South Korea: Beyond the US-China trade and hegemonic war

The South Korean economy has suffered the fall-out from the US-China trade war. Examples of the hegemonic competition between great powers throughout history remind us of the magnitude of the challenge ahead. For now, the Korean government‘s biggest stimulus since the global financial crisis seeks to buffer its economy, while the rivals learn to share the world stage.

26 Sep 2019 | 4 min read

While the US-China trade war has affected the US and Chinese economies, it has also taken a toll on Asian economies that have tight production links to China. Korean exports, for example, fell 11% in July from the year before, its 8th consecutive month of decline. Meanwhile, job losses in the manufacturing sector are expected to continue. While GDP growth rebounded in the second quarter (+1.1% yoy), this was on the back of strong government spending.

Thanks for subscribing!

Follow us :

The Thucydides Trap

The rivalry between the US and China has triggered references to the conflict between Athens and the Spartans in 5th century BC. Professor Graham Allison, a political scientist in the US, calls it the “Thucydides Trap” – when a rising power causes fear in an established power, it eventually escalates into war1.

The Thucydides Trap2 basically draws its argument from the text of the ancient Greek historian Thucydides – “It was the rise of Athens and the fear that this inspired in Sparta that made war inevitable”.

In 5th century BC, a fierce rivalry existed between two leading states, Sparta and Athens. Sparta, the dominant state, fearing the rise of Athens, organised the Peloponnesus League, a confederation of Greek city states and went to war, ultimately defeating the Delian League, an alliance organised by Athens.

According to Professor Allison, among the 16 examples of hegemonic competition between the great powers after the 15th century, only 4 did not result in war. See Fig. 1. These included the hegemonic competition between the US and Soviet Union from the 1940s which involved an arms race (Strategic Defense Initiative) started by the US in 1983 to defend itself from the Soviet Union’s intercontinental ballistic missiles. The Soviet Union, which had started to experience declining economic growth from a slow-down in agricultural productivity, eventually collapsed from the continuous arms race.

Fig. 1. Examples of hegemonic competition3


The rise and fall of great economic powers

While prior wars focused on military might, the core of hegemonic competition has largely shifted to economic influence after World War II. However, history tells us that the outcome can be surprising, and the continued ascendancy of any economy is not guaranteed.

After the Chinese civil war in 1949, the US and Japan united against communist power and ideology. USD60 billion worth of military supply orders from the US to fight the Korean (1950) and Vietnam (1965) wars caused the US to suffer a massive trade deficit with Japan. Japan’s GDP rose to become two-thirds of the US (See Fig. 2). Its manufacturing industry boomed as exports soared on the back of a competitive exchange rate as well as significant technology transfers from the US

Fig. 2. Trend of Global GDP Distribution4


This hegemonic competition did not end in a war as the Japanese economy subsequently lost steam after the Plaza accord. In 1985, Japan signed the Plaza accord which sought to correct the over-valuation of the US dollar by asking the main current account surplus countries (Japan and Germany) to boost domestic demand and appreciate their currencies. Accordingly, the yen appreciated sharply - up 46% against the US dollar and 30% in real effective terms by the end of 1986. As a result, Japan’s export and GDP growth essentially halted in the first half of 1986. Pressured to respond, policymakers introduced a sizeable stimulus which led to an unprecedented boom in asset prices, and ultimately a collapse - what is now known as Japan’s Lost Decades5.

The hegemonic competition between the US and China

China’s GDP is currently two-thirds of the US’ (Fig. 2.) and forecasts suggest that China will become the world’s largest economy by 20506. China is currently the world’s largest producer of aluminium7 and steel8. Many of its tech companies are market leaders and it is becoming a world leader in developing 5G technology. With its “Made in China 2025” blueprint, China aims to transform the country into a hi-tech powerhouse that dominates advanced industries such as robotics, advanced information technology, aviation and new energy vehicles.

The US views these ambitions as a threat to its technological leadership. Among other things, the US wants China to respect intellectual property rights, provide safe guards against unfair competition from its state-owned enterprises and provide a more level playing field.

At the same, hegemonic power goes beyond trade and potentially extends to the exchange rate – whoever owns the global reserve currency becomes the hegemonic power, and finance (capital markets). On the exchange rate front, China wants to share the global reserve currency spotlight, but this would require allowing market forces to play a greater role in determining the renminbi’s value and opening up the capital account further. Meanwhile, China has chosen to open up its capital markets at its own pace, to avoid destabilising capital outflows and excessive volatility in its financial markets.

Changes in global order affect other economies. Due to China’s rapid progress and Korea’s delays in innovation, Korea lost about 50% to 60% of global market share in light industries over the last 20 years. Previously known as one of the four Asian tigers, South Korea experienced exceptionally higher growth rates in excess of 7% per annum from the early 1960s to 1990s. Its growth outlook has since been clouded by ageing demographics, a low birth rate and more recently the decline of its manufacturing sector on the back of the US-China trade tensions as well as export restrictions imposed by Japan. In addition, if China achieves its goal of self-sufficiency in core components as laid out in its “Made in China 2025” blueprint, this could further hurt Korea’s hi-tech export sector.

Hope and unexpected turnarounds

With the world economy becoming ever more intertwined, emerging powers will have to share the world stage. The resolution of global issues will require the participation of more players, China included. It will be necessary to achieve mutual understanding and adopt a set of universal values – this will not be easy, as we have seen.

At the same time, the unpredictable path of events suggests that wild cards cannot be ruled out. Some form of the trade resolution ahead of the US presidential election will lift animal spirits as well as business and consumer sentiment. For Korea, successful negotiations between the US and North Korea, can lead to greater inter-Korea economic co-operation, giving the Korean economy a new boost. In view of the faltering economy, the Korean government has unveiled its most expansionary budget since the 2008 global financial crisis. Fiscal spending will rise 9.3% yoy in 2020, as the government looks to support economic growth through innovation and investment.

The Thucydides trap helps us understand the magnitude of the challenge ahead for the US-China relationship and the urgency for a solution. Although the current realities appear dark, the eventual outcome need not be negative. While it will take time, a resolution will lift Korea’s growth potential and increase the attractiveness of its financial markets to foreign investors. For now, within the Korean fixed income market, we are neutral on credit given increasingly stretched valuations. The Bank of Korea is likely to cut rates again in the fourth quarter and we will be looking for opportunities to tactically trade duration.

How to invest in Eastspring's fund(s)

This document is produced by Eastspring Investments (Singapore) Limited and issued in:

Singapore by Eastspring Investments (Singapore) Limited (UEN: 199407631H)

Australia (for wholesale clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore, is exempt from the requirement to hold an Australian financial services licence and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Australian laws

Hong Kong by Eastspring Investments (Hong Kong) Limited and has not been reviewed by the Securities and Futures Commission of Hong Kong.

Indonesia by PT Eastspring Investments Indonesia, an investment manager that is licensed, registered and supervised by the Indonesia Financial Services Authority (OJK).

Malaysia by Eastspring Investments Berhad (200001028634/ 531241-U) and Eastspring Al-Wara’ Investments Berhad (200901017585 / 860682-K).

Thailand by Eastspring Asset Management (Thailand) Co., Ltd.

United States of America (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is registered with the U.S Securities and Exchange Commission as a registered investment adviser.

European Economic Area (for professional clients only) and Switzerland (for qualified investors only) by Eastspring Investments (Luxembourg) S.A., 26, Boulevard Royal, 2449 Luxembourg, Grand-Duchy of Luxembourg, registered with the Registre de Commerce et des Sociétés (Luxembourg), Register No B 173737.

United Kingdom (for professional clients only) by Eastspring Investments (Luxembourg) S.A. - UK Branch, 10 Lower Thames Street, London EC3R 6AF.

Chile (for institutional clients only) by Eastspring Investments (Singapore) Limited (UEN: 199407631H), which is incorporated in Singapore and is licensed and regulated by the Monetary Authority of Singapore under Singapore laws which differ from Chilean laws.

The afore-mentioned entities are hereinafter collectively referred to as Eastspring Investments.

The views and opinions contained herein are those of the author, and may not necessarily represent views expressed or reflected in other Eastspring Investments’ communications. This document is solely for information purposes and does not have any regard to the specific investment objective, financial situation and/or particular needs of any specific persons who may receive this document. This document is not intended as an offer, a solicitation of offer or a recommendation, to deal in shares of securities or any financial instruments. It may not be published, circulated, reproduced or distributed without the prior written consent of Eastspring Investments. Reliance upon information in this document is at the sole discretion of the reader. Please carefully study the related information and/or consult your own professional adviser before investing.

Investment involves risks. Past performance of and the predictions, projections, or forecasts on the economy, securities markets or the economic trends of the markets are not necessarily indicative of the future or likely performance of Eastspring Investments or any of the funds managed by Eastspring Investments.

Information herein is believed to be reliable at time of publication. Data from third party sources may have been used in the preparation of this material and Eastspring Investments has not independently verified, validated or audited such data. Where lawfully permitted, Eastspring Investments does not warrant its completeness or accuracy and is not responsible for error of facts or opinion nor shall be liable for damages arising out of any person’s reliance upon this information. Any opinion or estimate contained in this document may subject to change without notice.

Eastspring Investments companies (excluding joint venture companies) are ultimately wholly owned/indirect subsidiaries of Prudential plc of the United Kingdom. Eastspring Investments companies (including joint venture companies) and Prudential plc are not affiliated in any manner with Prudential Financial, Inc., a company whose principal place of business is in the United States of America or with the Prudential Assurance Company Limited, a subsidiary of M&G plc (a company incorporated in the United Kingdom).