By Bok Deuk-Kyu of the Samsung Economic Research Institute
Fresh signs of the Chinese economy regaining its footing won’t necessarily lead to a huge windfall for Korean exporters. China is the top destination of Korean exports but structural changes have made selling Korea’s vital intermediate goods to China an increasingly tough challenge. The negative impact on the Korean economy is expected to mushroom, creating an urgent need for industries to devise pre-emptive measures.
In August, China accounted for 28.5 per cent of Korean exports. Some 80 per cent of the shipments were intermediate goods, but their future use in China-based production lines appears increasingly precarious.
The inability of Korean suppliers to catch much of China’s tailwind stems from the rising competitiveness of Chinese intermediate goods, which has pushed them to the top of the global export market since 2010, outpacing the US and Japan. This is evidenced in both macro and micro-economic data.
The Trade Specification Index of Chinese parts and materials shows at a macro level their decisive entry into the global market. The index for materials climbed from -0.16 in 2005 to 0.66 in 2012, while the index for parts grew from -0.09 to -0.04 during the same period. Although the figure for parts is still in negative territory, it has steadily risen since the mid-2000s.
Similarly, micro data illuminate the share of Chinese-made intermediate goods sourced by Korean companies in China. The share went up from 40.7 per cent in 2005 to 62.4 per cent in 2010. In contrast, imports of intermediate goods from Korea declined from 42.9 per cent to 24.5 per cent.
When foreign manufacturers begin operations in China they import most of their intermediate goods from their home countries. But once established they increasingly procure Chinese versions, especially appreciating their price competitiveness. For example, among Japanese companies in China the share of locally-sourced intermediate goods was 55 per cent in 2012. (The share sourced from Japanese companies operating in China was 37 per cent.) Korean producers in China also are increasingly using locally-made parts and materials from Chinese companies.
The competitiveness of China’s intermediate goods industry is being felt in Korea’s mainstay industries, such as display panels and cars, as well as in new industries such as polysilicon and materials for rechargeable batteries, and “primary industry” sectors such as machine tools.
Chinese suppliers, with support from government policy, are securing technologies through various channels, merging with and acquiring foreign companies, and conducting joint research with universities and research institutes. The firepower delivered when these factors converge was displayed this year in China’s solar cell industry. Investment in the industry and price cuts forced solar cell companies across the world to reduce production or restructure.
Korea will feel the impact in various ways. Intermediate goods producers in Korea obviously may suffer falling export volume to China. Korean suppliers will face more and more difficulty in competing against their Chinese peers, who have government assistance and a huge domestic market that can deliver economies of scale. Their ability to generate excess supply can drive down prices, deterring competitors. And China has become competitive in low-end products of the primary sector. This is seen in Thailand, where Japanese automaker Honda has installed Chinese machine tools on its production line.
Korean intermediate goods suppliers need to shift their approach in China. An all-out war against their Chinese competitors would be ill-advised. It would likely cause oversupply of parts and material, causing prices to nosedive, and foment trade friction.
Instead, they should focus on raising the quality and technological standards of parts and materials to the point they become a de facto industry standard and therefore a barrier to market expansion or entry by Chinese companies. This would help achieve steadier sales and confine competition to crucial parts and materials and equipment.
The Korean government should play a role by improving the business environment for the manufacturing sector. This could be in the form of lower utility fees and tax breaks, helping nurture talent and proving R&D assistance.
Bok Deuk-Kyu of the Samsung Economic Research Institute is a senior fellow at the Samsung Economic Research Institute
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