Securing South Korea’s Supply Chains

In October, China began restricting exports of urea water solution, an ingredient used by factories and diesel trucks to reduce emissions. The interruption in supplies threatened to disrupt diesel transport across a wide range of South Korean industries. This is just one of the more recent examples of supply chain disruption during the pandemic, which, along with China-U.S. geostrategic competition, is pushing Seoul to take steps to secure its supply chains.

Global supply chains have been strained during the pandemic due to a combination of surging demand for consumer durables, manufacturing and logistical disruptions, and temporary export restrictions. While the global shortage of semiconductors and its resultant impact on the automobile industry and consumer electronics has received much of the attention, disruptions in the supply of lesser known industrial materials such as urea continue to impact production in South Korea and other countries.

Despite once being a significant producer of urea, South Korea was unable to turn to domestic production to lessen the disruption. After years of cheap imports from China, domestic producers were unable to compete and halted production in 2011. South Korea is now dependent on China for 97 percent of its urea imports.

In this case, South Korea was able to ease the immediate strain on urea supplies in relatively short order. China agreed to release stocks of urea that South Korean firms had already contracted to purchase, while the government secured a three year supply of 120,000 tons per year from Indonesia, equivalent to about a third of its needs.

The urea water solution shortage is not the first case of a significant South Korean industrial input facing export restrictions, nor is China dependency the only factor pushing Seoul to reconsider its supply chains. In 2019, Japan placed tighter restrictions on exports of hydrogen fluoride, fluorine polyimide, and photoresists – industrial inputs critical to the production of semiconductors and displays. Tokyo also removed South Korea from its white list of trusted trade partners, easing Japan’s ability to restrict a wider range of exports to South Korea. Nominally Japan took these steps in response to concerns over South Korean export controls, but most analysts interpreted Tokyo’s moves as a signal of its displeasure over South Korea’s Supreme Court’s ruling that Japanese firms must provide compensation for forced labor during World War II.

The shock of Japan’s actions in 2019 pushed South Korea to take steps to develop domestic supply chains. Seoul initially pledged to invest $6.5 billion over seven years in R&D to reduce its dependence on Japan for industrial inputs and has since made additional investments in R&D. It also sought out other suppliers, such as DuPont, to invest domestically and to encourage Japanese suppliers to move their production to South Korea to avoid future disruptions.

In response to current concerns, South Korea is taking a broader based solution to securing its supply chains. The government is setting up teams under the Ministry of Foreign Affairs and the National Intelligence Service to help in securing supply chains for the resource dependent country. The teams will be tasked with determining specific industrial inputs that South Korea is overly reliant on a single country for. The next step will be finding ways to diversify supplies. The hope is that by working with South Korea’s embassies and trade promotion offices abroad, the teams will be able to identify potential disruptions early and take steps to mitigate them. Similar to South Korea’s response to Japan’s restrictions on semiconductor chemicals, Seoul will also look for ways to increase domestic production of critical materials.

Identifying disruptions early will be critical, but South Korea also needs to reduce its high level of dependence on single country sources for industrial inputs. According to the Korea International Trade Association (KITA), South Korea relies on a single country for 80 percent of its imports for 3,941 items. China is the source for 1,850 of those imports, while the United States (503) and Japan (438) represent far smaller sources of dependence for South Korean industry.

While seemingly a domestic matter for Seoul, securing South Korea’s supply chains is also an issue for the South Korea-U.S. alliance. While the Biden administration’s supply chain review can often appear more focused on returning production to the United States than helping to secure supply chains of the United States and its allies, its own initial 100 day review of supply chains noted that:

The United States cannot address its supply chain vulnerabilities alone. Even as we make investments to expand domestic production capacity for some critical products, we must work with allies and partners to secure supplies of critical goods that we will not make in sufficient quantities at home. Moreover, in an interconnected world, the United States has a strong interest in ensuring its allies and partners have resilient supply chains as well.

It is not feasible for the United States to produce everything that it needs domestically, and attempts to do so could also leave allies like South Korea vulnerable to supply chain disruptions and manipulations. It is critical for the United States work with allies like South Korea on developing secure supply chains.

South Korea’s supply chains hold special significance for the United States due to South Korea’s role in semiconductor production and the Biden administration’s transition to a green economy. U.S. firms are partnering with South Korean firms on the production of lithium ion batteries to power U.S. built electric vehicles. While a significant portion of this production will take place through investments in production in the United States, South Korea and the United States are highly dependent on China for critical battery components.

According to the KITA report, South Korea is reliant on China for 92.8 percent of materials such as manganese hydroxide, calcium hydroxide, and tungsten oxide, which are used in battery production. While not as high a level of dependency, South Korea relies on China for 63.9 percent of its imports of cobalt oxide, which is used in battery cathodes. In light of China’s control of cobalt mines in the Democratic Republic of the Congo, the source of two-thirds of the world’s cobalt, and dominance in the processing of cobalt, even U.S. production facilities will likely be highly dependent on imports of cobalt oxide from China for the foreseeable future.

South Korea’s semiconductor industry is also reliant on China for certain industrial materials. China accounts for 60.9 percent of South Korea’s imports of gallium, germanium, and beryllium, which are used in chip wafer production. Even in areas where South Korea seems to be dependent on Japan for semiconductor production, the supply chain is more complicated. Japan, which is a leading producer of hydrogen fluoride for the semiconductor industry, imports significant quantities of less refined hydrogen fluoride from China for refinement.

More critically, China accounts for nearly 60 percent of the production and nearly 90 percent of the processing of rare earth minerals, which are critical to a wide range of industrial and technological products.

Only a few years ago this dependence on China for key industrial inputs would not have been viewed as a potential risk, but with increasing China-U.S. geopolitical competition straining supply chains and China’s own demonstrated willingness to use trade restrictions as a geopolitical tool – which South Korea experienced first-hand with China’s informal sanctions in response to the deployment of the THAAD missile defense system – the security of supply chains can no longer be taken for granted.

Securing supply chains, however, will face challenges. Ideally, South Korea would look to tighten its supply chains by working with neighbors such as Japan, but Tokyo’s willingness to use economics as a tool for political gain means that the two U.S. allies are already undergoing their own version of decoupling. This increases the need for cooperation with the United States but also partners in Southeast Asia.

South Korea’s efforts are also likely to face push back from firms whose economic interests will not always align with national security interests. While subsidies may encourage the production of urea water solution domestically, as long as Chinese urea is cheaper there will be an economic interest for firms to maintain their current suppliers. This is something even the United States is learning as its firms continue to invest in China where it is in their economic interest. Balancing where subsidies can improve the security of supply chains for critical items with where they are economically inefficient and bring little national security gains will be a key part of South Korea’s calculus.

As a resource poor country South Korea will not be able to secure all of its supply chains through domestic production, but it can mitigate the risk by reducing its high level of dependence on a single country for a wide range of industrial materials. It can also reduce risk by working with allies and partners to identify common sources of risk and working together to find alternative suppliers, especially for natural resources, and encouraging the use of smart factories that can adjust production more rapidly during a crisis. The process will likely be drawn out, but in time South Korea can take steps to make its supply chains more secure.