[Special Report] The Widening US-China Trade War: Where Does Korea Stand? The Need for a New Trade Policy Blueprint Based on a New Paradigm

(Editor's Note)

The global economic order is being shaken by the escalating trade conflict between the world's two largest economies. In particular, the current conflict between the US and China is unfolding beyond existing trade rules and norms, unlike past disputes, and its repercussions are expected to be even greater. Moreover, it is particularly devastating for countries with high external dependency, like South Korea. Therefore, EAI has planned this special report to examine how the US-China trade war, which is expanding daily, will unfold, what impact it will have on the South Korean economy and the Asia-Pacific order, and to consider South Korea's response strategies. Four domestic experts participated as contributors to this special report. The authors unanimously point to the immense changes in the trade environment, accelerated by the US-China trade war, and call for the establishment of a new trade policy blueprint to systematically address these changes.

I. Introduction(Executive Summary)

In February 2017, EAI presented a new trade policy agenda and strategy for the five-year term of the new government that emerged after the impeachment crisis ("A Proposal for South Korea's New Trade Policy for the Next Five Years: Overcoming the Waves of Aggressive Unilateralism of the Trump Administration"). At that time, we identified the "Three Trump Risks" as: US-South Korea trade conflict, US-China trade conflict, and a vacuum in the Asia-Pacific order. Now, 18 months later, the US-South Korea trade conflict has been largely resolved through the renegotiation of the Korea-US FTA, but the US-China trade conflict, which was our greatest concern, and the resulting regional order disruption, are now in full swing.

The US-China trade conflict, triggered by the US's announcement of large-scale tariffs on Chinese imports on May 27, 2018, is escalating with China's retaliatory tariffs and the US's subsequent countermeasures. Of course, trade friction between the two countries is not new. Since China's accession to the WTO in 2001, the US and China have frequently checked each other through trade remedy and dispute settlement procedures. However, while past checks occurred at a conventional level within the WTO framework, the current conflict is taking on the characteristics of a "trade war," with a cycle of retaliation extending beyond existing trade rules and norms.

As the world's two largest economies enter a full-blown conflict, the global trade order is experiencing turmoil. For countries with extreme external dependency like South Korea, this reality is threatening. When South Korea's top two trading partners increase tensions, the impact on the entire Korean economy could be unimaginably large. Furthermore, if the overall US-China relationship deteriorates due to trade conflicts, leading to heightened strategic competition, South Korea's security interests, caught between the two nations, could be severely threatened. How will the US-China trade conflict unfold, and how far will it go? What will be the impact on the regional order and the South Korean economy, and how should South Korea respond?

The Nature of the US-China Trade War

The world of economics is inherently a win-win, non-zero-sum game. Therefore, a trade war, which results in mutual losses, must be understood as being driven by non-economic logic. For example, President Trump is implementing import restrictions based on Section 232 of the Trade Expansion Act, citing national security concerns regarding steel and aluminum imports, and is pushing policies that contradict economic theory by imposing tariffs to correct the bilateral trade deficit. All the contributors to this special report diagnose the current situation as a "multi-dimensional complex game," in the words of Professor Lee Seung-ju, where domestic and international political logic are intricately intertwined, going beyond economic logic.

According to Choi Byung-il's analysis, President Trump's aggressive trade policy is underpinned by an intention to consolidate his support base and solidify his political standing domestically. Specifically, if President Trump significantly reduces the trade deficit with China through these policies, it will not only serve as a solution to his political predicament but also act as a green light on his path to re-election.

Externally, there is an intention to be wary of China, which has grown into the world's second-largest economy, and to secure a dominant position in advanced industries that will shape the future global economic order. The reason the Trump administration is targeting "Made in China 2025," China's initiative to foster advanced industries, in this trade war is because while it may be inevitable for China to surpass the US in economic size, the US does not want to concede its leading position in qualitative aspects, particularly technological innovation. As all the contributors to this special report emphasize, the hidden essence of this US-China competition is the rivalry for technological hegemony.

Consequently, China is also reacting sensitively to the US's offensive against "Made in China 2025." This is because it is a matter directly related to China's national core interests as an industrial policy for its leap toward becoming a technological powerhouse. China maintains that while figures can be adjusted, the system itself is not subject to negotiation.

Furthermore, unlike its past approach of "hiding its capabilities and biding its time" (韜光養晦), China's current stance of responding to the US's strong offensive with a pattern of "declaration for declaration, action for action" is driven by the political logic of the Xi Jinping administration, which has consolidated its one-man rule by promoting the "China Dream" and "China's Rise."

The problem is that the Xi Jinping administration's nationalistic hardline stance could threaten regime stability if it intensifies the trade conflict with the US, leading to an economic downturn and damaging its international standing. Similarly, Trump faces numerous political challenges in escalating the conflict with China, with which economic interdependence is deeply entrenched, and entering a phase of full-scale strategic competition. Therefore, both countries will continuously seek to manage the conflict and explore exit strategies. In this light, the US-China trade conflict is unlikely to result in a head-on confrontation or a dramatic resolution; rather, it is likely to resemble a long-distance hurdle race, repeatedly jumping over established barriers.

The Future of the Asia-Pacific Order

Lee Seung-ju's analysis demonstrates that the Trump administration's trade policy is disrupting the Asia-Pacific trade order based on liberalism and multilateralism. The Trump administration views multilateral frameworks like the WTO and TPP as failing to ensure "fair free trade" and believes that a bilateral approach based on power is more effective in advancing national interests. Since taking office, the Trump administration has initiated the renegotiation of the Korea-US FTA and demanded bilateral FTA negotiations with the Abe government, seeking to establish "fair and balanced" relationships with traditional allies based on bilateralism. Furthermore, unlike the Obama administration's policy of rebalancing towards Asia, the Trump administration is pursuing a strategy of shifting the center of the regional order westward, expanding it to the Indo-Pacific, and comprehensively forming a regional network targeting China. This can be described as "Hub-and-Spoke 2.0" in that it aims to position the United States at the hub of a network based on bilateral relationships.

Lee Seung-ju emphasizes the need to establish a direction for structural response, keeping in mind that the US-China trade conflict could trigger fundamental changes in the global trade order depending on how the situation unfolds. He advocates for a strategy that strengthens the foundation of cooperation among countries with a vested interest in the liberal international order. Specifically, he calls for a macro-level, integrated approach that strategically pursues existing FTAs pursued by South Korea, such as RCEP, Korea-China-Japan FTA, and Korea-Japan FTA, as well as potential accession to the recently concluded CPTPP, not as isolated issues but in a coordinated manner under a larger framework.

Impact on the South Korean Economy and Responses

The US-China trade war is devastating for countries with high external dependency like South Korea. Moreover, it is particularly threatening given that these two countries are South Korea's first and second-largest trading partners. According to Jeong Chul's analysis, while the short-term impact of the US-China trade war on South Korea is relatively limited, if the front of the trade war expands and becomes prolonged, there is a possibility of impact extending beyond the real economy to the financial sector. If the current trade war, unfolding in the form of tariff battles, escalates into a currency war, such as designating countries as currency manipulators, it is highly likely to affect not only the domestic foreign exchange market but also the entire domestic economy, including the real sector. He recommends that the government devise institutional safeguards by analyzing changes in foreign investment policies of developed countries aimed at preventing the outflow of advanced technologies amidst the competition for technological hegemony, preemptively prepare for the possibility of a currency war, and ensure the soundness of the domestic financial market through measures such as stabilizing the foreign exchange market, expanding currency swap agreements, and managing household debt to prepare for the impact of foreign capital outflows, exchange rates, and interest rates.

Finally, Lee Jae-min's analysis presents the trade diplomacy that South Korea should pursue while navigating the intense competition between the US and China. The Chinese retaliatory measures following the THAAD deployment have led China to believe it can manipulate South Korea to its will if it applies strong pressure. The US, dissatisfied with South Korea's balancing act between China and the US in trade, has exerted trade pressure, making its ally status seem meaningless. To overcome this situation, the author urges a shift from passive responses of seeking favor from great powers to principled and objective, balanced responses based on the WTO and existing trade agreements, while also advocating for middle-power diplomacy that strengthens cooperation with like-minded countries.

In conclusion, the contributors to this report unanimously point to a profound transformation in the trade environment. A paradigm shift is occurring, characterized by power-based trade policies, bilateralism, protectionism, the linkage of security and trade, and the emergence of new issues. They argue that this should be accepted as the "New Normal" and that a new trade policy blueprint must be established to systematically address it. ■

Attachment: 180823_report.pdf