Have Japan and South Korea just opened a new front in the global trade war? Many seemingly think so, especially after Tokyo slapped Seoul with export restrictions impacting semiconductor production—a major South Korean industry. Some now fret the potential ramifications for two of Asia’s biggest economies as well as global Tech. While harsh rhetoric may stir headlines, the broader economic fallout is likely limited, in our view.
Some argue the row is rooted in Japan and South Korea’s tenuous historical relationship. Japan ruled Korea as a colony for most of the 20th century’s (tumultuous) first half. Today’s dispute revolves around two groups of Koreans, conscripted labor and “comfort women,” victimized in World War II atrocities—and whether Japan has paid adequate reparations for its actions. Japan argues the 1965 treaty with Korea that established diplomatic ties and provided monetary compensation settled the issue. South Korea disagrees and seeks more compensation.
Perhaps that seems like ancient history, but many think it is impacting Japanese export policy now. Last year, South Korea’s Supreme Court ruled a Japanese firm must pay South Koreans for forced labor during the war. Japan rejected this ruling, and when Tokyo announced recent export controls on photoresist, high-purity hydrogen fluoride and fluorinated polyimide,[i] many pundits—and Koreans—saw it as retaliation. Japan denies this, arguing the controls aim to ensure these materials don’t wind up in North Korean hands. The Japanese and South Korean governments are now squabbling, with both sides threatening harsher action to come (e.g., Japan removing South Korea from an export “white list” of countries with minimum trade restrictions). The dispute has enflamed passions among the citizenry as well. A majority of Japanese supports the restrictions while Koreans are organizing boycotts of all things Japanese.
Given both economies’ important roles in the global Tech supply chain, pundits have fretted the broader industry fallout. As trading partners, Japan is South Korea’s sixth-largest export market and fourth-largest import market—and vice versa for South Korea.[ii] Industry-wise, semiconductors comprise about 20% of South Korea’s total exports.[iii] Some estimates say Japan supplies over 90% of the three restricted materials to South Korean Tech companies. Given recent semiconductor demand weakness—exacerbated by other factors, including China’s shadow banking-related slowdown—Japan’s sanctions hit South Korea where it already hurt.
However, a deeper look suggests the restrictions aren’t as onerous as headlines make them seem. They don’t outright prohibit Japanese firms exporting the three raw materials to South Korea. Rather, Japan has stripped South Korea of its fast-track status, which it has enjoyed since 2004, and reverted back to rules consistent with international standards. Said another way, Japan’s new treatment of South Korea is akin to how the EU treats South Korea now. While pundits balk at the 90-day review timeline, export approvals take 20 – 30 days in practice—suggesting the time lag may not be as bad as feared.
While this and other potential restrictions could be a lingering headwind for South Korean exporters, the broader fallout looks limited right now. Companies have enough inventory to sustain production in the short term. A longer-lasting dispute could weigh on South Korean firms’ earnings and knock exports—potentially carrying downstream effects on the global Tech supply chain. Yet this isn’t an automatic negative for markets today, especially given how deliberately and publicly this dispute is playing out. Moreover, firms won’t wait to adapt if the regulatory environment darkens further—they are likely already evaluating existing supply chains and considering workarounds should restrictions continue. We have seen this happen during the US-China trade tussle. While the diplomatic row could drive uncertainty, little is likely to sneak up and shock companies—dampening surprise power.
Now, while talk of history and North Korea are the common explanations many cite for Japan’s action, there is another potential motivator: politics. Japanese Prime Minister Shinzo Abe likely benefits from taking a tough stance on South Korea. With a Diet Upper House election next week, nationalistic rhetoric could help bolster support for Abe’s ruling coalition, which looks likely to win a solid majority. Talking tough on Korea could be an attempt to ensure that happens.
While nothing is gameable right now—it wouldn’t shock if tensions escalated in the short term—harsh talk and limited actions don’t seem like irreconcilable differences. For long-term, globally minded investors, focus on the probabilities, not possibilities. Tensions between Japan and South Korea are neither new nor likely to disappear any time soon. Other geopolitical rows—from Saudi Arabia and Iran[iv] to Turkey and Russia[v] to China and Japan’s territorial disputes[vi]—have grabbed headlines over the years, too. But bull markets don’t need the world to be perfect to rise.
H/T: Fisher Investments Research Analysts Mark Deault, Galen Donaldson, Charles Dornbush and Austin Fraser
[i] Three chemicals used in semiconductor production.
[ii] Source: FactSet and Korea International Trade Association, based on annual import and export values for 2018.
[iii] Source: “Memory Chip Prices Soar as South Korea-Japan Dispute Escalates,” by Edward White, Song Jung-a, and Robin Harding, Financial Times, as of 7/16/2019. https://www.ft.com/content/f9f6a460-a7a4-11e9-b6ee-3cdf3174eb89
[iv] “Saudi Arabia and Iran’s Rivalry Is Key to the Middle East in 2018,” Kareem Shaheen, The Guardian, as of 1/4/2018. https://www.theguardian.com/world/2018/jan/04/2018-saudi-arabia-iran-rivalry-key-middle-east-year-ahead
[v] “NATO-Russia Tensions Rise After Turkey Downs Jet,” Neil MacFarquhar and Steven Erlanger, The New York Times, as of 11/24/2015. https://www.nytimes.com/2015/11/25/world/europe/turkey-syria-russia-military-plane.html
[vi] “Why China, Japan and Korea Fuss Over Tiny Islands – 4 Things to Know,” Tim Liao, The Washington Post, as of 4/17/2018. https://www.washingtonpost.com/news/monkey-cage/wp/2018/04/17/why-japan-is-making-a-big-fuss-over-tiny-islands-4-things-to-know/?utm_term=.a05e86b0cb70
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