U.S.-Korean Trade: An Update

May 28, 2003
By Marcus Noland

 Despite the passage of 50 years since an armistice ended military hostilities, the Korean peninsula remains divided, a Cold War vestige that seemingly has been unaffected by the evolution that has occurred elsewhere. If anything, U.S. confrontation with North Korea --a charter member of the “axis of evil”—has intensified in recent years. Yet today, increasing numbers of South Koreans, accustomed to living for decades in the shadows of the North’s forward-deployed artillery, do not regard the North as a serious threat. Growing prosperity and confidence in the South, in marked contrast to the North’s isolation and penury, have transformed fear and loathing into pity and forbearance. Instead, it is the United States , an ocean away, that regards the North and its nuclear weapons program with alarm. As the United States has focused on the nuclear program, its ally, South Korea , has observed the North Koreans’ nascent economic reforms and heard their talk of conventional forces reduction, and the gap in the two countries’ respective assessments of the North Korean threat has widened dangerously, threatening to undermine their alliance.  

The divergence in threat perceptions has been reinforced by the course of the U.S.-Korean economic relationship.  In 2002, total trade turnover between the United States and South Korea was $58 billion, up slightly from the previous year but well below its peak of $67 billion in 2000. For several years, South Korea has been America ’s sixth largest export market (behind Canada , Mexico , Japan , Germany , and the United Kingdom ) and its fourth largest market for agricultural products. Last year, the United States ran a $13 billion merchandise trade deficit with South Korea .

From the South Korean perspective, the share of merchandise exports to the United States has fallen dramatically from more than 40 percent in the late 1980s to less than 20 percent in 2002, with China actually surpassing the United States as South Korea ’s number one export destination in some recent months. Similarly on the import side, after briefly supplanting Japan as South Korea ’s primary supplier of imports in the late 1990s after the Asian financial crisis, the US share of South Korean imports has once again begun drifting downward, and in 2002 the United States supplied less than 15 percent of South Korea ’s merchandise imports.  

Bilateral trade in services, cross-border investment, and local sales by majority-owned foreign affiliates have grown more robustly than merchandise trade. The share of services trade in South Korean GDP doubled to 15 percent over the past decade, and the United States is the major supplier of services to the South Korean economy, running a $3.3 billion bilateral surplus in 2002.

The provision of services generally requires investment—if only to establish a local presence. Historically, South Korea maintained an unwelcoming stance toward foreign direct investment (FDI)—indeed, South Korea and India were the only countries in Asia where the primary mode of US investment was minority-stake joint ventures rather than majority-stake joint ventures or fully owned subsidiaries. The flow of US investment into South Korea increased much more rapidly than trade after the Asian financial crisis.  It peaked between 1999 and 2001, and then declined, though it remains significant. (Indeed, according to US government figures, the stock of US investment in South Korea grew by more than 10 percent in 2002.) In recent years, the United States has been the single largest investor in South Korea .  

The increase in investment is also intimately tied to the growth of services trade, as well as local sales of South Korean affiliates of foreign firms. In 2000, the most recent year for which data is available, majority-owned affiliates of US firms racked up sales of $1.7 billion in South Korea (while South Korean affiliates in the United States had sales of $385 million).  

In sum, the United States remains an important economic partner for South Korea , though the character of that relationship is changing. South Koreans perceive that American prominence in merchandise trade is eroding, especially in comparison to China . However, in the emerging areas of services and investment, the US role is growing. In essence, the United States is losing its relative prominence in the older, more slowly growing parts of economic life and is building an increasingly prominent position in the newer, more rapidly expanding areas.  

Despite ongoing sources of friction, economic relations between the United States and South Korea appear to be less contentious than they were 10 or 20 years ago. One can point to three reasons. The first is changes in the composition of trade. The increasingly intra-industry nature of bilateral trade would be expected to create less of an adjustment burden for import-competing sectors.  

Secondly, economically rational or not, the single best predictor of US trade policy actions is the rise of the bilateral trade imbalance. The United States has recently been through a period in which it ran surpluses or relatively modest deficits with South Korea . The counterpart to the rise of China in South Korea ’s trade pattern is the growing prominence of China in the United States . In effect, South Korea has fallen off the radar screen, supplanted by China , together with the perennial foci of US trade policy complaints, Japan and the European Union.  

Finally, there have been changes in both policy and the institutional environment. Nearly a quarter-century of liberalization in South Korea has made a significant dent in the ubiquity and restrictiveness of policy-derived impediments to trade in South Korea . This reduction in fuel for the fire has been reinforced by the formation of the WTO, which has provided a less visibly politicized and bilateral forum for the United States and South Korea to resolve their trade differences.  

Both countries have made use of the WTO dispute settlement mechanism in managing bilateral trade disputes, each initiating six cases. For both countries, the prospect of binding WTO rulings has encouraged bilateral “out of court” diplomatic settlements. When this has not been possible, both countries have won and lost cases, and thus far, the loser has brought its practices into conformity after adverse rulings. The big question is whether this will continue to be the case if the United States loses two pending steel-related cases.  

The economic relationship between the United States and South Korea , characterized by increasing intra-industry trade, rising services trade, expanding inter-corporate penetration, and growing FDI, appears to be evolving toward something more like the relationships that the United States maintains with most other rich OECD countries. As that occurs, it would not be surprising to see the U.S.-Korea relationship evolve away from its historic patron-client model and toward something like America's relationship with its European allies.  

It is also due to the declining relative importance of the two countries in each other’s global relationships—at least with respect to merchandise trade. In Washington, the rise of China has meant a diminution of at least relative attention paid to South Korea, while in Seoul the rise of China has added to interest in regional initiatives—which if implemented could harm the United States.  

The net result may well be a de-coupling of relative interests that could reinforce the widening strategic differences between the two historic allies, especially if South Koreans come to regard China and Japan as acting more constructively than the United States with regard to North Korea .  

Marcus Noland is a Senior Fellow at the Institute for International Economics (http://www.iie.com).  This essay is based on a larger report on U.S.-Korea economic ties prepared for the Institute.