Tensions are building between South Korea and China as Seoul has sped up plans to station the Terminal High Altitude Area Defense (THAAD) system on its soil. Beijing has been objecting the move, taking a series of provocative actions against Korean products and businesses. As economic risks stemming from China are becoming a major concern for the Korean economy, we'll take a closer look at how China has been responding by sector and ways to overcome the difficulties with Dr. Han Jae-jin of the Hyundai Research Institute. Let’s first take a look at China's response.
After the decision to deploy THAAD in Korea was made last July, China has been sending diplomatic messages to Korea. However, the decision to deploy the THAAD system on Korean soil is not a decision that we made alone, but a joint decision made with the U.S. Therefore, diplomatic tension was inevitable. China has been responding with retaliatory measures that it has taken against other countries like Japan or the Philippines in the past. But this time it’s more extreme. China has been putting restrictions on foreign-invested enterprises like Lotte, denying tourism visas and forbidding travel agencies from selling tour packages to Korea. This is a bit concerning.
China's economic retaliation against Korea for the deployment of the THAAD system has been spreading to various sectors. As of March 9th, 55 out of 99 retail shops in China run by South Korean retail giant Lotte were put under business suspension by local authorities as Lotte Group agreed to hand over a golf course to house the THAAD system. The retail giant has also been plagued with various tax investigations and delays in customs clearance. It has also been over eight months since China put a ban on all Hallyu content. However, the hardest hit sector is tourism.
In 2011, the Korea tourism deficit turned into a surplus thanks to Chinese tourists flooding into Korea. Because of the influx of Chinese tourists, Korea's tourism industry started to bloom with developments in infrastructure. The trend led to heavy investments in tourism packages and products for Chinese travelers as well as travel infrastructure. This is why the latest row is a big blow to the industry. The investments that have already been made cannot be taken back.
The ministry in charge of tourism in China made a verbal instruction to local travel agencies to stop selling tour packages to Korea. Korea's tourism balance against China reached a surplus of $6.9 billion in 2015. As of last year, over 8 million Chinese tourists visited Korea, accounting for 46.8% of the total number of tourists. Chinese travelers also wield great influence over sales at Korean duty free stores as they take up 70% of sales. That is why it is difficult to even fathom just how much damage the current row will cause for the industry. However, it's a different story for investments.
If these sanctions against Korean companies continue, employment for Lotte and other related companies will face uncertainties, as they might have to pull out of China. However, Korea is the third biggest direct investor for China so it is difficult to say that the losses will be one-sided. China is also pursuing major infrastructure projects under Xi Jinping's "One Belt, One Road" initiative. The initiative started off with a grand goal, but has been facing trouble due to the sluggish economy. That is why China is desperate for foreign investment. Korea has a lot of experience and know-how in infrastructure projects and construction so to lose Korean investment would be a big loss for China as well.
China takes up 9.4% of Korea's total direct foreign investment. If economic sanctions against Korean firms increase, we will continue to see cases like Lotte Group while investments will shrink. However, Korea has made big investments into the establishment of the Asia Infrastructure Investment Bank as well as China's One Belt, One Road initiative. So, in the long term, investments will not be affected greatly by the current row. This is also the case for commodity trading.
On the surface, it may seem like Korea is suffering a big loss in commodity trading. But as there are two sides to a coin, China will also be affected. China has long been the leader in creating a specialization structure for processing trade in Northeast Asia. As such, Korea has been sending parts and other intermediary goods to China which uses them to make finished products for domestic sales or exports. The current row can deal a blow to China as their technology to make intermediary goods is not as advanced as Korea’s. So, China also needs Korea for exports, which is why it seems unlikely that Beijing will directly sanction trade and exports.
Korea's exports to China reached $124.4 billion last year. Out of this sum, exports for intermediary goods such as information and communication technology equipment took up two-thirds. Exports of raw materials such as steel and chemicals also accounted for 30%. Against this backdrop, if there are sanctions preventing China's imports of Korean display panels or semiconductors, it could deal a serious blow to Chinese firms. As such, Korea and China are in a mutually beneficial relationship in terms of trade. The two markets cannot survive without one another. However, if China continues to link security issues with economic measures, Korea will need to reduce its dependence on China.
In terms of policy, it looks like it will be difficult to resolve the situation in the short-term. That is why we have to think beyond China. Rather than relying too heavily on China for trade, we have to turn our eyes elsewhere. The ASEAN market has been growing rapidly. Although the global economy has been sluggish, the ASEAN market has been growing and is seen to have investment potential. That is why Korea should move fast to advance into the market which has been seen as a relatively low-wage production base.
As exports to China take up one-fourth of Korea's total exports, China's economic retaliation will deal a blow to the Korean economy. That is why Korea's economic restructuring has been gaining attention as an imminent issue to resolve. Whether the current row with China will remain a risk, or become an opportunity to improve Korea's competitiveness through the diversification of its export market will depend entirely on how Korea responds to the situation.