Originally printed in the Wall Street Journal, Asia Edition, April 5.
Koreans Raise a Glass to Unintended Consequences
Since free-trade deals haven’t brought down wineprices as much as promised, Seoul is now under pressure to deregulate further.
During debates in the U.S. and Korea over ratificationof the free-trade agreement, politicians fought over the macroeconomic effectson employment, trade flows and investment. Now that the deal is coming into effect, implications for individual businesses and consumers are just starting to come into focus. One of the most interesting case studies is the wine industry, which is seeing significant—and somewhat unexpected—changes.
With a population of 49 million people each consuming an average of eight liters of alcohol annually, Korea has long been a desirable market for foreign vintners. Yet they have faced stiff tariffs and taxes.
First comes a 15% wine tariff. Then Seoul imposes a30% liquor tax, an “education tax” of 10%, a 10% value-added tax andcustoms clearance fees of 8%. Wine with an export price of $10 ends up costing a wine importer $17.62 after taxes since many of these taxes compound on each other. Such a wine will cost consumers $32 in a supermarket and be sold atrestaurants for $80 or more.
On their own, the FTAs have not had a huge effect on consumption. The deals with the U.S. and Europe (and an earlier Korea-Chile pact which came into effect 2004) remove the 15% wine tariff. But since this is only part of the tax mark-up, the impact on prices hasn’t been huge. That $10 bottle now costs an importer $15.43, a savings of only $2.19. Most of that saving is eaten up by rising distribution costs as inflation hits 4%. Such small price changes have been enough to tilt current consumption toward Chile and the EU, whose trade pacts were implemented earlier than America’s, but have not led to the expected explosion in consumption.
But the FTAs are leading to challenges to othergovernment policies that impinge importers’ ability to sell wine more cheaply.Seoul sold the Korean public the trade deals by promising they would make goods cheaper for consumers. Now the government is under pressure to deliver.
This started last year, when a consumer-rights group singled out a Chilean wine brand whose prices had risen despite implementation of the Korea-Chile trade deal. In an attempt to defuse public anger, the Ministry of Strategy and Finance announced in December that it would allow wine importers to sell directly to consumers for the first time in 29 years.Officials hoped this would reduce costs by cutting middlemen out of the supply chain. But small and mid-sized importers were cool to the idea on the grounds that it would be logistically tough for them to sell direct to consumers. The major importers already have their own retail shops so there would be no benefit for them. It also became clear that importer and retail margins are already low with some struggling to turn a profit. This proposal has been shelved indefinitely.
In a more consequential change, the Fair Trade Commission is now studying the feasibility of allowing wine to be sold online by importers and retailers. Opening this online door could be a huge boon to wine sellers, especially those targeting mid-tier consumers for whose won the competition is fiercest. It would also help offset market entry costs for smaller-volume wineries by providing a sales channel to consumers for wines that otherwise wouldn’t be carried by brick-and-mortar stores. The proposal faces stiff opposition from the National Tax Service, which thinks online wine sales would undermine revenue collection.
The combination of free trade and consumer expectations is also prompting changes in retailer behavior. After witnessing the popular uproar over that Chilean wine, retailers and importers are proactively cutting prices to avoid similar treatment in the media. On the day the U.S.agreement came into effect last month, major importers offered permanent price reductions of 10-14% on American wine on store shelves, taking a loss on existing stocks on which they had already paid the 15% duty. Hypermarket chain and department store Lotte promoted American wines with discounts of 30-40% to mark the FTA’s implementation.
This in turn is creating new opportunities for American wineries, which already enjoy several advantages. Koreans find the names of American wines less intimidating than those of Europeans, and perceive American wines as being easier to learn about. Americans also have a secret weapon: Korean-Americans. More Korean-American entrepreneurs are entering the wine business, driven by a passion for Californian wines and benefitting from an understanding of Korean culture.
None of this guarantees American success. Italian wines haven’t boomed despite lower tariffs and 700 Italian restaurants in Seoul, due to lack of co-ordination among regional marketing bodies in Italy and limited marketing investment in Korea. Americans will want to emulate Chilean wineries,who invested heavily in advertising, wine events and cross-marketing with fashionable products.
But as things stand, the Korea-U.S. trade deal already is becoming a good example of the unintended benefits of trade opening.As the deal creates political demand for additional reform, it is creating new opportunities for businesses and focusing Korean consumers on wine. That’s something worth raising a glass to.
Mr.Hall is a wine writer based in Seoul. He blogs at www.winekorea.asia
© 2012 Dow Jones & Company. Reprinted with permission. All rights reserved.