Pacific Money | Economy | East Asia

South Korea’s Struggle to Bring Manufacturing Home

Like other countries around the world, Seoul is trying to reshore production – with limited success.

Troy Stangarone
South Korea’s Struggle to Bring Manufacturing Home
Credit: Flickr/Valentin Janiaut

With COVID-19 disrupting global supply chains, countries have encouraged businesses to return production home. But as South Korea is learning, reshoring production is difficult to achieve.

Different countries are encouraging reshoring for different reasons. In some cases the goal is to ensure access to necessary parts and supplies in the event of a future crisis, especially medical supplies and parts for critical industries, or to promote economic growth domestically during the pandemic. These two imperatives are largely driving South Korean efforts. Other efforts, such as those by the United States and Japan, are also designed to reduce dependence on China for geostrategic reasons.

South Korea was the first country outside of China to experience a factory shutdown due to COVID-19. In February, closures in China during the coronavirus lockdown caused a shortage of parts that forced Hyundai Motors to suspend production. In June, the South Korean government announced that it would provide a series of tax and subsidy incentives to encourage companies to reshore production.

Companies looking to reshore are currently eligible to have their corporate taxes waived for the first four years and receive an additional 50 percent cut the following two years. The South Korean government is also offering to provide up to 20 billion won ($16.8 million) to cover relocation and facility costs for firms relocating to regions outside the capital, and up to 15 billion won to tech firms relocating to the capital region of Seoul. It is also increasing assistance for reshoring firms that build smart factories or utilize industrial robots from 300 million to 500 million won.

However, South Korea’s experience in promoting reshoring in recent years and during the current crisis demonstrates the difficulties countries face in moving supply chains outside of China. Incentives in place since 2014 have seen an average of 10.4 firms relocate to South Korea per year. In the first two months since the new incentives were announced, only six firms have decided to relocate back to South Korea. A recent survey of South Korean SMEs with operations in China and Vietnam found that only 8 percent were considering returning to South Korea.

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South Korea is not alone in finding it difficult to bring manufacturing home. Earlier this year, Japan announced that it would provide 220 billion yen ($2 billion) to firms for the purpose of relocating from China to Japan and an additional 23.5 billion yen for firms relocating to Southeast Asia. While Japan has seen a higher number of acceptances, with 87 proposed projects, they only account for 70 billion yen of the funds set aside for reshoring and a small fraction of the estimated 7,400 Japanese affiliates in China as of March 2018.

In its trade war with China, the U.S. has primarily used blunt instruments such as tariffs or national security restrictions to break connections between American and Chinese firms. Despite U.S. tariffs on goods from China rising to an average of 21 percent during the trade war, there are few indications that firms were leaving China in large numbers.

More recently, in a break from its unilateral approach, the U.S. is also exploring the creation of an Economic Prosperity Network “of like-minded countries, companies, institutions, and civil society that operate under a set of trust principles for areas of all economic collaboration.” It is also considering tax and other incentives for companies to move production back to the U.S. as it looks to add carrots to its previous use of sticks.

Why are South Korea, Japan, and the U.S. facing challenges in moving supply chains? For many firms it can be a difficult process. Firms in the automotive or high-tech areas often have high product safety and quality needs. It takes time to find new suppliers that can meet the necessary standards. While some reshoring plans cover wage costs temporarily, there are long-term increases in labor costs from moving. The incentives are also relatively small for some key industries. Japan’s $2 billion in incentives is dwarfed by the $8 billion Samsung recently invested in a new fab in Pyeongtaek.

Hyundai’s production suspension early in the crisis highlighted the risks on one side of the supply chain, but its later decision to suspend production at a plant due to a worker testing positive for COVID-19 highlights the risk to production from reshoring and shortening supply chains.

Perhaps most importantly, China provides a level of product specialization and infrastructure that is difficult for other countries to match, and with its economy recovering better than others, there will be a reluctance to move to countries still facing recessions.

Despite these challenges, South Korea has had some limited success in reshoring. After a nearly three decade long effort to increase domestic production, South Korea remains dependent on Japan for specialized parts and components necessary for its consumer electronics and automotive industries. In 2018, South Korea’s trade deficit in parts and components accounted for 63 percent of its total trade deficit with Japan.

However, in response to Japan’s trade restrictions on components for South Korea’s semiconductor and display panel industry, Seoul has worked to decouple the production of industrial materials and components in its supply chain from Japan. South Korea quickly announced in 2019 that it would invest $6.6 billion in R&D over seven years to create a domestic supply for 100 key materials.  It followed that with an additional $9.3 billion this year to further its efforts to lessen its dependence on Japan for industrial materials.

Early indications suggest that South Korea has been successful in lessening its dependence on Japan for certain key materials in semiconductors and display panels. It was only when concerns rose that Japan might no longer be a reliable economic partner, however, that a real shift began to take place.

A similar dynamic is taking place with regard to China and the U.S. While Made in China 2025 was already an effort to decouple from American technology, U.S. restrictions on Huawei and other firms have only accelerated Chinese efforts to decouple from the U.S. in areas such as semiconductors.

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South Korean firms have been successful in utilizing global supply chains to compete with firms around the world. Returning production to South Korea would likely lead to increased costs and reduced quality, if suppliers are unable meet the standards of those abroad. Both would make South Korean firms less competitive with foreign firms. In the absence of additional political risks to supply chains, it will be difficult for South Korea and other countries to induce firms to return home in large numbers.