KEI Spotlight

This article was published in East Asia Form on February 24, 2024.

After expanding by 2.6 per cent in 2022, South Korea’s economy cooled in 2023. Waning global demand for South Korean exports, continuing geopolitical challenges and weakening domestic demand saw growth decelerate to an estimated 1.4 per cent. While economic growth is expected to pick up in 2024, over the long term South Korean economic growth will be weighed down by structural challenges from the country’s changing demographics.

Heavily dependent on trade for economic growth, South Korea saw exports and imports decline in 2023. Exports finished down 7.4 per cent with only exports of automotives and ships seeing growth among major export items. Critically, exports of memory chips were down 30.6 per cent for the year, though they began to recover in October.

Despite imports decreasing by 12.1 per cent, South Korea recorded a trade deficit for the second straight year for the first time since the late 1990s. Continuing high energy costs and trade with China were among the primary factors.

While energy imports declined by 22 per cent in 2023, costs for imports of crude, liquid natural gas (LNG), coal and other petroleum products remained above levels seen prior to Russia’s invasion of Ukraine. Geopolitical concerns kept costs high, including a spike in prices around the beginning of the Israel–Hamas war.

Another factor is South Korea’s continued transition away from Russian fossil fuels. In 2023, South Korea eliminated imports of Russian crude oil and saw overall mineral fuel imports from Russia decline by 50.7 per cent.

South Korea has largely replaced Russian crude oil with increased imports from Saudi Arabia, Qatar and the United Arab Emirates, while Australia and Malaysia have seen exports of LNG to South Korea grow. To further strengthen overall energy security, South Korea reached an agreement with Saudi Arabia to store 5.3 million barrels of Saudi crude oil in Ulsan as South Korean strategic reserves.

Meanwhile, exports to China, South Korea’s largest trading partner and a significant source of its trade surplus, declined 20 per cent in 2023 to US$124.8 billion. Imports from China declined by a more gradual 8 per cent for the year, resulting in South Korea’s first trade deficit with China in 31 years.

Geopolitics is also playing a role in South Korean trade. In recent years, South Korea has found itself caught in the middle of the US–China tech war due to the critical role it plays in supply chains for semiconductors and electric vehicle (EV) batteries.

South Korean semiconductor firms are heavily invested in China and face increased risks from US export controls. US export controls put in place on 7 October 2022 raised concerns about the viability of South Korean semiconductor factories in China, but were resolved in 2023 with the United States designating Samsung and SK Hynix as validated end users.

The passage of the Inflation Reduction Act (IRA) in the United States in August 2022 has been an additional point of contention with South Korea. Designed to spur investment in US EV and EV battery manufacturing, as well as shift supply chains of critical minerals out of China, the legislation contains provisions that discriminate against South Korean firms, spurring these firms to invest more in the United States than in the European Union or any other country under the law.

Despite concerns about the IRA, it was a bright spot for South Korea in 2023. Regulatory adjustments to the law’s provisions related to the leasing of commercial EVs have helped Hyundai and Kia’s combined EV sales grow by over 60 per cent. The two companies combined sales trail only Tesla in the US market.

Overall, South Korea saw exports of EVs and other eco-friendly cars jump over 50 per cent in 2023 with total exports of ecofriendly cars exceeding 1 million units.

China’s own trade restrictions have also raised concerns. The introduction of new export controls for graphite, gallium and germanium — inputs necessary for the production of semiconductors and EV batteries — have increased supply chain risks. Beijing’s partial ban on US semiconductor firm Micron also reportedly found Seoul under pressure to not backfill any lost semiconductor supply in China.

In light of growing concerns about geopolitical risk, South Korea has sought to deepen cooperation with the United States on supply chains, critical minerals and green and emerging technologies. It is also expanding trilateral cooperation with the United States and Japan on the development of a supply chain early warning system and technology issues.

Weakening domestic demand from higher inflation was also a factor in South Korea’s slowing economy. While inflation has been declining in South Korea, interest rates remain high and have dampened private consumption and investment. The Bank of Korea is not expected to cut rates until the second half of 2024.

While South Korea’s economy faces geopolitical risks from wartime energy disruptions and the US–China trade war, its GDP is still expected to grow by 2.2 per cent in 2024. The more critical challenge for the South Korean economy is the continuing decline of its potential growth rate. The OECD estimates that South Korea’s potential growth rate — the rate at which the economy can grow without inflation — will decline to 1.7 per cent this year. This is largely due to demographics. South Korea’s working age population has begun declining and is expected to fall from 37.4 million in 2020 to 24.2 million in 2050.

Without addressing population decline, South Korea’s growth potential will likely decline to below 1 per cent annually by the 2030s. While South Korea’s economy faced geopolitical challenges in 2023, continuing demographic changes will have a longer-term impact on the economy in the future.