The Fallout

Steeling themselves for the ramifications, South Korean companies have said they possess a few months of stockpiles and that lower semiconductor demand will ease some of the production pressure. At the same time, Seoul's municipal government has promised money to assist with shortfalls, while the central government is seeking budgetary requisitions to kick-start the indigenous production of the restricted chemicals. Moreover, South Korea has also appealed to the World Trade Organization. 

Even so, Japan's restrictions threaten crucial South Korean sectors that rely on Japan for the key chemicals. Between January and May, Japan accounted for 44 percent of South Korea's hydrogen fluoride imports, 92 percent of photoresists imports and 94 percent of fluorinated polyimide imports, according to the Korea International Trade Association. South Korean manufacturers will need to scramble to replace these chemicals with supplies from elsewhere or face delays due to scrutiny that could hamstring operations. Naturally, the country could even face deeper repercussions if Tokyo removes Seoul from its export white list.

In terms of specific items, South Korea's dynamic random-access memory (DRAM) exports, 3D NAND flash memory, organic light-emitting diode (OLED) and liquid crystal displays (LCD) could all bear the brunt of Japan's anger. In 2018, South Korean semiconductors made up 24 percent of the global market share, behind only the United States at 45 percent. For South Korea, such exports are vital. Integrated circuits, which are produced using semiconductors, accounted for over 18 percent of total South Korean exports — the largest of any product category. Taken together with semiconductors themselves and smartphones, the Japanese chemical input restrictions could impact around 20 percent of South Korea's total exports. 

Top South Korean chipmakers could avoid some of the consequences by shifting production to China, but smartphone manufacturers who mostly make their displays in South Korea would need to make major adjustments to shift their production across the Yellow Sea. Moreover, offloading some chipmaking to their facilities in China carries its own risks given the still-burning U.S.-China trade war, as large South Korean companies in China are already working to shift some of their capacity to places like Vietnam. And then there's the lingering problem of Seoul's own relations with Beijing: In 2017, China instituted a tourist boycott and other economic measures on South Korea after the latter deployed the U.S. Terminal High Altitude Area Defense (THAAD) system. Today, ties between Beijing and Seoul are on the mend, yet they remain tenuous.

South Korea has other options as well, although they hardly present an easy solution. First and foremost, South Korean companies could simply request that Japanese manufacturers ship the necessary chemicals from their overseas factories, but this might prove difficult given the political pressure on corporations. Russia has reportedly offered to step in with some hydrogen fluoride supplies, but shifting import sources would be challenging given the need to implement new testing and quality-control regimens to ensure the new sources fit industrial standards. Ultimately, the saving grace for South Korean companies in the near term may be the very slowdown in global semiconductor demand that has hurt the country in recent months — meaning lower production will be tolerable due to the global glut in chips. With several months of stockpiles on hand, South Korea might thus not feel the true cost of the trade war for some time. 

A Measure With Staying Power?

Amid the debate, domestic Japanese factors could have a bearing on the future of Tokyo's measures. On July 21, Japan's ruling Liberal Democratic Party will go into upper-house elections with the hopes of grabbing the two-thirds majority needed to effect long-awaited constitutional reform, and recent polls indicate that the moves against South Korea are highly popular, with 58 percent expressing support versus just 24 percent who are opposed. But even if the hard line is an example of electoral posturing, Japan is unlikely to climb down even after the ballots are counted. South Korea, for one, has unilaterally pushed Japan since 2017, and Tokyo is now showing it will only back down if Seoul compromises. For Japan, too, the measures do not affect the economy much beyond the relevant chemical manufacturers — for whom product lines in question are not particularly critical. Given that the chemical export restrictions and potential move to strike South Korea from the white list represent only increased scrutiny from Japanese authorities — rather than a total export ban — Tokyo will have wide discretion to shape them in a way to maximize the damage to Seoul and minimize it for Japanese companies, meaning Japan has little reason to abandon its position of strength.

Moreover, South Korea would find it a tall order to retaliate. Japan could easily replace any imports from South Korea that fall under an export ban from Seoul. This leaves boycotts by South Korean tourists, who make up 22 percent of Japan's total, as one of the few levers Seoul has. But in contrast to China, South Korea does not have a means of initiating a state-sponsored boycott and would need to rely on rallying grassroots support from consumers. And with 2020 elections approaching, Moon may choose to heighten his confrontational approach to Japan, which could provide a convenient scapegoat for the country's economic woes. 

Ramifications for a Region

Diplomatically, the acrimony with South Korea could stymie Japan's efforts to reach out to North Korea amid the U.S.-North Korea negotiations — an evolving event in Japan's backyard for which Tokyo is on the outside looking in.

Most concretely, the mounting tensions between the two sides could directly affect the Regional Comprehensive Economic Partnership (RCEP), of which both are a part. Already hamstrung by Indian obstinacy, the RCEP could fall apart further as a result of Japanese-South Korean discord. Both countries are also embroiled in talks with China toward a trilateral free trade deal. The China-Japan-South Korea Free Trade Agreement has been floated since 2011 and gone through 15 rounds of talks since March 2013 — most recently in April, although the deepening Japan-South Korea tensions could calve the agreement off into bilateral deals. 

Their standoff notwithstanding, Japan and South Korea still share vital interests, with both remaining dependent on the U.S. military umbrella — something that will limit the fallout as Washington has no interest in watching a dispute among critical allies to go too far. But with neither side in the mood for compromise, the current spat between the two East Asian economic giants shows little sign of ending soon. And given that Japan has less economic incentive to bury the hatchet right away, South Korea's leaders will have to decide whether burnishing their nationalist credentials is worth the economic pain awaiting the country. 

Seoul and Tokyo Stare Each Other Down is republished with the permission of Stratfor Worldview, a geopolitical intelligence and advisory firm.

Image: Reuters.