South Korea's links with China increased markedly after diplomatic relations were formalized in 1992, developing to the point where China has become South Korea's most important export market – and its biggest foreign investment destination. There is a real China craze now, reminiscent of America's Gold Rush, raising concerns about whether the dazzle has blinded Koreans to Beijing's long-term strategic aims. China's economy is one of the world's fastest growing and with that prosperity comes power.
The magnitude of the problem was not clear until April last year when Premier Wen Jiabao warned that the overheated Chinese economy needed cooling off. His comments dealt a blow to the global markets but nowhere more severely than in South Korea. In one report, Morgan Stanley economists Sharon Lam and Andy Xie estimated that each 1% decrease in China's industrial production translates into a 1.5% decrease in Korean exports to China. Indeed, the China shock unleashed by Wen's announcement April 28, 2004 was blamed for Korea's benchmark KOSPI stock market price index losing approximately 20% of its value since.
An upset on that scale should make Korean companies carefully assess their "Chinese risk" both for the short and long term, and they might learn from the Japanese who have vigorously promoted their business operations in China since the 1980s, experiencing periodic setbacks along the way. Attracted by China's low wages, Korean low-end technology manufacturers have increasingly shifted production to the Mainland, and exported from there – making Korea's economy more vulnerable to Chinese policy shifts. Realizing this in the wake of the China shock, the government (under then acting President Goh Kun) began to reevaluate the country's growing dependence on China, and to assess potential alternatives.
For decades, the United States and Japan have been the main economic players in Asia and many now say China will soon take over that role. South Korean business leaders, having looked east for a long time, first to Japan and later to the US, are now making a 180-degree turn, to China. What they see is an economic giant with great potential and, although fascinated by the possibilities, they also feel uncertain about what the future may bring.
According to the Korea International Trade Association, direct investment in China jumped to US$6.25bn in 2004 from US$2.72bn two years previously; KITA data also show that the number of Korean companies operating in China since 1992 has increased from 650 in 1992 to 4,920 in 2003.
Cheap labor, as noted, has been one attraction. China's monthly average industrial wage is about a tenth that of Korea's. Another has been China's fast-growing and already huge consumer market- in what is the world's fastest growing big economy. Manufacturers especially have been keen to escape Korea's annual labor cost increases; decreasing consumer spending at home has also helped manufacturers focus on China's market-so it is no surprise that manufacturing accounted for more than 90% of Korea's mainland investment, a trend very likely to continue. Korean investment started relatively late. Diplomatic relations were established only in 1992 and it was the 1997 regional economic crisis that really drove the "Go China" phenomenon when Koreans charged in, often hastily and ill-prepared for the difficulties ahead. Flights between South Korea and China filled with executives convinced that China would replace the US as South Korea's main economic partner.
Although economic theory suggests that foreign direct investment benefits both investing and recipient countries, Research Institute of Economy, Trade and Industry (RIETI) fellow Chi Hung Kwan has noted that while investment into China increased sharply, GDP growth at home slipped from 6.2% in 2002 to 3.1% in 2003, raising concerns that increasing China investments might actually diminish Korean industry.
Still, China has yet to develop world-class technology or brands and development of a more stabilized, less foreign-independent economy will take several years, leaving China little but cheap labor for export competitiveness. There is no doubt that China's economy is progressing rapidly, but there is no reason for Korean companies not to be realistic and judicious now, because the risks are real. For instance, senior managers at Chinese companies routinely change, requiring their Korean partners to cultivate a community of trust again and again.
Another problem is legal. China's laws protecting businesses can be inexact and variable, making outcomes of legal claims difficult to predict. Political and personal connections may also be required in shaping outcomes. It is clear that China presents a broad range of opportunities for Korean companies producing basic products like pigments, synthetics, enzymes, citric acid and petrochemicals like glycols and polyethylene-or cheap consumer goods. But even these investors have to be sure to get the timing and the context right. More advanced manufacturers must weigh their expectations with great care.
The city of Yiwu in central Zhejiang province provides a low-end manufacturing success story. Over 3,000 Koreans have established businesses here, living in what might be called Yiwu's Little Korea.
Yiwu has been transformed into a city of private enterprises, which today are changing consumer markets around the world thanks to their aggressive cost structures and wide product choice. These companies did not exist 20 years ago.
Yiwu has become the marketplace for developing and developed economies from around the world. Manufacturers of low cost, small commodity goods-including socks, handbags, Christmas decorations, hair pieces, silk flowers, small appliances, toys and other products-sell directly to traders and wholesalers from small shops and booths in one of three enormous enclosed markets, or, indeed, from street stalls outside.
Last year, Yiwu's global marketplace posted sales of US$2.5bn, US$1.5bn of that in exports. China's Gold Rush can produce winners-for investors who go in properly prepared.
Historian Chung Dooeum is working on research at the Korean Study Center in Zhejiang University's College of Humanities.
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