Is South Korea de-risking?

As the West pushes to de-risk its trade and supply chains away from China,  South Korea, which is historically situated along the geopolitical fault line between the United States and China, has been on the front line of the supply chain shift in the region. Since China's accession into the World Trade Organization (WTO) in 2001, South Korea has benefited from the rapid economic growth of China and has maintained China as its number one trading partner for the last two decades, accounting for a quarter of total trade.

South Korea's exports to China have dropped while exports to the United States have increased

That is changing now. In 2023, South Korea's exports to China plummeted by 19.9 percent from the previous year, shrinking China's share of total exports to 19.7 percent, below 20 percent for the first time in 20 years, according to the latest trade data from the Korean Ministry of Trade, Industry and Energy. On the other hand, its exports to the United States as a share of total exports increased, bringing the US share of total exports to 18.3 percent, the greatest in two decades, and narrowing the gap between South Korea's two trading partners' shares of exports to 1.4 percentage points, the closest in two decades. In December 2023, South Korea's monthly exports to the United States ($11.3 billion) surpassed that of China ($10.9 billion) for the first time in two decades. Since 2007, South Korea's exports to China have been larger than that of the United States and Japan combined. But last year, South Korea's exports to the United States and Japan combined overtook that of China for the first time since 2006.

South Korea has been a bellwether state for the latest trends in trade and manufacturing supply chains in the Indo-Pacific. It is one of the most open trading nations with trade as a share of GDP amounting to 97 percent in 2022, one of the highest in the world. Its manufacturing sector, which accounted for 26 percent of GDP in 2022, one of the highest among industrialized nations, forms the backbone of its export-driven economy, covering a variety of industries such as semiconductors and IT, automobiles, batteries, machineries, steel, and petrochemicals.

South Korea has recorded a steady trade surplus with China since normalizing diplomatic relations in 1992. However, in 2023 South Korea recorded its first trade deficit with China ($18 billion), while recording its largest trade surplus with the United States ($45 billion).

Is this trend reflecting a structural shift towards de-risking? Or is it a short-term cyclical blip? It may be too early to determine, but changes in trade patterns have not just come from cyclical factors such as the relative macroeconomic performances of the United States  and China but also structural changes that started before the pandemic, such as China's own push for "self-reliance," and South Korea's own reaction to Chinese economic coercion and, more recently, to US industrial policies.

Changing trade trend reflects underlying structural shift and South Korea's reactions to US and Chinese government actions

China has stepped up its drive to move up the value chain and produce more sophisticated technologies domestically in recent years. This ambition has disrupted the mutually beneficial, complementary supply chains between the two countries, which has been characterized by a division of roles in which China has exported finished goods assembled with Korean intermediate goods. But as China rolled out "Made in China 2025", this vertical division of roles in supply chains began to change into a more horizontal competition between the two. A Bank of Korea study found that for the last several years semiconductors were the main driver of South Korea's export growth to China, whereas exports of other goods only moderately increased or even decreased. The oversized role of semiconductors in bilateral trade flows, comprising more than a quarter of total exports to China, masked the structural changes that were gradually happening in other sectors.

Another turning point in relations between the two countries came in 2016 when South Korea suffered from China's economic retaliation over Korea's Terminal High Altitude Area Defense (THAAD) missile deployment. The coercion measures included an opaque ban on Chinese civilian group tours to South Korea and also a ban on licensing of Korean cultural exports such as games, K-pop (Korean popular music), and Korean TV dramas in China. China has also boycotted Korean products such as automobiles and mobile phones. For 113 big Korean companies, sales by Chinese subsidiaries have dropped by 13.1 percent since 2016, and by 37.3 percent if semiconductors and battery sectors are excluded. Lotte, a retail group on whose property the THAAD missiles were deployed, eventually pulled out of the Chinese market entirely. Hyundai's sales in China dropped by 75.7 percent during the same period, and Hyundai has sold three factories out of five in China so far. These experiences shattered these companies' confidence in China as a reliable business partner and motivated them to pursue diversification early on as a hedging strategy.

On the other hand, the recent industrial policy of the Biden administration,  especially the Inflation Reduction Act (IRA), has attracted almost $20 billion  of Korean investment in electric vehicles (EV) and batteries in the United States, making it the biggest foreign investor in the United States, followed by Europe and Japan, according to the Financial Times. Problems caused by the discriminatory elements of the IRA were addressed by the Treasury guidelines expanding eligibility for tax credits to leased commercial vehicles. Exports of investment-induced products from South Korea to the United States increased in the last year, such as machineries with a 76.9 percent gain in 2023 from the year before. In the end, US industrial policy contributed to incentivizing the establishment of new supply chains between the allies in the critical supply chains of semiconductors, electric vehicles, and batteries.  

The uncertain US political landscape also represents a risk to South Korea

The de-risking happening in Korea's supply chains and trade structure can be attributed to a combination of market forces such as China's upgraded technological capabilities, Korean companies' diversification, and government actions such as China's move towards self-reliance, economic coercion, and US industrial policy. The effects of de-risking in South Korea have yet to be seen, but it is a legitimate rebalancing act for any country to hedge against the overdependence of its trade portfolio on one country and the possible weaponization of the overdependence.

Risks can run to the US side as well as China. A new US administration could overturn the direction of US industrial and climate change incentives for EVs and batteries, posing a big risk to South Korea and other allies. The trade surpluses that South Korea recorded with the United States in 2023 might provoke a political backlash in the United States over its surging trade deficit with Korea. Both sides need to maintain coherent, stabile trade relations through the Korea-US Free Trade Agreement framework, now in its 12th year of implementation, in order to accelerate de-risking and secure resilience in critical nascent supply chains emerging between the United States and the Indo-Pacific region.