Korea - Japan Economic Relations : Today and Tomorrow


Article for the Kokusaku Kenkyukai (Institute for National Policies) presented at Japan Club, Tokyo, Japan, April 12, 1983. Translation in edited version from Japanese text.

An Overview

               This year (1983) marks a great leap toward closer economic cooperation between Korea and Japan, as symbolized by the visit of Japanese Prime Minister Nakasone to Korea and by the conclusion of negotiations on the $4 billion package of capital assistance from Japan to Korea. This juncture provides us with a good opportunity to look back at the past performance and look forward to the future prospect in our bilateral economic relations.

Statistical figures speak for themselves of the rapid expansion in economic relations between South Korea and Japan since their diplomatic normalization in l965. The pace has been amazing indeed. In 1965 merchandise trade between the two nations stood at a paltry $200 million. In the following 16 years it increased 47 times, to approach the $10 billion mark by 1982. During that period, 23 percent of Korea's total exports went to Japan, while Korea's imports from Japan accounted for 34 percent of its total.

As is well known, Japan and the United States are Korea's two largest trading partners. The United States is the largest export market for Korea, while Japan is the primary source of imports to Korea. This has been the general pattern of Korea's foreign trade all along. At the same time, Japan, as well as the United States, remained one of the main sources of capital and technology. Its investment has made a significant contribution to the economic development of Korea.

Statistics show that Japan accounts for about one-fifth, or $3.9 billion-including $l.3 billion in public loans-of the total foreign capital Korea received from overseas. Japanese direct foreign investment in Korea amounted to $650 million, accounting for nearly half of all foreign investments made in Korea. In terms of both amount and industrial diversity, Japan led all the other countries.

Japanese investment in Korea has centered on textiles, garments, electric appliances, electronic goods, and machinery. These sectors absorbed 74 percent of Japanese investment. The trend obviously reflected business strategies of the firms in the respective countries in response to the shifting comparative advantages: Korea needed industrialization in those lines of labor-intensive products, while Japan had to move away from those labor-intensive smokestack industries toward more technologically intensive products.

Korea sought to introduce Japanese technologies and know-how in a wide range of industries. By 1981 a total of 1,287 items of Japanese technology found their way to Korea-more than half of the total cases of technological transfer from abroad. The type of technology included electricity, electronics, metallurgy, machinery, oil refining, and chemicals, and most of it was relatively simple and low-level technology that could readily be used by the newly emerging enterprises in Korea.

Japan's capital assistance and technology transfer played a significant role in modernizing Korean industries. Yet as it is, the pattern of trade between the two countries bears the characteristics of a "north-south relation" in which dependence rather than interdependence prevails between developing and developed countries. For example, one-fifth of Korean exports and one-third of Korean imports depend on the Japanese market, while only 4 percent of Japan's exports and 2 percent of Japan's imports depend on the Korean market. This disparity is also well reflected in the type of commodities traded between the two countries. Korean exports to Japan consist mostly of primary products or light industry goods, such as fishery products, textiles, garment, steel products, and electronic goods. The commodities Korea buys from Japan are mostly capital goods, including machinery, chemicals, steel, and other metallic products.

The chronic imbalance in trade account in favor of Japan is another aspect of the lopsided economic relations between the two nations. Between 1965 and 1982, Korea ran up a trade deficit of $24 billion with Japan, or some 70 percent of Korea's total trade deficit with all countries combined. It is not difficult to explain the causes of the trade imbalance. Since the early 1960s, Korea-based on an outward-looking development strategy-started to vigorously introduce the foreign capital and technology needed for industrialization and export expansion. The drive called for the massive import of production goods wherever available. Japan was situated at the ideal vantage point relative to other countries in meeting Korea's needs, by virtue of her geographic vicinity and cultural affinity-as well as her industrial competitiveness in terms of price and quick delivery and after-services.

For Japan, the rapid industrialization in Korea in the 1960s, followed by the boom of the procurement demand from U.S. military forces at the time of Korean War in the 1950s, provided a strong stimulus to her economic recovery and growth. Yet the spill-over effect of the rapid economic growth in Japan on the Korean economy was minimal, mainly because of Korea's inability to satisfy Japanese needs in industrial goods on the one hand and the traditional import barriers erected in the Japanese market on the other. It is indeed a striking observation that in spite of the rapid economic growth both in Japan and Korea during the past two decades, their industrial linkage has been so limited and trade relations have been so unbalanced.

It is often contended in Korea and elsewhere that one element of the chronic trade imbalance against Korea has something to do with the type of Japanese loan contracts and the technological license agreements with Korea. For instance, most Japanese public loans, as well as supplier credit extended to Korean businesses, required the purchase of Japanese goods. A survey of the terms of technical license agreements also showed that about half of them made it obligatory to buy raw materials, parts, and equipment from Japan, often restricting the source of imports or choice of materials to be used.

This situation was sometimes brought to the attention of the Japanese policy makers by Korean officials, demanding loosening of the strings attached to economic cooperation. One reaction from the Japanese side was that it is contradictory for Korea to ask for capital and technological help from Japan and then take issue with a trade imbalance caused by increased imports from Japan. To put the matter in proper prospect, I may point out that even though the import-inducing effect of the technical license agreement and the loan contracts usually extends itself well into the future, it need not be overly exaggerated. The loans received by Korea from 1965 to date totaled only $3.9 billion, as compared with Korea's total trade deficit with Japan, which added up to $24 billion in the same period, implying that other causes carry much greater weight.

In my view, the other causes include the trade barriers created by the Japanese projectionist trade policies. Needless to say, Japan is not alone in having such trade walls, for many other countries including Korea also have their won trade barriers. We appreciate the fact that Japan sponsored the Tokyo Round, which has brought down tariff and nontariff barriers, promoting an international open-trading system. However, it seems to be a prevailing opinion in the international community that it is too difficult for foreign firms to penetrate the Japanese market, and the Japanese government should do much more to open her market, commensurate with her leading status in the world economy. According to a trade organization in Korea, 28 percent of Korea's exports to Japan were subject to direct control of the Japanese government in 1981, let alone other nontariff barriers. It is also argued in Korea that the major items of export entitled to the Generalized System of Preferences are not given the full treatment as stipulated in the system.

For a Better Tomorrow

Let me now turn to future prospects. International economic cooperation, in my view, means exploration of mutual benefit by joint effort of the countries involved. Mutual benefit presupposes the existence of some economic complementarity or interdependence on which to base economic cooperation. Economic cooperation is also expected to facilitate economic growth of developing countries and reduce the economic disparity and imbalance between them. In short, mutual benefit, complementarity, interdependence, and balanced relations are major ingredients of economic cooperation.

There is no doubt that both Japan and Korea have derived enormous mutual benefit from economic cooperation since 1965. The basis of this cooperation has been the normalization of diplomatic relations and the complementary nature of industrial structure in both countries, which, guided by market forces, defined a pattern of the division of labor between them. However, Korea's industrial structure has been changing over time according to the shifting comparative advantages. Korea is now moving from the traditional labor-intensive type of light industry to more capital- and technology-intensive industries for the obvious reason that Korea has been losing the competitive edge in the international market in traditional lines of production in the face of the economic gains of the less developed countries of China and Southeast Asia.

In this connection, I have always envied the process of Japanese industrialization. In the early days, Japan relied on imports from the advanced countries for most of its required capital goods, as Korea does today. At that time, Japan-with its large domestic market and availability of foreign technology-was able to develop new sophisticated industries not only for import substitution but also expansion of exports. Because the domestic market was large enough, it was easy for producers to sell new products on the protected domestic market, which also served as a testing ground for improving the quality of the new products before placing them on foreign markets. The result was that Japan's exports increased rapidly and its external account has been in balance for most of the time, while the commodity structure of imports has shifted from finished products to raw materials and energy resources. At present, Japan, one of the major economic powers in the world, is moving toward more high-tech and labor-saving industries, giving away some less efficient industries to less developed countries-including Korea.

Korea wishes to emulate in many respects the successful experience of Japanese industrialization. However, one limitation, among others, is that the domestic market base is relatively small and, therefore, has to aim at foreign markets from the beginning. Korea, therefore, is in need of a larger market as well as technology and finance. In this regard, it is encouraging to note that wide-ranging cooperative ventures have been taken up by Japanese and Korean firms in recent years to produce heavy industrial goods, some of which are exported to Japan.

I am aware of the concern expressed by some Japanese friends over the so-called boomerang effect-that Japan's technical aid to Korea will lead to enhanced competition between producers of the two countries in the international market and possibly some loss of Japan's market share in Korea and elsewhere. Here we can see a seeming contradiction between the micro and macro aspects of economic relations. From the micro point of view, the boomerang effect may be true for an individual firm at least for the short run, but from the macro point of view, the boomerang effect is what is called for to reduce the chronic trade imbalance between the two countries.

On the micro level, however, it should be noted that an individual firm may suffer from the boomerang effect indirectly even if it refuses to transfer technology to Korea. In other words, if a Japanese firm refuses to share technology with a Korean firm, the latter will turn to other countries to get the same or similar technology with the result that the Japanese company will still face competition with the Korean firm both in Korea and the international market. The lesson is that if the company finds it a matter of time to lose the comparative advantage to the latecomers, the company may well join hands with its counterpart in Korea or elsewhere in the form of a joint venture, technical license agreement, coproduction, and so on. In particular, if Japanese and Korean firms develop a relationship of intra-industry division of labor and specialize in specific parts of the production process of the same product according to comparative advantages and exchange them for the production of final goods, it will increase productivity and enhance competitive power in the third market. There is then no need to worry about the boomerang effect.

From the macro perspective, technological transfer and intra-industry division of labor appear to be the major avenues through which the chronic trade imbalance can be corrected. I personally have a dream of regional economic cooperation among countries-particularly in Northeast Asia-in which the network of specialization could someday be similar to the European Community today. In particular, both Japan and Korea are resource-poor nations and have to live on trade and industry. Thus they have every reason to give high priority to regional economic cooperation on the basis of an open trading system and division of labor in line with their comparative advantages. Let me stress that it is only an open market that can reveal true areas of comparative advantage in a country. It would be wrong for Korea, for example, to take up any investment in heavy and chemical industries for the simple reason that the trade deficits occur mainly in those areas, and the assumption is that the protectionist policies of the government will last forever. For the same reasons, it would be unwise for Japan to produce whatever it needs domestically within the protectionist wall. Currently Japan is said to be self-sufficient in 85 percent of its manufactured goods. If the Japanese market were wide open, the Japanese people might find many products that are much cheaper in foreign markets that could preferably be imported to economize resources and at the same time to reduce the trade surpluses with many countries.

I am strongly opposed to the argument recently voiced by some Koreans that Korea should manage imports in order to switch import sources from Japan to other countries with which Korea has a trade surplus. This not only runs counter to the principles of the open and fair trading system but also hurts Korea's export industries by obliging them to use inputs of higher cost and different quality. Any measure that would shrink the trade volume between the two countries should be avoided because it serves no purpose in realizing a more balanced trade relationship between the two countries. As I said earlier, the right direction for both countries would be to encourage and promote the intra-industry specialization. As a matter of fact, such specialization has been in progress in some industries. In the textile industry, for example, Japan has come to specialize in artificial fiber, synthetic fiber, and their secondary products, while Korea has been concentrating on cotton yarn, silk spinning, and apparel. They then exchange and combine their respective semifinished goods to produce final products to be sold both at home and abroad. There are also many examples of business tie-up in the areas of iron and steel, electronics, and machine industry. The market forces are mainly responsible for this development, but the conscious efforts by the business community and the government would accelerate this trend for mutual benefit.

Concluding Remarks

Let me conclude my remarks by saying that Korea is greatly appreciative of the financial resources, technology, and the market that the Japanese people and government have made available to Korea since the normalization of relations between our two countries in 1965. Japan thereby has made a significant contribution to the rapid economic development in Korea thus far, forging a bond of friendship and cooperation between the two nations. Building upon this achievement, Korea and Japan are now seeking new ways of economic cooperation for a better tomorrow. I have tried to stress the importance of potential complementary relations that can be explored by widening the scope of intra-industry specialization, which in turn calls for technological transfer from Japan to Korea. Mutual effort in this direction will help reduce the chronic trade imbalance that is one of the major issues in economic relations between our two countries. I am convinced that, although the market forces will guide us in that direction, conscious efforts by the business community and our respective governments are also essential.

Statistical Appendix

Table 1. Korea's Trade Balance with Japan (In Million U.S. Dollars)
Year Exports to Japan Imports from Japan Trade Balance with Japan Korea's Total Trade Balance
  1965  44  167  -123  -288 
  1966  66  294  -228  -466 
  1967  85  443  -358  -676 
  1968  100  624  -524  -1,008 
  1969  133  754  -621  1,201 
  1970  236  813  -577  1,152 
  1971  262  954  -692  -1,327 
  1972  408  1,031  -623  -898 
  1973  1,242  1,727  -485  -1,015 
  1974  1,380  2,621  -1,241  -2,391 
  1975  1,293  2,434  -1,141  -2,193 
  1976  1,802  3,099  -1,297  -1,058 
  1977  2,148  3,926  -1,778  -764 
  1978  2,627  5,963  -3,336  -2,261 
  1979  3,353  6,657  -3,304  -5,092 
  1980  3,040  5,858  -2,818  -4,787 
  1981  3,444  6,374  -2,930  -5,139 
  Total  21,663  43,739  -22.076  -27,010 
Source: Customs Administration, Korea

Table 2. Japanese Shares in Korea's Total Trade
Year Total Exports (A) Exports to Japan (B) Japanese Share (B/A) (%) Total Imports (C) Imports from Japan (D) Japanese Share (D/C) (%)
  1971  1,068  262  24.5  2,394  954  39.8 
  1972  1,624  408  25.1  2,522  1,031  40.9 
  1973  3,225  1,242  38.5  4,240  1,727  40.7 
  1974  4,460  1,380  30.9  6,852  2,621  38.3 
  1975  5,081  1,293  25.4  7,274  2,343  33.5 
  1976  7,715  1,802  23.3  8,774  3,099  35.3 
  1977  10,046  2,148  21.4  10,811  3,926  36.3 
  1978  12,711  2,627  20.7  14,792  5,981  39.9 
  1979  15,055  3,353  22.3  20,338  6,646  32.7 
  1981  17,505  3,039  17.4  22,290  5,858  26.3 
 1966-80  Total  80,973  18,181  22.5  107,450  36,710  34.2 
Source: Customs Administration, Korea

Table 3. Imports from Japan (In Thousands of U.S. Dollars)
  Imports From Japan* % of Total**
  1971  1980  1971  1980 
 Heavy Machinery and  Petrochemicals 538,130  4,117,897  62.9  76.7 
 Fuels and Raw Materials 41.323  249.078  4.8  4.6 
 Light Industry Goods 183.256  735.821  21.4  13.7 
 Foods 78,582  81.961  9.2  1.5 
 Total 855.687  5,368,310  100.0  100.0 
Source: White Paper on Trade, Japan, 1981.
* Japanese Exports to Korea in FOB prices recorded in the above document.
** Does not add up to 100% becasue of rounding.

Table 4. Korea's Exports to Japan (In Thousands of U.S. Dollars)
  Exports to Japan* % of Total
  1971 1980 1971 1980
 Foods and Consumables 55,145  584,455  20.1  19.5 
 Fuels and Raw Materials 49,401  190,973  18.1  6.4 
 Light Industry Goods 100,846  1,311,312  36.7  43.8 
 Heavy Machinery and Petrochemicals 20,246  909,532  7.4  30.4 
 Total 274,421  2,976,272  100.0  100.0 
Source: Same as Table 3.
* Japanese Imports in CIF prices.

Table 5. Inflow of Japanese Capital to Korea: 1959-1981
(In Millions of U.S. Dollars)
Year Total Capital
from All
Countries (A)
Capital from
Japan (B)
Share in
the Total (B/A)
    Total Public Private  
1959-66  349  79  14  65  22.6 
67-71  2,414  544  178  366  32.7 
72-76  5,873  845  404  441  47.8 
77-81  13,589  2,482  769  1,713  31.0 
1959-81  22,225  3,950  1,365  2,585  34.6 
Source: Economic Planning Board, White Paper on Foreign Investment, 1981, in Korean.
Note: Loans with maturity of one year or longer, which have arrived.

Table 6. Direct Foreign Investment from Japan: 1962-1982
(In Thousands of U.S. Dollars)
Year From All Countries  From Japan  Japanese Share 
1962-66 21,263  4,663  21.9 
1967-71 96,354  37,373  38.8 
1972-76 557,040  395,473  71.0 
1977-81 632,401  235,485  40.3 
1962-82 1,307,058  672,994  54.0 
Economic Planning Board, White Paper on Foreign Investment, 1981, in Korean.
Ministry of finance, Arrivals of Foreign Investments, 1982, in Korean

Table 7. Technological Transfer From Japan
 and Royalty Payments : (1962-1982)
(In Million U.S. Dollars)
Year From All Countries From Japan Royalies Paid
      To All countires To Japan
1962-66 33  11 
1967-71 285  203  16 
1972-76 434  280  97  59 
1977-82 1,529  793  567  169 
1962-82 2,281  1,287  681  233 
Source: Economic Planning Board

Table 8. Technological Transfer to Korea by Industries : 1962-1982
(Number of Cases and %)
  From All Countries (A) From Japan (B)
    Cases (B)/(A), %
 Food 66  31  47.0 
 Oil Refining and Chemicals 388  230  59.3 
 Metal 203  128  63.1 
 Electrical 419  272  64.9 
 Machines 644  399  62.0 
 Electrical Power 54  14  25.9 
 Others 507  213  42.0 
 Total 2,281  1,287  56.4 
Source: Economic Planning Board.

Table 9. Conditions Attached to Technological
License Agreements with Japanese firms (%)

 1. No Conditions Attached 51.0 
 2. Conditions Attached 49.0 
 a. Specification of Selling Markets 48.0 
 b. Import of Related Goods from Japan 40.0 
 c. Japan's Right as Selling Agent for Korea 8.0 
 d. Japan's Right as Buying Agent for Korea 4.0 
 e. Limitation in the Selection of Inputs 8.0 
 f. Others 8.0 
Source: Economic Planning Board