Asia’s Latest Trade War: Japan vs. South Korea

Welcome to Pacific Exchanges, a podcast from the Federal Reserve Bank of San Francisco. I’m Paul Tierno.

I’m Sean Creehan. Today we continue our Rethinking Asia series, where we look at noteworthy, and unusual trends in economics and finance in Asia. We’re talking about a trade war brewing in the region, but not that one between the United States, and China.

Yeah. We’ve touched on the US/China trade conflict in recent episodes, but today we’re going to talk about emerging disputes between South Korea, and Japan. We sat down with Chad Bown of the Peterson Institute for International Economics, he’s a global trade expert, to get his take on recent moves by Japan to make it harder for Japanese companies to export products to Korea, a move that could disrupt some of South Korea’s largest industries.

So, even to the extent that this trade friction between South Korea and Japan may start to impact their trade with one another, it’s also likely to spill over, and impact trade with third countries, as well… I do think this has the ability to spill over, and affect supply chains even well beyond just the simple South Korea, and Japan relationship.

Tensions between the two countries, which in some cases date back to the early 20th century, and even earlier, are suddenly spilling over into trade. In the context of rising disputes between the United States, and China, not to mention a number of negotiations going on around the world, countries seem to be increasingly willing to use trade actions as a tool when traditional diplomacy fails.

Right. But, before we dive into the chat, just a note to our listeners, this dispute is moving very quickly, and some things may change by the time listeners get to this conversation, but the underlying issues, and the tensions will be ones that we’ll be talking about for a long time. So, let’s get to it.

Hey, Chad. Thanks for joining us.

My pleasure. Thanks for having me.

The China/US trade tensions attract a lot of press, which is understandable considering what’s at stake, and their size, and importance in the global economy, but over the last few weeks, there’s been something of a new trade tension, and feud brewing in North Asia, namely between Japan, and South Korea. Can you set the stage? What’s going on between these two countries, and how did they get there?

The current trade tensions between Japan, and South Korea actually date way back, and have nothing to do with trade. So, I think to best understand it, you’ve really got to go back a century, or so. In the early 20th century, Korea was a colony of Japan, and then during the period of World War II, a lot of South Korean’s were actually forced into service by the Japanese on the Japanese side in one of various forms. Some were forced to work for the Japanese military, some were forced into labor, and then there were issues of mistreatment of women, forced prostitution, and a lot of issues.

So, when finally the war ended in 1945, and Korea was liberated, there was a couple of decades of essentially tensions between the two countries before in 1965, there was finally a treaty that reestablished permanent, normal trade, normal relationships between the two countries. As part of that 1965 treaty, there was also some restitution, so some kind of financial payments, a couple of hundred million dollars worth of payments at the time, in today’s dollars, maybe a couple of billion dollars, to kind of resolve the longstanding historical issues between the two countries; that wasn’t sort of the end of things.

What’s happened most recently is from the Japanese side, they very much perceive that 1965 treaty as resolving the tensions between the two countries, but on the South Korean side, over the last couple of years, they have actually had, in their courts, private parties, so individuals say, “Hey, the restitution of that 1965 treaty was only between the two governments. We as private individuals, we haven’t gotten our day in court. We haven’t had all of our issues resolved.”

The South Korean Supreme Court essentially agreed with them, and said, “Okay. We’re going to allow South Korean individuals to be able to file claims against Japanese companies for some of the atrocities that took place during the second World War.” You’ve had a couple of individuals in South Korea that have brought these cases forward, had them heard, and the South Korean government has essentially agreed with their case.

So, obviously, this reignites longstanding, old wounds between the two countries. The issue doesn’t involve a lot of money, so the damages that the Korean courts have awarded to these individuals are in the ranges of hundreds of thousands of dollars, and these are big Japanese companies worth billions of dollars, so it’s not as if they can’t afford to payout these claims, but it’s really just kind of an igniting of old tensions between the two countries.

On the Japanese side, to kind of signal displeasure with these turn of events, what they have done is to say, “Well, we’re going to take these problems, and push them into the trade world. We’re going to retaliate through trade.” The way they’ve retaliated is by essentially imposing export controls, by saying there’s a number of very important products, a number of very important inputs that South Korean companies in particular—South Korea is known for its electronics sector, it’s semiconductor sector, companies like Samsung, and SK Hynix, some of the biggest major semiconductor companies in the world—rely on a lot of inputs coming in from Japan.

Initially, these export controls, the limits on the potential exports from Japan were things that you or I have never heard of, something called resist, hydrogen fluoride, fluorinated polyamide, but these are basically inputs needed to make semiconductors, to make the panels, things that go into ultimately electronic products like smartphones, that are sort of ubiquitous as coming out of the East Asian region. So, what is really not a trade issue, these longstanding tensions between South Korea and Japan recently flaring up again, have now turned this as a potential trade tension between the two countries.

Chad, just right off the bat, one interesting distinction just hearing you explain this is– if listeners are following the US/China trade dispute, most recently China has basically banned import of US agricultural products, so that’s more of an import control, whereas in this case, this is the Japanese using an export control. In some sense does that not cause damage to their own economy, to those exporters to focus on this or is there a sense that those products are going to be diverted to other countries?

You really have to know the details of these industries, and these supply chains, but I think there really is a good chance that Japanese companies will get caught up, and be hurt by these actions. I mean, obviously the Japanese companies that export these particular products that are now under control that may have additional difficulties getting out, and getting into South Korea, they’re going to suffer if they can’t sell as much, but also as part of the Japanese economy, they have a huge electronics sector that make final goods, and they’re probably reliant on Samsung, on SK Hynix for a lot of semiconductors, and display panels, and these inputs coming in. One could imagine that this actually could end up having a negative impact on various companies, and industries in Japan, as well.

So, look at South Korea for a minute, since so many of the semiconductor, and chip makers in South Korea are being affected, is the South Korean government doing anything to help divert some of the pain that these companies might feel from an export control?

The South Korean government has announced that they are going to allocate funding to try to create alternative supplies of some of these key inputs. Now, this is probably not easy to do. The fact that two out of the three key inputs that were put in the export control list to start, when you look at the data, Japan supplies essentially 90% of these that are actually imported into South Korea. That suggests that there’s probably not an easy way to find alternative suppliers. They don’t seem to be ubiquitous elsewhere out there, in Asia, in the economy, and it’s probably not entirely straightforward for South Korean companies to just quickly start making these products, as well.

When you read the press, these companies are reporting that they have somewhere between one and three months of inventory on-hand, so that if these export controls actually end up slowing down their access to be able to acquire them, they may be able to deal with the shortages for a while, but it’s unlikely that the South Korean government is going to be able to replicate those supplies very, very quickly.

As you already said, in some ways, this is a dispute over a small number of esoteric chemicals, and other components to a certain extent, but as you said, these are an important component of a lot of devices that people use on a nearly daily basis. I’m wondering, just particularly in the context of the US/China trade war, many people may not realize the extent to which non-Chinese components of a product made in China, the extent of non-Chinese components. So, could you walk us through how common this complex global supply chain is, and what these specific tensions in South Korea, and Japan mean for broader supply chain integration, diversion, et cetera?

I think these sort of supply chain interactions, and the complexity of them are probably a lot more common than people think. I think the obvious example that folks are probably aware of is something like the iPhone, right? The iPhone is an Apple product, so it’s an American designed, and marketed product, but the final assembly of the iPhone, at least in East Asia, takes place in China, but is done by primarily a Taiwanese company, Foxconn, and what it does is it puts together, it assembles, a lot of parts, and components from lots of different countries in Asia.

So, you think about what’s in an iPhone. There’s a microphone, there are speakers, there are cameras, there is the touchscreen, and on the inside, there’s all of these microchips, these semiconductors designed as sort of little computers, all of those different parts, and components may come from different places. Some may come from South Korea, some may come from Japan, some may come from Taiwan, some may be local in China, and some come from other countries.

So, even to the extent that this trade friction between South Korea and Japan may start to impact their trade with one another, it’s also likely to spill over, and impact trade with third countries, as well. Now, if the iPhone assembler can’t get, say, one of the chips that it might need from a company in South Korea, that’s going to hold up the process, and also affect their demand for stuff coming in from Japan, stuff coming in from Taiwan. I do think this has the ability to spill over, and affect supply chains even well beyond just the simple South Korea, and Japan relationship.

Are we going to start seeing that? I mean, I know there’s been a lot of discussion about the impact on consumers in the US of new tariffs on Chinese goods. There’s a price impact, but also, do you expect we’re going to start seeing potentially delays, or shortages of certain important goods as these sorts of effects broaden across the regional economy in Asia, which supplies so much of global demand?

It is possible. I mean, so far what’s happened in this dispute is Japan has effectively taken South Korea out of a special category of countries, for which it’s very easy to get access to these inputs on a quick basis. Now, just over the last… in early August, they’ve actually pulled South Korea off of this program, which expands the list of products that could be subject to these more stringent export controlled measures well beyond just those three products. It could be dozens, and dozens more.

Ultimately, what this does is it can slow down the ability of companies to be able to get access to these inputs. They have to now go through a more bureaucratic process, they’ve got to do paperwork. It effectively gives some discretion to Japanese bureaucrats, and policymakers to make the life difficult for these South Korean Companies. Whether or not they choose to exert that leverage, that pressure of making that life difficult, that’s probably going to be dependent on other things: what the position of overall tensions are between the two countries on these non-trade issues; on the question of reparations from the atrocities in the second World War; and whether the South Korean government is engaging with the government of Japan on those types of issues.

If they don’t, if they don’t engage, and the Japanese government does exert additional controls on these types of products, then they could very well start to show up as reductions in access to these things, making it more difficult, making it slower to be able to get these products to end consumers, that will ultimately lead to higher prices, and probably have other ripples, as well.

So, Chad, we’ve talked a bit about tension, and how things have escalated most recently, but if we take a step back, what are the current agreements that govern trade between these two countries?

Interestingly enough, for as much as these two countries trade with each other, Japan, and South Korea, and it’s about 7% of Japan’s total exports go to South Korea, and about 5% of South Korea’s exports go to Japan, they actually don’t have a free trade agreement with each other. They’re both members of the World Trade Organization, but what that means is these two countries have lots of free trade agreements with other countries out there around the world, South Korea has got a free trade agreement with the United States, with Europe. Japan’s got a free trade agreement with Europe. They don’t have one with each other.

What that means is they face what are called the most favored nation tariffs, or sort of the non-discriminatory tariffs, but in many instances, these are kind of the worst tariffs that you can face out there in the trading system. Japan’s average tariff towards stuff coming in from South Korea, I think is about 4%, but South Korea’s average tariff towards stuff coming in from Japan is 13% or 14%, so it’s relatively high. They do a lot of this electronic stuff, but they’re actually trading a lot more with the major economies of China, the United States. That’s where a much bigger share of their overall trade is with.

Now, the specific question about what deals, or what rules constrain the use of these export controls, the main issue here is countries have a number of products that can have what are called dual-use. So they may be useful for civilian purposes. We can use these inputs for these semiconductors to ultimately make smartphones that you or I would go out and buy, but some of these inputs can also have- feed into things that are useful for military purposes, or national security purposes. That’s why they’re put on these potential export control lists.

To help expedite the trade in those types of potentially sensitive products, it’s kind of the countries that are allies sign up for something called, or are part of something called a Wassenaar arrangement. That’s kind of a big, multilateral deal helping to address concerns over export controls. And that’s what’s potentially breaking down here. These two countries not getting along with one another at the moment means they’re starting to not treat each other like they would the other major economies that they would get along with, and have economic, and military alliances with like the United States, like Europe, like Canada. I think that’s a very different set of trade rules, these export control rules than is necessarily the case of the rules that come out under the WTO, or even free trade agreement, because it starts to spill into this area of national security.

There’s an element of national security in this issue between South Korea, and Japan, right? Where Japan believes that some of the exports that it’s shipping to South Korea might getting into the hands of North Korea. I wonder, can you talk a little bit about that, and whether there’s any truth to that, or whether that’s a smokescreen?

It’s hard to tell. It certainly is the justification that the Japanese government is giving for this particular action. Whether there’s a lot of evidence to be able to back that up, or whether that’s something that there’s always a little bit of that kind of thing that’s going to be happening, and now it’s just, “We’re really going to put our foot down, and enforce it, because we have these other reasons.” I mean, I think that’s the really, really big question. There always is a question, I think, about leakage when it comes to export controls, and so I think what’s just really new this time around is perhaps focusing on enforcing it, and focusing on enforcing it at this particular moment of time of political tension.

So, Chad, how does this incident reflect the much broader complexities of escalating trade tensions that have primarily been viewed in the context of the U.S.-China trade war? Can you talk a little bit about how the shifting current attitudes, and norms may be fanning these flames?

Yeah. I think that’s a good point. I mean, to be clear, Japan and South Korea, over the last- even since the 1965 treaty that has kind of normalized relations between them, relations aren’t always great between these two countries. There’s a lot of political tension between them dealing with their historical problems with one another, dealing with other challenges in the region: how they may face the national security challenges of the North Korea, and the nuclear threat there differently. South Korea shares a border with North Korea, whereas Japan doesn’t. How they feel as though they need to interact with China, the big, big economy on the block. They don’t always line up necessarily the same way.

The one thing that they’ve had historically in common is this military, and arguably, economic alliance with the United States. So, when they weren’t necessarily getting along with each other, they did have the United States in common as sort of a source that was, at least in the background, providing some discipline, and not getting the bilateral tensions between the two countries, not letting it escalate, and perhaps get out of hand.

Arguably, the United States’ own actions have opened up the door for other countries to mimic that. That’s part of how one might interpret what Japan is doing here. This isn’t to say there aren’t underlying issues between the two countries, but by turning these non-trade issues into these… “Now, we’re going to make it be about export controls, and national security.” There are hints, and similarities with what we’ve seen happen coming out of the United States.

So, not even considering specific examples that you just mentioned, but just taking a step back, and just thinking about it from the perspective of a greater focus on bilateral negotiations, whether they’re between the US, and Mexico, or the US, and South Korea, does that sort of focus on bilateral versus more regional, and global agreements, which had been the norm post-World War II in general, does that open up a lot of these negotiations to these sort of completely unrelated political, social, cultural issues?

It could. I mean, I think it may just be though that the current administration’s not engaging with these two economies in Asia in the same way, and kind of being very confrontational toward each of them at various moments in time. That then can make other countries say, “Well, we’re getting bullied by the United States. Who do I have the opportunity to go out, and bully myself?” That’s a little bit of a concern here.

Now, one other interesting angle though, on the trade front, South Korea and Japan, they don’t have a free trade agreement between each other, but there was some talk that South Korea might be interested in joining the CPTPP (Comprehensive and Progressive Agreement for Trans-Pacific Partnership), which was the follow on agreement after the TPP that the United States had negotiated with 11 other countries in the Asia Pacific region. Japan is part of this deal, Canada, Australia, Mexico. South Korea was interested in potentially acceding to that deal. There’s a concern now that because of the tensions between the two countries, the talk of that, of potentially those two economies perhaps choosing to get along, and having a trade deal in that vein might not be happening, as well.

Yeah. I would imagine it’s difficult now, because in a lot of ways, Japan has taken up the mantel of putting that deal together, right? I mean, if you have one of the key leaders of this new negotiating round antagonizing a potential new entrant to the conversation, it makes it a little difficult to find a way to resolve a dispute.

Yeah. That’s exactly right. I think politically now- what’s different about the CPTPP agreement is there’s an accession process. Other countries are welcome to join, but they basically just have to sign up to the existing deal that everyone else has already agreed to. You don’t really get to negotiate, and say, “Well, I want that piece of the deal. I don’t want that piece of the deal.” It really would be South Korea acceding to the demands of the existing CPTPP members of which the leader is Japan. When Japan is being seen politically within South Korea to be engaging in this kind of behavior, a little bit of bullying, it’s almost impossible for politicians to say, “Well, then let’s go agree to whatever Japan’s terms are as part of some future trade deal.”

Chad, maybe as we wrap up, and maybe ask you to kind of look out to the future, a lot of people view the general trend towards globalization post-World War II as maybe the second such globalization in modern world history, and the first would be the one that preceded the first World War, and the wake of the Industrial Revolution, and evolving economic thinking on the gains from trade. Do you see any resolution to the broader trade tensions in the midterm that doesn’t involve a relatively more close trade from a regional and global basis?

I guess, in the context of the TPP, and the successor, I mean, one way I’ve previously thought about this is if it were successful, I guess historical allusion, maybe this is a bit random, buy the Holy Roman Empire, where you don’t know what’s going on back in Rome, but somehow a new center of power, and a number of countries that were previously allies, or client states of the center, decided, “This is actually a good framework. We should keep going with it.” D How would you handicap the next few years, or the next decades in terms of trade movements? Are we going to see a regression, is this just a temporary issue?

Yeah. I think that is the really big question, and I think this is the critical moment, the next couple of years, I think, in particular. It hasn’t been all bad despite the activities of the United States in this area. You do have some positive signs out there. Up until this incident, Japan actually had been showing leadership in the trading system. They had signed their own free trade agreement with the European Union, which was kind of a big deal politically. They were partially responsible for leading the TPP into going into effect with only the 11 countries that remained after the United States left with the Trump administration.

The European Union is continuing to negotiate, and sign free trade agreements, not only the one with Japan, they’ve recently pushed through one with Canada, and announced one even with the major South American economies that have historically been very, very protectionist- Brazil, and Argentina. There are some positive signs that, despite the United States pulling back, other countries are pushing forward.

But that being said, we’ve obviously witnessed, and we’re still witnessing what’s happening with the United States, the US/China trade actions, the Trump administration renegotiating the USMCA agreement, the new NAFTA agreement with Canada and Mexico, that in a way is ultimately seeking to reduce the amount of trade between the three countries, move more production, in particular sectors like automobiles, back to the United States, and out of Mexico, out of Canada. The tariffs they’re doing on steel, and on aluminum, that they’re threatening on autos, that they’re threatening on Europe, on Japan.

One follow-up there, I mean, thinking about the historical comparisons, and this is getting a little bit into political economy, but do you need a superpower, or a hegemon to lead a group of nations into new trade agreements? Is it harder to get to a consensus when you don’t have that sort of leadership from a great power? Incidentally, while the U.S. cares a lot about trade, I mean, it’s not necessarily as big a part of its economy as other countries. And so to a certain extent, as you’ve already alluded to, and we’ve discussed, I mean, this is about bigger geopolitical issues, and strategies. I’m just wondering, do you think that’s a prerequisite for progress, having an engaged superpower?

Yeah. I mean, I just don’t think that we know. We don’t have historical evidence really that it’s worked without it, but that being said, I’m not sure we can draw all future-

Sure. A small sample size-

Exactly… conclusions about what’s going to happen in the future based on what’s happened in the past. I’m not willing to rule it out. I think getting to an open system is going to require not having a hegemon, because simply the United States isn’t going to play the same role economically in the global economy as its played for the last 50, 60, 70 years. There’s other economies out there that are growing, and the US is just a much smaller share.

It’s still going to require leadership arriving somehow. If it’s not going to be the United States, is it going to be able to be put together by a coalition of countries? I think that really is a big, open question. We haven’t really seen it happen historically, but I’m an optimist. Other countries may be willing to try to take up the challenge. At least, I’m hoping so.

Well, this has been great, Chad. We really appreciate your time today.

Thanks for having me.

Thanks, Chad.

We hope you enjoyed today’s conversation with Chad. For more episodes like this, you can find us on iTunes, Google Play, Stitcher, and Spotify. If you like what you hear, please leave a review. Feedback from listeners like you will help more people find us, and for even more content, look up our Pacific Exchange blog, available at FRBSF.org. Thanks for joining us.