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Over the past year, key U.S. allies South Korea and Japan have been embroiled in a political and trade dispute which has many antecedents in the past, but which has been exacerbated by more recent developments. At the heart of the dispute is South Korea’s continued push for restitution for Japan’s World War II–era transgressions, claims Japan contends were settled in the 1965 Treaty on Basic Relations. However, from November 2018 to June 2019, a series of South Korean court rulings awarded compensation from Japanese companies to forced wartime laborers and their families, reopening long-standing tensions between the two nations on this issue.
Then, in July 2019, Japan removed South Korea from a “white list” of countries accorded preferential treatment for export licensing. Japanese officials initially appeared to justify the restrictions as a response to alleged South Korean violations of United Nations prohibitions against exporting certain materials to North Korea. Later, Japanese officials explained that the “relationship of trust” with regard to South Korea’s export control and regulation procedures had been “significantly undermined” due to Seoul’s refusal to participate in working-level export-control talks for three years. Regardless of the true reason (or reasons), South Korea’s removal from Japan’s white list was seen by many as a response to simmering tensions—and moreover as a direct threat to South Korea’s information and communications technology (ICT) sector.
More than 1,100 products were potentially exposed to enhanced Japanese regulatory scrutiny when South Korea was removed from the white list. But three chemicals or components key to semiconductor manufacturing were of particular concern to South Korea: hydrogen fluoride, fluorinated polyimide, and photoresists. This matters, because Japanese vendors account for 90 percent of the world’s supply of fluorinated polyimide and photoresists and 70 percent of global hydrogen fluoride production. Moreover, Japan supplies 90 percent of South Korea’s fluorinated polyimide and photoresist imports and 44 percent of its hydrogen fluoride imports.
This has greatly concerned South Korea, because the semiconductor sector is foundational to its economy. Korea is the world’s second-largest semiconductor manufacturer, led by Samsung and SK Hynix, which are the world’s second and fourth-largest semiconductor producers, respectively. Moreover, Korea remains an export-led economy (the world’s fifth most export-intensive, in fact), and semiconductors or related equipment account for fully one-third of Korea’s exports, 92 percent of its export growth in 2018, and 80 percent of its current account surplus (trade balance) in that year.
And while the relative value of South Korean imports of these three inputs from Japan is relatively small—just $33.6 million worth of these three chemicals each month—South Korea exports $8.4 billion worth of semiconductors each month that depend on those chemicals. This means that South Korea’s export-loss exposure is 250 times greater than that of Japan’s chemical manufacturers, and thus that South Korea has much more to lose in this dispute.
Of course, it’s not just South Korea’s semiconductor and broader ICT sector that’s potentially exposed. LG appliances along with Hyundai and Kia cars increasingly depend on semiconductors, many of which are produced in South Korea. (In fact, digital and electronic components now account for as much as 40 percent of the inputs in global automotive production.) In short, if Japan were to aggressively restrict or delay the export of these key chemicals to South Korea, it could have a dramatic impact across South Korea’s entire economy. So much so that one market analyst wrote last fall that, “the downside risk of the ongoing trade dispute may reduce South Korean GDP by as much as 2.6% in 2020.”
But there’s much at stake for Japan as well. As a U.S. International Trade Commission report on the dispute, “The South Korea-Japan Trade Dispute in Context: Semiconductor Manufacturing, Chemicals, and Concentrated Supply Chains,” noted, “Japan’s actions create incentives for Korean chipmakers to significantly lessen their sourcing from Japanese suppliers, not only in specialized chemicals, but throughout the entire semiconductor supply chain.” Indeed, SK Hynix has already begun switching to domestic sourcing of hydrogen fluoride, and LG is reportedly testing Taiwanese hydrogen fluoride as a replacement for Japanese product. Moreover, over 11 percent of Japan’s exports to South Korea are in the semiconductor sector, so if Japan harms South Korea’s semiconductor sector, it could end up unwittingly harming its own ICT firms. However, it’s consumer-facing Japanese sectors such as automotive, retail, tourism, and beer that have been hardest hit by the dispute thus far. For instance, Japanese automotive exports to Korea fell by 60 percent from April to September 2019. And in terms of country share of South Korean imports of foreign beer, the Japanese share fell from 16 percent to 1.5 percent last year, while Asahi beer fell from being one of the most popular foreign beers in South Korea to 36th.
As 2020 begins, however, it appears tensions have cooled down somewhat. A mid-December meeting between senior Japanese and South Korean trade officials lasted hours longer than expected and resulted in the two sides reporting they had reached “common ground” and agreeing to hold another dialogue in Seoul in the near future. To be sure, the situation remains sensitive, and the lack of South Korea’s inclusion on Japan’s white list has generated significant uncertainty for Korean companies. However, Japan has been approving recent export requests for the key chemicals in question on a timely and expeditious basis. So long as this continues, it would allay concerns that Japan could use the export controls to inhibit the competitiveness of South Korea’s semiconductor industry and disrupt global semiconductor supply chains more broadly.
What the Japan-Korea Trade Dispute Means for the United States
While certainly concerning, the trade dispute in some ways has presented an opportunity for the United States to assert renewed diplomatic engagement in the region. While the United States stayed on the sidelines for most of the summer and fall of 2019, pressure from Secretary of State Mike Pompeo in November played a pivotal role in persuading South Korea to not withdraw from the GSOMIA (General Sharing of Military Information Agreement), an intelligence-sharing agreement among the three nations which has played a critical role in monitoring Chinese and North Korean military activities and has provided a “pillar of stability” for regional security issues.
U.S. engagement in the region is crucial, particularly as there’s a battle now being fought for the soul of the global economic and trading system. It’s a contest of competing visions: On one hand, China’s model of state-directed capitalism predicated on an aggressive innovation mercantilism that distorts markets through a vast array of unfair trade practices ranging from forced intellectual property (IP) theft, to forced IP and tech transfer as a condition of market access, to excessive industrial subsidization. On the other hand, liberal democracies that embrace rules-governed, market-based, private enterprise–led trade in accordance with the fundamental World Trade Organization tenets of reciprocity, non-discrimination, and national treatment.
The United States must working with its like-minded allies not just to confront China on its unfair trade practices—as ITIF argues in a new paper earlier this week, “Why and How to Mount a Strong, Trilateral Response to China’s Innovation Mercantilism”—but also to ensure the vibrancy of market-led capitalism, in part by pursuing higher-standard trade agreements with both Japan and South Korea, as the Trump administration has done with both nations. Ideally, the United States also would reengage in the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) and bring all three nations into the fold of a high-standard Pacific region trade agreement. The U.S. Department of Commerce should also hold a working-level meeting with Japanese and South Korean officials on export controls.
In fact, the only winner in an ongoing Japan-South Korea trade dispute would be China, partly because of the wedge it would drive among key U.S. allies and in partly because a continuing dispute would harm Korean and Japanese firms, which represent key competitors to Chinese ones. Disruptions to global ICT supply chains will only further China’s ambitions to achieve autarky, or domestic capacity, across every facet of semiconductor production. Moreover, the ongoing dispute detracts from Korea and Japan focusing, along with the United States, on what really matters: rolling back Chinese innovation mercantilism.
However, the United States also needs to engage to ensure an amicable resolution is reached in order to maintain confidence in globalization of both semiconductor supply chains and the broader cause of liberalized, market-based trade. Of course, beyond the economic concerns lie serious national and global security issues, particularly regarding North Korea, and here as well the United States needs to present a united front with its closest Asian allies to effectively address security challenges.
In conclusion, there’s a tremendous amount at stake for Japan, Korea, the United States, and China in this dispute. For the United States, it’s an opportunity to reassert leadership and engagement in the Asia-Pacific region and to deepen ties with critical allies it needs both to assure regional security stability and to present a concerted front against China’s expansive, state-led capitalism. For South Korea and Japan, much is at stake for their own economies and for the preservation of global supply chains and liberalized trade on which their export-dependent economies rely.