North Korea – The real threat to East Asian commerce

North Korea’s decision to test-fire missiles that could potentially reach the U.S. mainland has far-reaching consequences. For businesses operating in East Asia, the greatest risks emanate not from a nuclear war, which is highly unlikely, but from the conflicting responses of China, the U.S., South Korea and Japan to the North’s antics. China has proven itself willing to penalise foreign companies in order to deter any U.S.-led military expansion in the area, but this tactic risks economic retaliation from a U.S. administration that is volubly dissatisfied with China’s trade policies.

 

North Korea

North Korea’s government has a single overriding objective: its own survival. This explains why the North is developing nuclear weapons, which it sees as the ultimate guarantor against invasion, but also why it will avoid conflict with the U.S. at all costs, even once such a nuclear deterrent is in place. Such a conflict would almost inevitably end in the North Korean regime’s downfall.

This strategy also means avoiding war with South Korea and Japan, which could easily escalate into a U.S.-led regional conflict. The North knows it can no longer rely on China to fight for it, as China did in the Korean War of the 1950s; China would only intervene on the North’s side in the event of an unprovoked U.S. military attack, and perhaps not even then. Nor does China have the military experience or systems to be confident of a victory in any conflict against the United States.

The prospects of the North instigating a war against the U.S, Japan or South Korea are therefore low. The main risk stems from the North miscalculating the character of the administration of U.S. President Donald J. Trump, which even seasoned American political commentators find unpredictable.

China & South Korea

China does not desire a re-unified Korea, particularly one created by U.S. military intervention. This would embarrass China’s claims to being Asia’s regional hegemon and would bring U.S. forces to China’s 1,420km-long border with North Korea. China is content for the North to remain a buffer state and for a large U.S. military presence to remain in South Korea, because its presence reduces the arguments for Japan’s re-militarisation.

China’s response, therefore, has been to play a double game

In the short term, North Korea’s nuclear and missile tests are a threat to the status quo that China is seeking to preserve. Should the North develop a nuclear deterrent, this poses a dilemma for China. On the one hand, it could pose an existential threat given that Beijing is only 900km from North Korea and any large-scale conflict resulting from the North’s activities would have a major adverse impact on China.

On the other hand, the North’s nuclear weapons could actually cement the status quo to China’s strategic advantage, by taking any outright invasion of the North off the table and ensuring regime continuity.

China’s response, therefore, has been to play a double game. It is trying to persuade the U.S. that it is serious about stopping the North’s nuclear missile programme, for instance by supporting sanctions at the United Nations.

At the same time, China placed economic pressure on South Korea to refuse U.S. military deployments aimed at interdicting a Northern attack. Beijing is particularly concerned over the Thaad anti-missile defence system’s radar, as it believes that it could undermine its own missile systems’ effectiveness.

The experience of South Korea’s Lotte Group is illustrative. In 2017, China forced Lotte, South Korea’s fifth largest ‘chaebol’ family-owned conglomerate, to close 87 of its 99 retail outlets in China and to cease work on a theme park after the group ceded a golf course it owned in South Korea to the Seoul government so that the U.S. could deploy Thaad missile-defence systems on the land.

The Chinese authorities claimed – implausibly – that their anti-Lotte purge was due to ‘fire safety’ considerations. Other Korean conglomerates such as Hyundai reported increased scrutiny from Chinese authorities and lower sales which they attributed to anti-Korean sentiment. Tour operators also suggest that China was deterring Chinese visitors from booking holidays to the South.

The United States

China’s attitude to South Korean companies poses risks to their profitability and the returns sought by their investors.
Yet these risks fade in comparison to those facing the Chinese economy if the U.S. concludes that China is not only failing to place real pressure on North Korea but that it is also punishing U.S. allies such as South Korea for equipping themselves with the means to defend their.

This does not mean, however, that the threat of a trade war is an empty one

U.S. President Trump has been a critic of China’s trade policies for decades, as Allan & Associates noted in a Special Report from November 2016, Trump versus China. So far Trump’s campaign promise to impose a 45-per-cent across-the-board tariff on all Chinese exports has not materialised. This does not mean, however, that the threat of a trade war is an empty one.

In August 2017, the Office of the U.S. Trade Representative (USTR) launched an investigation of China under Section 301 of the Trade Act of 1974. Section 301 covers ‘Relief from Unfair Trade Practices’. USTR formally initiated the investigation on 18 August.

In early February 2018, former acting deputy US trade representative Wendy Cutler warned that Washington is likely to “imminently” announce trade retaliation measures against China.

Meanwhile, in January 2018, Trump implemented a 30 per cent tariff on imported solar panels and cells, leading to complaints from Chinese manufacturers.

Section 301 allows the administration to unilaterally cancel trade agreements with China, impose duties on its goods, and block its foreign direct investment into the United States. Intellectual property is a focus for investigation, and the conclusion is not really in doubt. The USTR has castigated China for years for violating U.S. intellectual property.

Any use of Section 301 powers in the five-year outlook would pose immediate and substantial disruption to U.S and international companies that include China in their supply chains. China is likely to respond by harassing or even closing prominent U.S. companies operating within its borders, with American consumer brands at particular risk due to their symbolic value. Other sectors and products vulnerable to the threat include soybeans and automobiles.

Such retaliation could easily trigger further anti-China moves by the Trump administration, creating a tit-for-tat cycle that significantly reduces trade volumes. Chinese companies and telecommunications operators working in high-tech industries in the U.S. would be particularly vulnerable to accusations of espionage and could lose market access altogether, and there is a high risk of U.S. manufacturers re-locating production sites away from the Chinese mainland.

All this would be far more destabilising for China than for the United States – which has a political system with a record of surviving severe economic turbulence and popular division. China’s does not, and manufacturing could easily migrate away from China to South Asia and mainland South-East Asia.

Viewed rationally, therefore, it is in China’s interest to prevent North Korea progressing any further in its nuclear missile programme. Going by its treatment of Lotte and other South Korean corporations, however, it is not clear that the standing committee of China’s ruling politburo appreciates the imminent danger to China’s own economic and political stability from its failure to police North Korea as rigorously as it punishes the South.

Japan

Japan is the only country to have been attacked with nuclear weapons. Those attacks brought about the end of the Second World War, whereupon Japan adopted a pacifist constitution that prevented its remilitarisation. The revision of this constitution has been an ideological driving force behind Prime Minister Shinzō Abe, who believe the constitution has unfairly restricted Japan’s ability to respond to new threats. North Korea’s increasing number of missile tests appears to have added fuel to his movement.

Abe has said that he intends to revise the constitution by 2020, the most controversial aspect of which is article 9 as an amendment will allow for active-duty military deployments and broaden Japan’s definition of self-defence.

China will most certainly express its strong opposition and could exert its economic leverage on Japanese business entities and Japanese-made products, just as it did to South Korea. Beijing could also stoke large-scale nationalist demonstrations across China, as it has done in the past. The eruption of such mass civil unrest will be detrimental to Japanese interests as well as companies reliant on North Asia’s supply chain, particularly in the electronics and automotive manufacturing industries.

Updated 09/02/18

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