Korea's decoupling with China

By Peter S. Kim

For the past couple of weeks, global financial markets saw a relief rally in hopes of a resolution to the war in Ukraine and stability to inflationary pressures. Most importantly for Asian markets, the Chinese government calmed investors with some supportive language regarding the political clampdown on large corporations.

Long before Russia invaded Ukraine, China made a pivot away from decades of globalization pressured by the U.S. Even before the U.S.-China standoff, South Korea saw a preview of China's abrupt departure from the international community ignited by its decision to place a Terminal High Altitude Area Defense (THAAD) system in 2016.

During his election campaign, President-elect Yoon Suk-yeol declared his support for the controversial THAAD system, already causing frosty responses from China. South Korea's decoupling with China is set to accelerate politically and economically under the new conservative president.

North Korea started testing its nuclear weapons in 2006, but it was not until its successful testing of a long-range intercontinental ballistic missile (ICBM) that the U.S. awoke to the real dangers of North Korea's nuclear capabilities to the U.S. mainland.

Just before the last conservative president was dismissed in 2017, the U.S. hurriedly placed its THAAD system as a deterrence to North Korea. However, China accused the U.S. of directing its THAAD against the mainland rather than North Korea. Even more worrying than the saber-rattling from North Korea has been China's sanctions against South Korea and its companies.

Since the THAAD issue first broke out, China has placed South Korea on a "silent sanction" list via measures like banning group tours. Lotte Group, which supplied the land where the THAAD battery is deployed, was eventually forced to withdraw all of its operations from China due to unsustainable business conditions.

As a result, Korean companies operating on the mainland have sought opportunities outside of China in the past few years. South Korea's experience with THAAD and China could serve as a "canary in the coal mine" for many other countries, as China has continued to escalate its sanctions and reverse its market reforms.

Under the banner of "common prosperity," China is scrutinizing not only companies operating in its territory but also its national champions. It seems President Xi Jinping has only time for ardent servants of the communist party while being ready and willing to purge dissenters.

To be fair, a similar response is seen from the U.S. and its allies. After many decades of a globalization boom, the era of a rules-based international law and trade is reversing before our eyes.

Historically, Korean exporters were known for their aggressive boom-bust approach, which helped them establish dominance in many cyclical industries like construction, chemicals and semiconductors.

The emergence of China, armed with massive government support, has taken away Korea's advantage in many industrial products. Also, Korea's rising GDP and wages have turned the country into an expensive labor market for manufacturing. Within less than a decade, China has turned from Korea Inc.'s largest customer to an emerging competitor.

Such a turnaround is unprecedented in history, considering it took Korea more than 40 years to overtake Japan on a similar mission. With an intensifying global competitive landscape, Korea Inc. will have to find industries befitting a developed economy.

Since the THAAD decision, Korea's listed stocks focused on China have suffered while the Korean stock market reached historic highs. Initially, political backlash from the Chinese government was declared as the reason, but more damaging was China Inc.'s rapidly improving products and "import substitution" that ensued.

Even Samsung has seen its mobile handset business in China dwindle, with its market share now at below 2 percent from 20 percent just a few years ago. Likewise, Hyundai's automobiles have slipped to the lower-end segment, where some local brands are considered higher in terms of brand positioning.

Reminiscent of Korean exporters' pricing strategy, Chinese products pursue market share gains with the potent combination of improving quality and aggressive pricing. Most recently, even Korean cosmetics brands are seeing the locals attacking their market position.

The economic transition from old to new has been difficult for Korea's egalitarian society, which still holds a strong ideology of income equality coupled with uninterrupted growth. Fortunately, Korean companies have been looking for alternatives to China as a consumer market and manufacturing base.

As replacements for China, markets like India and Indonesia are now the focal point for overseas expansion. The transition will be slow, but they are ahead of many other multinationals still looking to China for future growth. China's political positioning over the Russia-Ukraine conflict will be critical in deciding its place in global trade. China's political decisions in the coming months could determine the pace and scale of the South Korean economy's decoupling with China which is already on course.

Peter S. Kim (peter.kim@kbfg.com) is a managing director at KB Financial Group.