Testimony of

L. Gordon Flake

Executive Director,

The Maureen and Mike Mansfield Foundation

Before the

Commission on U.S.-China Economic and Security Review

Public Hearing on

“China’s Growth as a Regional Economic Power: Impacts and Implications.”

Thursday, December 4, 2003

Summary

The opening of economic relations with China has been a considerable boon for South Korea.  To date, the rapid expansion of Korea-China trade and investment has had few economic or political downsides for Seoul, but has instead been the source of considerable growth and stability for Korea’s economy.  However, longer-term concerns over the growing competitiveness of Chinese firms, the hollowing out of Korea’s manufacturing sector, and an increase in China’s regional political and diplomatic clout commensurate with the growth of its economy compete with the potential presented by the growing Chinese market to cloud the future.

Recent Trends

The development of economic relations between South Korea and China over the past decade has been dramatic.  At the beginning of the 1990s, China was a relatively minor trade partner for South Korea, yet by the end of this year China will have become South Korea’s dominant partner in trade and investment. 

While the security situation on the Korean peninsula remains essentially unchanged since the Korean War and the onset of the Cold War, South Korea’s economic relations with its wartime adversary have been completely transformed.  According to KOTRA (The Korean Trade-Investment Promotion Agency), in July 2003 China surpassed the U.S. as the largest destination for Korean exports.  Earlier this year China claimed the top spot from the U.S. as a destination for Korean foreign direct investment, and by end of 2003 it is likely that total annual trade between Korea and China will exceed total trade between the Korea and the United States. 

Such developments are all the more remarkable in light of the fact that South Korea and China only normalized diplomatic and economic relations in 1992.  The truth be told, however, when Korean trade with Hong Kong and Taiwan (much of which is actually destined for or emanates from China) is factored in, these milestones were actually passed much earlier.  In numbers, direct bilateral trade between Korea and the PRC has gone from $4.4 billion in 1991, the year before the normalization of relations, to $41.1 billion in 2002 and has already reached $39.8 billion in just the first three quarters of 2003.  (Source KITA—Korea International Trade Association.  www.kita.org)

Overall Korea-China trade has averaged more than 20 percent growth year-on- by year for the last decade, and most economists predict that even with moderate rates of growth in China’s economy, bilateral trade volume will more than double to over $100 billion annually by 2010 if not earlier.

The driving factors behind these trends are not difficult to understand.  Much of recent South Korean economic growth has been driven by record levels of consumer spending, and Korean consumers are buying up the same low-costs goods from China to which we in the U.S. have become so addicted in recent years.   On the other hand, China’s rapid economic development and growing middle class have been snapping up relatively more expensive and higher tech Korean products. 

On the investment front, Korean firms have been attracted by the same low wage work force that has made China the world’s largest destination for foreign direct investment. China’s natural attractiveness for investment has been accentuated for Korean firms by China’s relatively close proximity and the existence of a ready-made work force in the form of Korean-speaking ethnic minorities in China.  Of course, Korean firms primarily want to invest in local production to take advantage of labor costs and position early for name recognition and market share in the rapidly increasing Chinese domestic market.  In this regard, Korean firms have been remarkably successful at riding the Chinese “wave.”

According to the Korean Ministry of Finance and Economics, 34% of the total amount of outward Korean investment (US$5.06 billion last year—on an approval basis) was destined for China.  Total Korean investment in China in 2002 was US$1.72 billion.  As indicted earlier this amount for the first time surpassed Korean investment made in the United States, which totaled US$1.37 billion in 2002.

The expansion of Korea-China economic relations has been accompanied by and in many cases facilitated by the normalization and acceleration of Korea-Chinese political and diplomatic relations. Following the initial success of South Korea’s Nordpolitik under President Roh Tae Woo, successive South Korean administrations have made the improvement of bilateral relations with China a top priority.  The level and frequency of high level exchanges, which have even included top level defense officials, have steadily increased and stand in sharp contrast to the strained and seemingly anachronistic relationship between China and its wartime ally, North Korea.  By any possible measure, relations between South Korea and China far surpass those between China and North Korea.  While much attention was lavished on Kim Jong Il’s train treks to Beijing in May of 2000 and January of 2001, the next generation of Chinese leaders as embodied by President Hu Jintao and Premier Wen Jiabao is reported to have little affinity for or even patience with North Korea.  In contrast, there has already been a summit between President Roh Moo-Hyun and PRC President Hu Jintao in July of 2003.

On a cultural level as well there has been a revival of traditional Korean interest in and in many cases affinity for things Chinese. Korean tourism to China has dramatically increased as has the bi-directional flow of pop culture.  In education alone there has been somewhat of a “China Boom” in Korea.  In 2002, the approximately 36,000 Korean students officially studying in China accounted for 44 percent of the total number (85,829) of foreigners studying in China.  Interestingly, despite having a much smaller population, the number of Korean students in China far outpaced those from Japan (16,084) or the United States (7,359).  Korean diplomats in China estimate that the actual number of Korean students in China, including those visiting on a short-term basis is actually much higher, perhaps as high as 60,000.  If accurate, this number would exceed even the number of Korean students in the U.S., which totaled approximately 49,000 in 2002.

This is not to say that the trend lines in Korea-China relations have been without friction.  South Korea has run a relatively consistent trade surplus with China and this coupled with Korean concerns about a flood of inexpensive Chinese products has led to trade frictions on both sides that have spilled over into the broader public realm.  Most memorable was the “garlic war” in 2002 where a Korean attempt to stem the inflow of Chinese garlic led to Chinese retaliation on much higher value Korean electronic imports and a rather hasty Korean retreat.  While China’s admission to the WTO has placed bilateral trade disputes in the context on international rules and norms, Korea has been the primary target of Chinese legal action on trade issues.

Implications

The opening of trade and economic relations with China was greeted in Korea with both trepidation and anticipation.   The potential embodied in the huge Chinese market and the prospects for the overall expansion of China’s economy have represented somewhat of a double-edged sword for Korea.  The expansion of the Chinese market is at once one of the major sources of growth for the Korean economy, while at the same time, Chinese firms are increasingly likely to compete with Korean firms both in the global marketplace and in Korea’s domestic market.

The implications of the Korea-China relationship, however, extend far beyond Korea’s domestic economy and include not only Korea’s role in the region, but also its relationship with the United States, and the all-important question of Korean Peninsula reconciliation.

Impact on Korea’s economy

Some Korean scholars have considered the opening of trade with China to be a “shock” to the Korean economy comparable to the “shock” experienced when Korea normalized relations with Japan in 1965.   As might be expected, this “shock” is viewed both with fear and as an opportunity.   One overriding concern, particularly in Korea’s manufacturing sector, is that China’s economic ascendance will inexorably lead to the hollowing out of Korea’s manufacturing sector.  Ultimately, the worry is that Korea will not be able to compete with Chinese competition both at home and abroad and that this will lead to the flight of Korea’s manufacturing sector.   These concerns have focused on China more than on any other significant trading partner such as the U.S. or Japan primarily due to cost factors and China’s geographical proximity to Korea.   To many Koreans, the “giant sucking sound” that Ross Perot heard coming from Mexico during the NAFTA debates can now be heard across the Yellow Sea.

Concern over the decline of manufacturing is of course not unique to Korea, nor is China the only recipient of Korean foreign direct investment or competitor for the market niches traditionally dominated by Korea.  However, the concern is particularly acute in Korea due largely to the fact that  despite its OECD status and its historic rates of development, it does not yet consider itself a fully mature economy, ripe for or prepared for the “hollowing out” that has impacted other more developed  economies.  In an August 30, 2003 report on the issue, the Samsung Economic Research Institute (www.seri.org) reported 1,800 cases of overseas investment by Korean firms in 2002 compared with 1,000 cases in 1994.  More significantly, the ratio of Korea’s total outward FDI to domestic facilities investment now approaches 10 percent.  To put Korean investment in China in perspective, even with China commanding the lion’s share of outgoing Korean FDI in manufacturing, the total amount of manufacturing investment in China by Korean firms still accounts for only around 5 percent of Korea’s domestic investment in manufacturing.

While still relatively small, the trend lines worry Korean analysts who point to the danger of the hollowing out taking place too early in this stage of Korea’s development.  For example, the Korean manufacturing sector “constitutes 29.6% of the nation’s whole economic output, hires 26% of the labor force, and its export takes up as much as 35% of the nations GDP.”  (SERI, Korean Economic Trends, August 30, 2003, www.seri.org) By contrast, the manufacturing sector constitutes approximately 13 percent of employment in the U.S. and 20 percent in Japan.

These concerns are not new in Korea.  They were commonly voiced in the early 1990s as the Korean footwear and textile industry fled, not just to China but throughout the region.  The concern then, which is mirrored today, is that Korea was stuck in a “mid-level technology pinch.” In this view Korea is struggling to keep abreast of China and other low-wage economies that continue to erode what was once Korea’s advantage in low-value added products, particularly in manufacturing.  While on the upper end of the scale, Korea is unable to compete fully with the most advanced economies in terms of technology.

Such concerns, however, tend to be longer term in nature.  Moreover, Koreans tend to view these trends as inevitable, even natural—ones that must be adapted to rather than fought.  As such, with the exception of a few minor trade disputes, Korean concern over its economy is not yet reflected in political relations between Korea and China. More intangibly, fear of Chinese competition is widely regarded within Korea to have been a primary motivating factor behind Korean economic reforms.  

In the short run, the positive benefits of the expansion of ties with China are undeniable.  While the relative portion of Korea’s trade with the U.S. and Japan has decreased, from a Korean perspective this trend represents a much-needed diversification of Korea’s export market.  In fact, Koreans widely credit the expansion of Korean trade with helping their economy to not only survive but thrive during the chronic downturn of the Japanese economy and the recent U.S. downturn.  Similarly, while not abandoning the U.S., Japanese or European markets, many if not most Koreans see their future as tied to the Chinese market.

Impact on Korea’s Foreign Policy

To date, China’s growing economic relationship with Korea has yet to translate into untoward Chinese political or diplomatic influence on Korean politics or diplomacy.  The relationship with China has not been in a vacuum, and Korea’s ongoing relationships with the United States and Japan, have provided a counterbalance.   Korea has also been one of the foremost supporters of international and regional institutions.  At any rate, the relationship with China remains largely economic in nature and while challenged in recent months, Korea’s primary security relationship in the form of its alliance with the United States, and by extension its relationship with Japan through the U.S. alliance, remains preeminent.

The impact on Korea’s economic diplomacy is likely more pronounced.  In recent years, Korea has envisioned a role for itself as the business and financial hub in Northeast Asia.  In this view it is squarely in competition with China, which sees Shanghai as taking on that role.  The more that Korean investment pours into China and the greater the expansion of China’s trade not only with Korea but also with the other countries in the region, the more difficult that it will be for Korea to lay claim to the title of “hub.”  More accurately, Korea will likely become a spoke of a Chinese hub.  This of course has longer term impacts for Korea’ role as China assumes a central position in the region and Korea’s economic fate is increasingly tied to China.  An alternate and perhaps more accurate view is that there will not be a single trade and investment hub, but rather multiple hubs and spokes resembling the U.S. domestic airline system.

Given modern history on the peninsula, the most obvious worry about Chinese influence on Korean policy would be how it affects the continuing divide of the Korean peninsula, and in particular relations with North Korea.  This too tends to be a sword that cuts both ways.  At present it is ironically the Republic of Korea that appears to be lobbying the PRC to work together against what they perceive to be a dangerous U.S. hard line toward the North.  Both South Korea and China are firm in their aversion to instability or conflict on the peninsula and are working together toward a diplomatic solution.  As Korean and Chinese positions are largely in sync, there is little room for China to use economic leverage to influence South Korean policy on the North Korea issue.  Conversely, South Korea can be considered to have greatly influenced the Chinese willingness to take a more active role in mediating the current crisis surrounding North Korea’s nuclear program.  To be sure, China would almost certainly not have taken such an active role without South Korean support or in the face of South Korean opposition.

If there is a political price South Korea has paid for its improved relations with Beijing, it is in the litmus test issues that China demands of nearly all of its relationships.  China has successfully pressured South Korea—which has a sizable Buddhist population—to forego visits by the Dalai Lama, and has of course been most sensitive about Korea’s relationship with Taiwan.  A further issue that is of particular sensitivity to China is the status of North Korean refugees in China.  While this issue is of particular concern to religious groups and human rights organizations in South Korea, the South Korean government remains ambivalent about the refugee flows to the point that it has yet to become a serious issue in Korea-China bilateral relations.

China-North Korea Relations

While the Commission has previously considered China’s relations with North Korea, it is still worth noting that despite the dramatic expansion of China-South Korea economic relations, China arguably maintains greater economic influence over North Korea than South Korea.   This is not due to significant levels of trade or investment—both remain moribund—but rather to that fact that China continues to provide North Korea with essential energy and food inputs.   This lifeline has never given China proactive influence over North Korea, as it was seen by North Korea as a Chinese effort to shore up its own interests by avoiding the collapse of North Korea and the resulting instability in the region.  Such key transfers of food and grain, however, do provide China with a negative or punitive influence over the North—something which until this year it was not willing to wield. The most noticeable shift in China’s position occurred this March when China apparently temporarily cut off its main oil pipeline to North Korea in a successful attempt to induce North Korea to attend three-party talks in Beijing regarding the nuclear issue.

Implications for United States

In conversations I had during a visit to Seoul three weeks ago, two prominent members of the Korean National Assembly from two different parties expressed their concern that the U.S. was ceding to China too large a role in addressing the North Korea crisis.  Their worry was that South Korea would get sucked back in to a traditional suzerain relationship with China.  Much of the Korean elite today are U.S. or Western educated and have fully bought in to the belief that South Korea’s interests are best served by maintaining a strong relationship with a great power that is “far away.”  While China holds an undeniable cultural allure for Koreans, the extent of this allure is also limited by the nature of China’s system and society.   As long as the process of opening, liberalization, and reform continue in China, and more importantly as long as China continues to grow economically, South Korea will inevitably be drawn closer to China.  That said, however, the extent to which Korea and its institutions have democratized should not be underestimated.  In its core values of democracy, human rights, the rule of law, and economic liberalism, Korea will likely remain much closer the U.S. at least until and if China more clearly pursues a similar path.

To date, the Chinese-Korean economic relationship has served as a backdrop for Korean interest in and affinity for China.  However, it is difficult to make the case that the relationship thus far has been a zero-sum competition with the United States for South Korea’s favor.  To the extent that there are serious problems in the U.S.-ROK alliance, and there are, they have more to do with changes in Seoul and Washington—particularly in regards to policy towards North Korea—than with the rise of China. 

Nowhere is the axiom “the only constant is change” more true than on the Korean peninsula.  Ultimately, the respective roles of the U .S. and China in either resolving or failing to resolve both the current nuclear crisis on the peninsula and the continuing division of Korea will be key determinants of future relations with Korea.