China, Korea’s largest export partner, is making some troubling moves following South Korea and the United States’ July 2016 joint announcement to deploy the Terminal High Altitude Area Defense (THAAD) system. On January 3, Beijing announced a ban on the import of 19 South Korean cosmetic products citing various reasons including insufficient documentation. Amid rising concerns over a potential ripple effect, we’ll take a close look at the events leading up to China’s economic measures and forecasts hereafter with Director Cho Yong-chan (조용찬) of the U.S.-China Industrial Economic Research Center.

On January 3, the Chinese General Administration of Quality Supervision, Inspection and Quarantine refused to approve imports of massive amounts of South Korean cosmetic products. The Chinese authorities issued a list of cosmetic products that failed to win approval for import, and 19 out of the list of 28 were Korea-made. From facial creams, mask packs, cleansing products, bath products to toothpaste, the banned goods include Korean products that are popular in China, totaling at about 11 tons. The rest of the list was made up of six products from the U.K. and three from Thailand. The local cosmetic industry regards China’s strengthened restrictions as a warning to Korea following the THAAD deployment decision, as China is the biggest buyer of Korean cosmetics, accounting for a whopping 37% of all exports.

Korea’s Ministry of Food and Drug Safety concluded that the banned products did indeed fail to meet various Chinese cosmetics-related regulations. But questions remain as China’s list of cosmetic products that failed to win approval for import for the month of November included those from only three countries, namely Korea, the U.K. and Thailand, and up to 70% of the products on the list were made in Korea. The growth of Korean cosmetics exports to China has slowed as well. From 278-million US dollars in 2013 to 543-million dollars in 2014 and 1.08-billion dollars in 2015, Korea's export of cosmetics to China doubled on-year each year over the past few years. However, as of November 2016, the export amount had only reached 1.31-billion dollars, showing a significant drop in the growth rate. Concerns are mounting for Korea as China continues to increase its restrictions on Korean products since the THAAD deployment decision.

Since the announcement of the THAAD deployment decision, the customs process has been strengthened, and other general regulations such as sanitary or tax regulations are becoming tighter. For example, in the food industry, China announced tightened rules on baby formula makers in June last year, limiting the number of products to three and nine for local and foreign companies, respectively. Rules regarding company registration, product ingredients and labeling were also tightened, effective as of October 2016. Meanwhile, Beijing also initiated an anti-dumping investigation on polyacetal and polysilicon produced by South Korean companies, and cut subsidy for Chinese electric vehicles using Korean batteries. Not so long ago, Chinese authorities also launched a tax investigation on Lotte Group’s office in China after Lotte provided land for the THAAD deployment. In addition, China's civil aviation administration declined China-to-Korea charter flight route applications from three Korean airline companies, namely Jeju Air, Asiana Airlines and Jin Air, just prior to China’s biggest holiday, the Spring Festival. It seems inevitable that the number of Chinese tourists will shrink.

Since the announcement of the THAAD deployment decision in July last year, China has banned TV appearances of Hallyu celebrities and cut subsidies on electric vehicle models using batteries made by Korean companies like Samsung SDI and LG Chem. At this rate, the possibility cannot be ruled out that China may even play the finances card.

If the conflict grows further, there’s a possibility that China will target a Korean firm on an annual investigative TV show that airs around consumer rights day in March. The Korea-China currency swap deal worth 64-trillion won expires in October, and China may reject an extension. What’s even more concerning is that China may consider pulling out Chinese capital from Korean stocks and bonds. Chinese investors sold 1.5-trillion won worth of stocks in the Korean market since the THAAD deployment decision, which is 10 times more than the sales made in 2015. Beijing also holds some 17.5-trillion won worth of bonds, including Korea’s government bonds. If China sells these bonds all at once, the risk of an interest rate hike in Korea increases.

China’s stance on the THAAD deployment is firm. China’s official news agency Global Times published an editorial on January 7 under the title “South Korea to antagonize China with THAAD.” On January 11, Chinese Foreign Ministry Spokesperson Lu Kang said during a regular briefing that the deployment of THAAD would lead to “huge damage to Korea and Chinese relations.” As China continues to raise its voice, the Korean government also made its response.

On January 11, a Ministry of Trade, Industry and Energy official said that the ministry will launch its own investigation into the quality and documentation process of the Korean cosmetics products that were banned by China, adding that an official complaint will be made afterwards. With the Korea-China free trade agreement talks underway, the issue is expected to be brought up during high-level talks, including minister-level talks. The ministry hinted that it will arm itself with indisputable proof for such negotiations. China is a member of the World Trade Organization and a major economic power. There’s a growing voice calling for at least a warning against China’s continued linking of Korea’s diplomatic and security issues with trade.

Korea’s Ministry of Trade, Industry and Energy delivered its concerns regarding China’s non-tariff barrier at a meeting of the bilateral joint free trade agreement (FTA) committee held on January 13. Trade Minister Joo Hyung-hwan (주영환) also stressed that the ministry will consider taking legal action if any violation of international law is discovered. However, China is Korea’s largest trade partner, accounting for 26% of Korea’s exports and 21% of imports. A more fundamental solution is needed.

The most important thing is to avoid providing a pretext. When tension amounts, Korea should stay close to the United States, while increasing efforts to become closer to China. Regarding the THAAD battery deployment, in addition to diplomatic persuasion, Korea should also consider actively cooperating with China in its efforts to promote the Regional Comprehensive Economic Partnership, the Korea-China-Japan FTA or the Asian Infrastructure Investment Bank. With the incoming Donald Trump administration, both trade and military tension between U.S. and China is expected to intensify. At such a time, Korea should stick to its principle to protect its own security while cooperating with its allies. Korea must officially issue complaints against China’s violation of international law and call for rectification in order to avoid becoming a victim of China’s tactics.

Conflict with China is hurting Korean exports’ recent upward path toward revival on the back of international oil price hikes. Korea must exercise its right to complain against unfair measures. And both Korea and China must not forget their past, when they were able to overcome their systematic and ideological differences to forge diplomatic relations in 1992, based on the principle of separation of politics and economy.