The global economy is currently undergoing a profound realignment of production, investment, and trade geography to reduce exposure to geopolitical tensions, meet sustainability requirements, and capitalize on the potential of digital technologies. The COVID-19 crisis exposed the extent of disruption in global supply chains, alongside an over-reliance on China, which has become a source of concern. Decisions to relocate industries and organize value chains are no longer driven solely by economic calculations; countries and companies must now adjust their strategies with geopolitical considerations in mind.
In this context, an April 2023 report by the French Institute of International Relations examines South Korea as a case study. South Korea’s economic development has relied heavily on its participation in complex cross-border supply chains and its close economic ties with China. The report analyzes potential reorganization of value chains by examining various localization strategies and their drivers, highlighting the importance of public policies, the private sector, and the potential role of external factors, as well as the options that could be adopted in this area.
Relocating Away from China
South Korea’s economic growth has been largely driven by its ability to achieve optimal regional integration. Over time, South Korean companies have re-evaluated their localization strategies to adapt to changes in the economic environment and maintain competitiveness. In the early 2000s, South Korean firms focused on “offshoring” industries to Asia, particularly to China, especially after China’s accession to the World Trade Organization.
However, since 2010, South Korean companies have begun reducing their investments in China, diversifying them into Southeast Asian countries where labor costs remain relatively low compared to China, with a strong focus on Vietnam as an offshore destination. Samsung Electronics is a prime example of a South Korean company that closed or downsized its operations in China and shifted to Vietnam. By 2017, Samsung accounted for nearly a quarter of Vietnam’s exports, and around 60% of Samsung’s smartphones are now manufactured in Vietnam.
Beyond rising production costs, another reason for Samsung’s move from China to Vietnam was increased competition from local producers and the company’s inability to adapt to local demand. Samsung’s market share in China dropped to 2% in 2018 and 0.6% by 2022, leaving the company with only three factories in China. Many other South Korean labor-intensive companies, whose operations in China had become less efficient, relocated to Vietnam to diversify their supply chains outside China, particularly following the global disruption caused by the COVID-19 pandemic.
Additionally, India has become another preferred destination for South Korean companies. In 2018, Samsung opened what it called “the world’s largest mobile phone factory” in Noida, near New Delhi, in a bid to compete with Chinese manufacturers like Xiaomi and double its annual production capacity in India.
While economic considerations remain the primary factor in South Korean decisions, geopolitical factors have also started to play a role. Although China’s business environment has become more complex, its market remains highly attractive, especially for the middle segment of the production chain and intermediate goods. Few countries can match China’s capacity, infrastructure, and skilled labor force. As a result, South Korean companies may diversify investments outside China while maintaining some in the country, adopting what is known as the “China+1 strategy.”
Reshoring Industries
The concept of “reshoring” refers to companies bringing back the production and manufacturing of goods to their home country, the opposite of “offshoring,” where companies relocate production to foreign countries, primarily for cost-efficiency reasons.
Reshoring has emerged as a way to achieve a degree of economic security. The South Korean government began adopting this strategy even before the COVID-19 pandemic, fearing that the outflow of industrial production and investment could lead to declining employment and growth rates at home. To facilitate the return of industrial companies, the government implemented support measures. In June 2013, the National Assembly passed the U-Turn Law, aimed at halting the growing trend of offshore production by offering incentives to bring back South Korean firms.
Unlike the U.S. and Japan, South Korea has been less successful in reshoring its industries. Despite Seoul’s extensive efforts, South Korean companies have not returned from China in significant numbers, even amidst the COVID-19 pandemic and growing U.S.-China trade tensions. This highlights the risks of over-reliance on Beijing as a manufacturing base. The failure of Korea’s reshoring efforts may be attributed to the inefficiency of its strategy and the government’s engagement in this effort without adequately considering the interests of the business sector, reflecting a possible disconnect between government policy and business interests. For many companies, security and political considerations take a backseat to economic and profitability concerns.
In a 2018 survey conducted by the Korea Economic Research Institute (KERI), 16.7% of companies expressed no desire to return to Korea due to high domestic wage costs, while 77.1% of companies cited the need for a physical presence in foreign markets to grow their business environment as their reason for not returning. According to the Ministry of Trade, Industry, and Energy (MOTIE), an average of only 10 companies returned annually between 2014 and 2018. Although South Korea has improved its investment environment, reshoring remains limited due to significant domestic obstacles, including a rigid labor market, high employment costs, and stringent environmental regulations.
Korean Geopolitical Calculations:
In addition to economic factors, geopolitics has become a crucial determinant in the decision-making processes of Korean companies. One of the most prominent examples of political disputes spilling over into the economic realm is the tensions between South Korea and Japan, which have led to sanctions, export controls, and other restrictions.
The Korean strategy of reshoring appears to be a direct response to these geopolitical tensions with Japan. This trend was particularly evident in the recent trade dispute between the two nations over semiconductor exports. In 2019, the Japanese government removed South Korea from its “white list” of trusted trade partners who receive preferential trade treatment. This was in response to South Korean Supreme Court rulings that required Japanese companies to compensate victims of forced labor during World War II. Japan then banned exports of three key materials used in the manufacturing of semiconductors and computer screens in South Korea: photoresists, hydrogen fluoride gas, and polyimides.
This trade conflict presented an opportunity for South Korean companies to explore options for restructuring global semiconductor value chains to mitigate potential risks. The government also allocated approximately two trillion won annually to fund research and development, fostering cooperation with the private sector to reshore supply chains.
Japan’s tightening of export controls united the interests of large Korean corporations and the government. To complement the reshoring strategy, Korean companies diversified their supply sources. For example, they began importing hydrogen fluoride gas from countries like the United States. For photoresists, which are used to form circuit patterns on chips and are produced 92% in Japan, South Korean companies diversified their imports to include Belgium and Germany.
While South Korea is unlikely to abandon its goal of enhancing economic security through local production, it has so far failed to establish fully independent supply chains separate from Japanese producers. The anticipated normalization of bilateral relations between the two countries will likely result in adjustments to this strategy, as sourcing from Japan remains economically logical. Depending on other countries for these materials poses the risk of receiving lower-quality products than what Japan offers, and it may incur additional costs for covering defective goods.
U.S.-China Competition:
In terms of geopolitical factors, South Korea’s key industries—such as 5G, semiconductors, batteries, and rare earth elements—are heavily influenced by the competition between the United States and China. Given South Korea’s high degree of economic integration with China, decoupling from it would be extremely costly. At the same time, Seoul is under pressure from the U.S., which seeks to curtail Beijing’s ambitions to access the latest technologies in order to maintain its technological dominance and strengthen its manufacturing capabilities.
In 2022, the U.S. Department of Commerce announced new export controls on technology to China, aimed at preventing companies, including those outside the U.S., from selling semiconductors to China if they were produced using American equipment. This effectively froze China’s production of advanced chips and supercomputing capabilities.
These U.S. regulations posed a threat to South Korean companies, as they could disrupt the significant trade flows between companies in Korea, China, and the U.S. The U.S. Chips Act and export controls also directly impacted some Korean firms, particularly SK Hynix and Samsung, which rely on American technology and operate in China to serve part of the U.S. market. These companies are expected to build more factories in the U.S. since they cannot produce advanced chips on a large scale without American equipment and technology.
At the same time, South Korean semiconductor companies have doubled their domestic investments, especially following the recent approval of the “K-Chips Act,” which aims to bolster the semiconductor industry by increasing tax credits from 8% to 15% for large companies investing in this sector. Small and medium-sized companies will benefit from a tax reduction from 16% to 25%. These developments clearly indicate that U.S. export controls are reshaping global semiconductor supply chains.
On the other hand, South Korea is also striving to reduce its dependence on rare earth metal imports from China. To achieve this, Seoul has sought to reduce imports from China and increase them from alternative sources such as Australia and Vietnam. Additionally, efforts are underway to find innovative ways to reduce the consumption of these metals, boost domestic production, and create an integrated supply chain through regional partnerships.
In conclusion, despite the ongoing discussions about redistributing global value chains and decoupling from China, Korean companies’ decisions on where to locate remain largely based on cost factors. Even with increasing consideration of security concerns, economic factors still dominate corporate calculations. Although there have been instances of Korean companies relocating from China to ASEAN countries, this does not signify an easy departure from China due to the sheer size of its market.
Meanwhile, the reshoring of Korean industries, which has been a top priority for the South Korean government for some time, seems to have limited impact despite the government’s efforts. The success of public policies is contingent on aligning with the interests of the private sector. Economic considerations continue to drive companies to favor low-cost production locations. In the future, some Korean companies may opt for unexpected alternatives that skillfully balance both economic and geopolitical considerations.
Source: Françoise Nicolas, Reshuffling Value Chains: South Korea as a Case Study, Ifri, and Center for Asian Studies, VISIONS, No. 135, April, 2023.
