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Introduction Over the last several decades, governments have collectively pledged to slow global warming. But despite intensified diplomacy, the world is already facing the consequences of climate…
Coordinating U.S.-South Korean Approaches Toward Supply Chain Resiliency
The fifth workshop for the project on Bolstering U.S.-South Korean Cooperation to Meet the China Challenge examined how the United States and South Korea should strengthen policy coordination on supply chain resiliency.
Introduction: Reshaping the Global Supply Chain
The current strategic competition between the United States and China has highlighted the importance of economic security, particularly as countries with major economies have changed the international trade environment by reorganizing their supply chains. In recent years, countries have embarked on strategies to diversify their supply chains, including by strengthening their own productive capacities.
The existing global division of the labor system—in which firms share the process of product planning and design, procurement of raw materials and components, processing and production, and final delivery—has been a product of globalization since the 1990s. Among other things, the development of information and communication technology, the collapse of the U.S.-Soviet Cold War system, the advancement of free trade agreements, and the integration of the European Union have served as the backdrop for increased globalization and the development of global supply chains. Based on their respective comparative advantages and market choices, the United States and China have deepened their shared division of labor, enhanced complementarities, and established a mutually beneficial relationship by the U.S. focusing on high-value-added sectors and China on low-value added sectors.
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However, an efficiency-driven division of labor is not always a good thing. Force majeure factors, such as natural disasters and deliberate policies, can significantly disrupt supply chains. At the beginning of the COVID-19 outbreak, for example, China banned the export of masks, and after the COVID-19 vaccine was developed, the United States controlled the export of the vaccine. In other words, the international division of labor for critical materials opened everyone’s eyes to the risk of nationalism in emergencies.
The recent emphasis on building secure supply chains can be traced to the recognition of this vulnerability. Building resilient supply chains inevitably comes at an additional economic cost, as it necessitates redundancy. For companies whose goal is to maximize profits, building additional domestic production facilities, stockpiling large quantities of commodities, and developing human resources for an unlikely crisis does not always make sense. Markets naturally favor the lowest-cost supply chains, and governments have to pay the price by encouraging the private sector to diversify their supply chains, even if it means incurring higher costs. Reorganizing global supply chains can also be risky. Both businesses and governments have to incur opportunity and friction costs—the breadth and depth of which are difficult to gauge—and countries could fall into protectionism and try to pass on their own costs to others.
CFR Workshop
The Council on Foreign Relations held a virtual workshop on November 28, 2023, on “U.S.-South Korea Policy Coordination Toward China on Supply Chain Resiliency.” The workshop’s major takeaways include the following:
- The United States and South Korea share the same broad policy goals in the context of China: both wish to widen the technology gap to the point where China cannot substitute imports with indigenous semiconductors. However, the logic of the two countries is different. South Korea wants to widen the gap to keep its industrial competitiveness over China, an economic reason, while the United States is motivated by national security. The semiconductor industry is particularly difficult, as the division of roles makes each countries’ economic security interests different. The United States’ strength is in equipment, which it can sell regardless of the location of fabrication. South Korea’s strength is in manufacturing, but many of its fabrication plants are in China. If South Korean companies have to relocate their fabs, it will have huge costs. While the United States is focused on containing China, both countries should think more about how they can leverage China to strengthen their supply chains.
- South Korean companies have begun to recognize that help from the government is increasingly important for navigating U.S.-China competition. However, the main actor is still the private sector, which is reorganizing supply chains, developing new technologies, and investing in strategic industries. Therefore, public-private partnerships are more important than ever. The extent of business-to-business cooperation between the United States and South Korea remains a question.
- Workshop participants were concerned that the current fragmentation of the global trading environment could lead to slower trade and investment growth, which, if prolonged, could prompt a loss of global growth momentum. Simply put, the international division of labor and supply chain systems that is built on trust between countries could collapse. The International Monetary Fund (IMF) warns that the global economy is facing its greatest test since World War II. A recent report by the IMF notes that the cost of investment fragmentation could lower the global gross domestic product (GDP) by 1 percent, and more than double that for China’s GDP. It also warns that trade and technology fragmentation could be even more damaging. The cost of reduced global output from trade fragmentation ranges from 0.2 percent to as much as 7 percent in a limited fragmentation scenario. When technological decoupling is added to the mix, the report suggests that output losses could be as high as 8 to 12 percent in some countries. Countries will likely have to consider how far and how long they can afford to take economic losses.
De-risking and a Fragmented Global Economy
If there is one word to describe the goal of supply chain reorganization policies in major countries, it is de-risking, which is defined as reducing the probability of being exposed to risks. Therefore, de-risking is a goal for all countries, not just a select few.
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In recent years, in the absence of international rules such as those of the World Trade Organization (WTO), countries have been basing their trade, investment, and cooperation decisions on whether they trust each other. In the context of supply chain reorganization, countries increasingly emphasize technological independence, reshoring, and the promotion of indigenous material components and equipment to become more self-reliant.
This trust-based reorganization of supply chains is leading to geoeconomic fragmentation. In April 2023, the IMF reported blocked outward investment in strategic industries, while the WTO highlighted blocked global trade in its annual report in August. Looking at trade and investment data, it appears that the global economy is beginning to experience a value- and trust-based blockade.
Governments are deliberately reshaping the global trade order through domestic industrial policies. The challenge is to minimize additional costs. On top of the U.S.-China conflict, the green and digital transformation is causing supply chain restructuring. The focus on environmental, social, and corporate governance is forcing companies to find the “best cost”—which takes into account geopolitical and geoeconomic factors—rather than just the lowest cost. In the rapidly changing global trade environment, this is inevitably confusing.
Currently, the centerpiece of U.S. strategy toward China is selective decoupling, a so-called “small yard high fence” strategy. The problem for South Korea is that many of its critical industries overlap with the “limited areas” selected by U.S. National Security Advisor Jake Sullivan, such as advanced semiconductors and green technologies (including electric vehicle batteries). In addition, the EU has been emphasizing the fight against climate change and has proposed various policies, such as the Carbon Border Adjustment Mechanism, to achieve its decarbonization goals. Korean companies are concerned about whether those measures are purely to combat climate change or a means to protect European companies. China has also adopted an asymmetric decoupling strategy, intended to makes it less dependent on the world and the world more dependent on China. Indeed, since 2015, China has been steadily reducing its share of imports from South Korea (see figures one and two). If this were done in a transparent and fair way, South Korea would not have any concerns, but South Koreans suspect the Chinese government could be strategically substituting South Korean goods through nontransparent and unfair government support.
Because countries have different industrial and trade structures, they have different perceptions of economic security risks and what measures to take to mitigate them. Centrally, they should ask whether de-risking measures are coordinated to avoid harming allies and similarly positioned countries. Given that the era of economic securitization has only just begun, this seems unlikely. Some have argued that a rules-based order is needed, but there is no consensus on what those rules should be. It would be nice if the new rules were as inclusive as those of the WTO, but in an era of U.S.-China strategic rivalry, this could be an unattainable, naïve hope.
This situation underscores the importance and necessity of minilateral cooperation, especially bilateral cooperation. For example, when Japan tightened export controls on semiconductor materials in 2019 to target South Korea’s semiconductor industry, South Korea did not resolve the issue through the WTO, but through the normalization of bilateral relations with Japan. In 2021, shortages of urea supplied by China to South Korea were also quickly resolved through dialogues between the Chinese and South Korean governments. Regarding the October 7, 2022, U.S. semiconductor export restrictions on fabrication plants in China, South Korea also received an indefinite exemption through the Validated End-User program, which was a result of bilateral negotiations between the United States and South Korea.
U.S.-South Korea Cooperation in the Era of Economic Security
On its seventieth anniversary, the U.S.-ROK alliance has evolved from a military-security alliance to a comprehensive alliance that encompasses economic security. The visit of the two countries’ leaders to the Samsung Electronics semiconductor factory in Pyeongtaek, South Korea, shortly after the inauguration of President Yoon Suk Yeol in May 2022 symbolized that economic security had become an important pillar of the alliance.
In a rapidly changing international environment, the United States and South Korea are facing new challenges, and close bilateral cooperation is more necessary than ever. With the U.S.-China strategic competition in mind, the Joe Biden administration has begun to analyze its own vulnerabilities and implement complementary policies in various ways. Immediately after his inauguration in January 2021, Biden issued an executive order to analyze supply chain vulnerabilities for four key products—semiconductors, batteries, rare metals, and pharmaceuticals—for one hundred days as a priority. In February 2022, another report was published on the supply chain status and countermeasures against supply chain vulnerabilities in six major industries related to defense, health, information and communication technology, energy, logistics, and agricultural products and food.
In 2022, the U.S. government took practical actions in each sector. In particular, it focused on the main areas reviewed in 2021: the CHIPS and Science Act for semiconductors, the Inflation Reduction Act for batteries and rare metals, and the BIO Executive Order 14081 (Advancing Biotechnology and Biomanufacturing Innovation for a Sustainable, Safe, and Secure American Bioeconomy) for pharmaceuticals—all of which took effect in August and September 2022. South Korea is concerned that the United States has shown its own nationalistic tendencies in implementing those recent economic security laws, including requests for excessive financial, supply chain, and information technology sharing, and the implementation of discriminatory provisions that subsidize only North American–made vehicles.
Conclusion
The United States and South Korea should take the following steps to coordinate their respective approaches toward supply chain resiliency. First, redundancy is critical. Diversifying supply chains by building redundancy in domestic and international supply chains is a response strategy that all major countries are adopting. However, rather than blindly pursuing reshoring, the United States and South Korea should actively utilize strategic friendshoring to minimize inefficiencies. Second, adaptability is essential, especially in the event of a crisis. The two countries should aim to respond quickly through stockpiling and modularization, which can be accomplished by sharing standards and making their products compatible. Third, the United States and South Korea should build transparent and short supply chains and maintain continuous monitoring to identify disruptions in advance. Fourth, the two countries should prioritize sustainability by improving access to financing in times of crisis and expanding talent and research and development. This will help companies to build up their capacity to respond flexibly in the event of a supply chain disruption.
The convergence of economic and security concerns among major countries underscores the importance of coordination and cooperation in supply chain resiliency, reducing the costs associated with de-risking and industrial policies, and reducing trade-related miscommunication. The South Korean government should strengthen economic security approaches to pursue tangible projects with the United States and jointly develop future markets.
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Wonho Yeon is a research fellow and head of the economic security team at the Korea Institute for International Economic Policy.