US-China Trade War Turns Up the Heat for South Korea

The recent escalation in the U.S.-China trade war is a troubling development for Seoul. While some South Korean sectors stand to benefit from the new economic barriers between Washington and Beijing, a protracted trade war will exacerbate the long-term challenges for the South Korean economy as a whole.

In early May it seemed as if U.S. President Donald Trump and Chinese President Xi Jinping were close to ending the standoff, which resulted in tariffs on hundreds of billions of dollars of bilaterally traded goods. Then events took a sharp turn as Washington increased tariffs on $200 billion worth of Chinese goods from 10 to 25 percent and banned U.S. companies from selling goods to Chinese telecom giant Huawei. In retaliation, Beijing raised tariffs on $60 billion worth of U.S. imports and created an unreliable entities list in direct response to the move against Huawei. With the Trump administration looking into tariffs on the remaining $300 billion of imported Chinese goods, things could get worse before they get any better.

Despite not being a belligerent, South Korea is among the countries facing the most potential impact from the trade war. About 40 percent of South Korea’s GDP is tied to exports, of which China is the largest destination, followed by the United States. The picture is a bit more complicated, however, as nearly 80 percent of South Korea’s exports to China are intermediary goods, many of which go on to be incorporated in final products sold to the United States and are thus directly hit by the new tariffs.

A recent study by the Korea International Trade Association analyzing South Korea’s trade with both China and the United States before and since tariffs were applied last summer highlights the mixed results for Seoul so far. The report shows South Korean industries are exporting more to each country in areas where the U.S. and China have placed tariffs on one another. In the United States, South Korean exports of products that are being targeted in the trade war increased by 20 percent while imports of the same Chinese goods have fallen nearly 25 percent during the first quarter of this year compared to the same period last year. Essentially, many Chinese products targeted by U.S. tariffs are being substituted by their South Korean competitors – particularly autos, semiconductors, home appliances, cell phones, and plastic and rubber products. This same substitution effect is occurring in China to the benefit of South Korean chemical, machinery, electronics, and cosmetics companies. However, Seoul’s overall exports of goods to China are down by 6 percent, due to the large share of South Korean goods that are sent to China but ultimately bound for the United States.

As much as South Korean exports to the United States and China have already been affected, the uncertainty generated by the trade war poses a larger issue. Since the beginning of the year, the South Korean won has dropped by more than 6 percent against the dollar. The KOSPI, South Korea’s key stock index, is also down by more than 3 percent since early May. The declines of both have largely been attributed to the trade war. Financial markets are concerned with Seoul’s exposure to more U.S. tariffs vis-à-vis its significant intermediary trade with China. Additionally, the spillover effects of more trade barriers between the U.S. and China could further dampen global demand for trade, which would disproportionately impact South Korea considering its dependence on trade more broadly.

Though navigating the trade war is a challenge for South Korea, in many ways it adds to what Seoul would be facing otherwise. While the new economic barriers between Washington and Beijing raise the premium for operating in China, the cost of doing business there was a concern for South Korean companies even before last summer. Rising labor costs and unfair market practices such as technology transfer laws in China have led many South Korean companies to move their operations to Southeast Asia. A notable example of this is Samsung Electronics’ 2017 announcement that it would close its network equipment production facility in Shenzhen and relocate to Vietnam. Beijing’s retaliation against South Korean businesses starting in 2017 – which some estimate may have cost South Korea’s GDP as much as $15 billion – after the deployment of the THAAD missile defense system also accentuated the risks of being subjected to the Chinese government’s whims.

A slowing Chinese economy has additionally been cause for concern in Seoul, irrespective of the trade war. Beijing’s efforts to move away from an export-led growth model and strengthen the domestic market – predating the Trump administration – have major implications for South Korea considering its large trade volume with China. Changes in the Chinese market have so far been linked with the significant drop in South Korean semiconductor exports.

Semiconductors have been key to not just South Korean export growth, but GDP growth over most of the past two years. Since fall 2018, however, semiconductor prices have dropped precipitously, mostly caused by slowing Chinese demand, cutting into the profits of these companies. South Korean semiconductor exports in May were down 30.5 percent from last year, contributing to a 9.4 percent drop in total exports.

Seoul’s approach to address these issues has been to diversify and strengthen drivers of economic growth. South Korean President Moon Jae-in’s domestic economic agenda of equitable and innovative growth seeks to grow the economy in such a way that the country will be less dependent on global markets as well as concentrated more in Fourth Industrial Revolution industries such as artificial intelligence. Moon’s varied economic outreach is also reflective of a desire to be less dependent on trade with China. Interest in bolstering economic ties with ASEAN and India through the New Southern Policy, with Latin America through Moon’s push to be an associate member of the Pacific Alliance, and with Europe through new memoranda signed during Moon’s most recent trip to several Nordic countries are some key endeavors where Seoul is looking beyond Beijing for trade and investment. 

What the trade war is doing, however, is raising the stakes and shortening the timeline for these South Korean initiatives to succeed. By pressuring Beijing, Washington is in effect hastening major shifts in the Chinese economy. Seoul must deal not only with the immediate consequences of new trade barriers, but with an environment that is changing more quickly than it would be without the tariffs. The longer and more contentious the trade war becomes, the greater the pressure will be on Seoul for its policies to bear fruit.

In every challenge, though, there are hidden opportunities. While still not ideal, the trade war can create new openings to help Seoul maneuver through a more rapidly changing environment. How some South Korean companies have benefited in the United States and China via the substitution effect is an example of this, but potentially more lucrative is how Samsung’s 5G business can take advantage of U.S. actions against Huawei. This won’t come automatically, however, and will require action to exploit this opportunity. Similarly, the Moon administration should read the field, with an eye for promoting new growth prospects, to adapt its policies to meet the heightened challenges brought on by the trade war.