In July, Japan tightened its control of exports of certain materials for semiconductor production to South Korea. On Aug. 28, the government took further action and removed South Korea from its whitelist of nations granted preferential trade procedure.
South Korea responded to these actions by removing Japan from its own whitelist, and by declaring it would terminate the General Security of Military Information Agreement (GSOMIA) between the two countries. In the past, the GSOMIA has served as the framework for sharing defense intelligence on such matters as North Korean nuclear weapons and missile deployment.
Behind these developments is the smoldering issue of compensation for Koreans conscripted as wartime laborers for Japanese companies. In fall 2018, South Korea’s Supreme Court ruled in favor of the former laborers in cases brought against Mitsubishi Heavy Industries Ltd. and Nippon Steel & Sumitomo Metal Corp., and ordered the Japanese firms to compensate individuals for their labor. South Korean courts later approved the seizures of these firms’ assets in order to extract compensation for the plaintiffs.
The Japanese government has pushed for the third-party arbitration stipulated by the countries’ 1965 agreement on the settlement of problems concerning property and claims deriving from Japan’s past colonial rule of the Korean Peninsula, but the South Korean government has not complied with this request.
Japan and South Korea are bound together by dense ties of economic interdependence. Japan’s economy is three times larger than South Korea’s (the two countries have the third- and 12th-largest economies in the world, respectively). In terms of trade, Japan’s exports to South Korea comprise 6.6 percent of total exports, while imports from South Korea make up 4 percent of the total. By contrast, South Korea’s exports to Japan make up 5.3 percent of total exports, and imports from Japan total 9.6 percent of all imports. Japan thus enjoys a significantly favorable balance of trade.
South Korea’s dependence on Japan for semiconductor components and materials is a major structural factor in this imbalance. South Korea is home to Samsung and SK Hynix, the world’s second- and third-largest semiconductor manufacturers, respectively. Yet both manufacturers rely on Japan to provide much of their components and raw materials. Most notably, Japan controls 80 percent of the world’s supply of three materials needed in semiconductor production: fluorinated polyimide, resist and hydrogen fluoride.
According to estimates by the Korea Economic Institute, a 30 percent decrease in the supply of essential materials to Korean semiconductor manufacturers would result in a 2.2 percent decrease in South Korea’s GDP. The Bank of Korea (South Korea’s central bank) views Japan’s regulation of semiconductor-related exports to South Korea as one of three major risks facing the country’s economy.
Within the Japanese government, very detailed consideration was apparently given to the question of how to issue a “warning” to the administration of South Korean President Moon Jae-in. These deliberations centered around two questions: Where is South Korea’s “chokepoint” and what kind of leverage does Japan have over South Korea?
For example, while refusing to conclude the Trans-Pacific Partnership 11 or a currency swap agreement with South Korea would constitute “leverage,” many veteran finance experts believe that taking aim at South Korea’s vulnerable financial institutions is the best way of going for the jugular.
South Korea has a number of powerful industrial conglomerates, but their financial units are weak. Leading Korean enterprises, including Samsung, have borrowed enormous sums (in the trillions of yen) from the three Japanese mega-banks and other Japanese lenders.
During the Asian financial crisis of 1997-1998, the South Korean currency plummeted and the country suffered from a shortage of foreign currencies. Ultimately, the International Monetary Fund responded to South Korea’s appeals for relief by approving loan assistance to the country. At the time, the Japanese government used the Bank of Japan to channel ¥165 billion in short-term bridge loans to the South Korean central bank.
Notwithstanding South Korea’s obvious vulnerability, finance could prove difficult for Japan to “weaponize.” Doing so would inflict catastrophic damage on the South Korean economy. Not only would Japan also suffer the repercussions of this damage, but it would be subjected to worldwide criticism for its actions.
In the current dispute, the entanglement of historical problems with economic interdependence have left politicians in both countries struggling for a solution. As mutual irritation intensified, South Korea chose to weaponize history, while Japan has weaponized economic interdependence. This is the most distinctive feature of the current dispute. The administration of Prime Minister Shinzo Abe is attempting to use economic leverage to suppress the Moon administration’s flagrant demonstration of “moral superiority” over history issues.
The ties of economic interdependence often render power invisible, concealing the potential for its weaponization should circumstances demand. From the beginning, the economic interdependence between the two countries, which emerged from the 1965 normalization of relations through the conclusion of the Treaty on Basic Relations and accompanying agreement on the settlement of property and economic claims, was characterized by an asymmetrical power relationship borne of stark economic disparity. South Korea believes it was forced to accept a mutual settlement of claims and a “lump sum” payout in the form of economic cooperation.
Japan’s economic cooperation laid the groundwork for South Korea’s subsequent development but also contributed to the growth of the Japanese economy. As South Korean economic power grew, however, so did its desire to “take back” what it was unable to claim in 1965. This political sentiment was on display when South Korean President Lee Myung-bak became the first postwar South Korean political leader to set foot on the disputed islets of Takeshima in August 2012, and observed that “Japan’s international influence is not what it used to be.”
The current standoff between Japan and South Korea is not only an ideological problem posed by the Moon administration’s hard shift to the left and the North. We should take a sober look at the changing power balance in Japan-South Korea relations.
Yoichi Funabashi is chairman of the Asia Pacific Initiative and a former editor-in-chief of the Asahi Shimbun. This is a translation of his column in the monthly Bungei Shunju.