By Troy Stangarone
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Instead, Japan chose to escalate the conflict despite the United States asking both Japan and South Korea to refrain from taking measures that would further enflame the situation.
By removing South Korea from its "whitelist" of favored trading partners, Japan has raised the level of uncertainty in the economic relationship by making it more difficult for South Korea to import key components.
As global value chains have expanded, most firms have adopted a "just-in-time" model for supplies that have allowed them to increase efficiencies, reduce costs and more quickly adjust to changes in market conditions. This also means companies were able to reduce the amount of supplies they hold in inventory, making it easier to adjust to economic downturns.
As a country on Japan's whitelist, South Korean firms were able to relatively easily import key components and take advantage of these efficiencies as part of a trade relationship that saw South Korea import almost $55 billion in goods from Japan in 2018.
With South Korea's removal from the whitelist, Korean firms will now face new burdens. They will be required to submit additional paperwork, while being subject to a review process of up to 90 days and the need for more frequent approvals for the purchase of key goods from the Japanese government.
All of this will raise costs and reduce efficiencies that had developed in global value chains. Rather than a just-in-time model, South Korean firms will potentially have to adjust to a less flexible model that imposes higher overhead costs for inventory.
How Japan handles the new approval process remains another source of concern. After its initial decision in July, Tokyo said it would not ban exports of the three chemical components placed under new security restrictions for legitimate trade. However, it also has not approved any license for export to date either. It is this newfound ability to delay or deny exports that will give Japan the leverage going forward.
Tokyo's decision also has implications for other trading partners in the region. South Korean firms account for 60 percent of the world's memory chips. These are key components of most modern electrical devices from smartphones to cloud-based servers. Memory chips are also components that are not easily replaceable. The Korean firms are also a key supplier of display screens used on smartphones, computers, and televisions.
Over the last decade, much of the world's electronics production has shifted to global value chains in Asia, and according to the OECD 21 percent of South Korean exports are upstream products used in the production of other goods. These components are largely concentrated in electronics and chemicals.
Japan has tried to downplay the potential damage. Minister Hiroshige Seko from the Ministry of Economy, Trade and Industry was quoted as saying they "think that there will be basically no effect on global supply chains, or adverse impact on Japanese business."
If Japan quickly approves licenses to export to South Korea that would be the case, but that seems unlikely at the moment given the experience of Korean firms after the initial restrictions in July.
Additionally of concern is Japan's continued use of national security to justify its restrictions. As I noted in my last column, using national security restrictions which are intended to be used during true national emergencies to economically coerce another country undermines the rules-based trading system. While Japan may have grievances with South Korea at the moment, it should also consider how the tactic could increasingly be used against it in the future.
The real question now is how both sides can avoid what could be economically costly to both and other countries in the region. While South Korea needs to reach out to Japan, Tokyo could help to facilitate that process by clarifying what technical steps South Korea could take to improve its export control regime and be restored to the whitelist if the current standoff is not related to the issue of wartime forced labor.
At a minimum, Tokyo should quickly provide export licenses to help de-escalate the current standoff, as delays and license rejections for certain products would only undermine its own claim that there will be minimal impact from this change.
Troy Stangarone (ts@keia.org) is the senior director of congressional affairs and trade at the Korea Economic Institute.
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