanitary and phytosanitary (SPS) measures, standards and origin criteria within the cooperation framework.

Since the ROK has a comparative import advantage in sectors such as electronics, automobiles and construction, Mongolian businesses should look for opportunities to produce and export value-added goods in these sectors to the ROK by attracting investments into Mongolia and establishing joint ventures. Therefore, it is essential to negotiate a zero tariff on final value-added finished products.

4. Conclusion and recommendation

Overall, it is imperative to determine whether to use the GATT XXIV and/or the Enabling Clause, depending on the development status of the parties before tariff negotiations under the FTAs. Whichever legal aspect is chosen, the customs authority has a leading role, for instance, in determining the SAT of the GATT Article XXIV based on the tariff line and the value of trade made by the parties, or in accurately incorporating the goods to be included in the national schedule of tariff concessions of the partner country with the HS national code when negotiating with the Enabling Clause. In this case, it is necessary to consider future trends and not rely solely on current trade conditions.

The ROK uses the GATT Article XXIV as the legal basis for tariff negotiations within the framework of FTAs with other countries, and there are cases where this provision was used in combination with the Enabling Clause provision in agreements with ASEAN countries and India. Mongolia should draw on these examples in tariff negotiations with the ROK and conduct a more specific study on which of the two options is more efficient.

Since the SAT of Article XXIV of the GATT does not specify a certain percentage or amount, Mongolia may choose not to aim to reach 90 per cent of the total trade following the practices of other countries when negotiating tariffs. There is a common understanding that the elimination of customs tariffs for SAT between the countries establishing the FTAs will occur within 10 years. In the case of the ROK, however, since the period is 15 or 20 years, in line with other countries, it is desirable to negotiate to reduce customs tariff for domestically produced goods for as long a period as possible.

In addition, it is essential to consider the modality for tariff reduction and elimination when determining SAT. In other words, if the customs tariff for imported goods is reduced to zero (0) and will negatively affect the domestic production and economy of Mongolia, it can be excluded from negotiations and included in category X. If, however, it is considered necessary to protect the domestic industry for a certain period, it is feasible to negotiate the tariff elimination through uniform and gradual reduction within category B.

To sum up, when determining SAT, it is important to identify the sectors and goods that Mongolia needs to protect and classify the highest export potential goods by HS. This study identified these goods by analysing the RCA index.

According to the overlap of the RCA of Mongolia’s imports and the ROK’s exports, 144 types of mostly value-added goods such as automobiles, machinery and their parts, tobacco, cosmetics and noodles have the highest export potential from the ROK to Mongolia. Hence, it would be appropriate to conduct tariff negotiations while considering that the ROK will submit a request to include these goods in SAT. On the other hand, in line with the overlap of the RCA of Mongolia’s exports and the ROK’s imports, mostly mineral products, textiles and agricultural goods have the highest export potential from Mongolia to the ROK. It is crucial for Mongolia to carry out a more detailed study on the domestic production and export potential of these goods, to determine whether they can meet the criteria of origin, and to negotiate by indicating the goods of interest in the schedule of tariff concessions of the ROK by the code and description of the HS.

According to the MFN tariff list of Mongolia, 95.6 per cent of all goods have a 5 per cent tariff, 1.4 per cent have a 0 per cent tariff, and the remaining 3 per cent have a 6.5–40 per cent tariff. If SAT is determined at 90 per cent of the tariff line, it is appropriate to concentrate only on goods with 0 and 5 per cent tariffs during negotiations on tariff elimination. However, it is concluded that high customs tariffs should be excluded from any commitment (or X category) in relation to the implementation of Mongolia’s national development strategy and policy.

The findings of this study should prove useful to the Mongolian Customs Authority and members of the tariff negotiation team, trade policy makers and domestic producers. By conducting tariff negotiations successfully, there will be opportunities to implement FTAs effectively with increased benefits.

We also intend to expand this research by investigating which countries will develop trade creation and trade diversion by tariff elimination.