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ECONOMIC Journal 2006, Vol. 20 No. 4, 379392 Asian Economic Journal 1998, Vol. 12 No.

3] [AsianEconomic RELATIONS BETWEEN KOREA

AND CHINA

379

Trade, Investment and Economic Interdependence between South Korea and China*
Joon-Kyung Kim, Yangseon Kim and Chung H. Lee
Received 23 February 2006; accepted 26 September 2006

The Korean economy has been signicantly affected by the emergence of China. It is now the largest market for Korean exports and a major supplier of its lowcost imports but has at the same time become a serious challenger to Korea in the world markets for manufacturing exports. This paper investigates changes in Chinas export structure and its effect on Korea, and bilateral trade between the two. It also examines the motives for Korean investment in China and its effect on bilateral trade and cross-border production networks. Keywords: China, investment, Korea, production networks, trade. JEL classication codes: F10, F21.

I. Introduction Economic relations between South Korea (henceforth Korea) and China have expanded ever since the two countries established a formal diplomatic relationship in 1987. Trade between the two has grown steadily in both volume and variety, and capital ows likewise have increased although they have been mostly from Korea to China in the form of direct investment. Between 1989 and 2004, for instance, Koreas merchandise exports to China grew from US$1.3bn to US$49.8bn while Chinas merchandise exports to Korea grew from US$472m to US$27.8bn. During 2004 alone Korea invested US$2.0bn in China, and by the end of that year the total stock of its investment in China stood at US$8.9bn. These increases in both trade and investment are signs of growing economic interdependence between the two countries. The emergence of China has had, as observed by Gaulier et al. (2005), Lall and Albaladejo (2004) and Rodrik (2006), far-reaching consequences on the East Asian economies: It has accelerated the restructuring of production in these economies and the expansion of their intra-regional trade as well as trade with
* J-K. Kim: Korea Development Institute, PO Box 113, Cheongnyang, Seoul 130-012, Korea. Email: joon@kdi.re.kr. Y. Kim: East-West Center, 2404 Maile Way, Honolulu, HI 96822, USA. Email: yangk@hawaii.edu. C. H. Lee (corresponding author): University of Hawaii at Mnoa, 541 Saunders Hall, 2424 Maile Way, Honolulu, HI 96822, USA. Email: lchung@hawaii.edu. An earlier version of the paper was presented at a conference on Korea and the World Economy, Korea University, 78 July 2006. The authors wish to thank an anonymous referee for very helpful comments and suggestions on earlier versions of the paper. doi: 10.1111/j.1467-8381.2006.00243.x

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the rest of the world. Korea, one of the East Asian economies, has likewise been signicantly affected, both positively and negatively, by this development in the region. China is now the largest destination of Koreas manufacturing exports and a major source of its low-cost imports. At the same time China has now become a serious challenger of Korea in the global markets for manufacturing exports.1 In this paper we carry out a detailed examination of the changes that have taken place in economic relations between China and Korea. Specically, we examine in Section II the changes in the export structures of the two economies, their bilateral trade, and the production networks spanning the two. In Section III we report the motives for Korean investment in China and examine the sources of procurement and sales destinations of Korean afliates in China, in order to explore the effect of Korean investment in China on bilateral trade and economic interdependence between the two economies. Section IV concludes the paper. II. Competition or Complementary?

How has the rapid change in Chinas export sector affected Koreas trade vis-vis China and the rest of the world? Has Korea lost its export market share to China or have its exports expanded along with the growth of Chinas exports? In an attempt to answer these questions we examine the changes in the export structures of China and Korea and their bilateral trade. II.1 Changes in the export structure

To learn about the changes in the export structure we group, following the OECD classication, the exports for 1992 and 2004 into (i) low-technology; (ii) mediumlow-technology; (iii) mediumhigh-technology; and (iv) hightechnology products.2 We nd that in 19922004 China, and Korea to a lesser extent, went through major changes in their export structure (Table 1). It is clear that Chinas export structure has shifted increasingly toward technologically more sophisticated products. In 1992, more than half of Chinas manufacturing exports were in low-technology products, such as textiles, apparel and footwear, with medium (mediumhigh and mediumlow) and high-technology products accounting for 23.1 and 10.9 percent, respectively. By
1. Eichengreen et al. (2004) and Eichengreen and Tong (2006) argue that economic growth in China has had a positive effect on high-income countries and on countries that produce and export capital goods, components and technology, and a negative effect on low-income countries and countries that produce and export consumer goods. In this paper we show that it has had both a positive and a negative effect on the Korean economy. 2. For this purpose we regroup trade data using the International Standard Industrial Classication (ISIC). The four technology groups thus consist of the following ISIC sectors: 1522, 36 and 37 for the low-technology group; 23, 2528 and 351 for the mediumlow-technology group; 24 (excluding 2423), 29, 31, 34 and 35 (excluding 351 and 353) for the mediumhigh-technology group; and 353, 2423, 30, 32 and 33 for the high-technology group. The non-manufacturing group consists of 0114.

Table 1 Export share by industry and revealed comparative advantage (RCA)

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China Share (%) 1992 Manufacturing products High-technology and ICT products Aircraft and spacecraft Pharmaceuticals Computers and ofce products Semiconductor, electronic valves Radio, TV, communication equipment Precision, medical, optical instruments Mediumhigh technology Electrical machinery Chemical products Motor vehicle and trailer Other transport equipment Home appliance and machinery equipment Medlow technology Shipbuilding and repairing Coke, petroleum products Rubber and plastic products Non-metallic mineral products Basic and fabricated metal products Low technology Textile, apparel, footwear Food, beverages, tobacco Wood and paper products Other misc. manufacturing products Non-manufacturing products ICT, information and communication technology. 2004 1992 RCA 2004 Share (%) 1992 2004

Korea RCA 1992 2004

10.9 0.5 1.3 1.3 0.8 4.5 2.6 12.4 3.3 4.1 0.8 0.7 3.5 10.7 0.6 0.9 2.0 1.9 5.3 53.4 37.5 6.4 2.0 7.5 11.2

34.2 0.1 0.8 14.9 3.7 11.7 2.9 19.6 5.6 3.9 2.0 1.0 7.1 12.4 0.5 0.8 2.6 1.7 6.7 31.0 20.6 2.6 1.6 6.3 2.6

0.56 0.14 0.74 0.30 0.26 1.24 0.75 0.36 0.87 0.56 0.07 1.26 0.32 0.83 0.61 1.30 0.83 1.31 0.71 2.43 4.42 1.08 0.45 2.43 1.34

1.46 0.07 0.25 2.85 0.78 2.44 0.81 0.62 1.35 0.49 0.20 1.87 0.80 1.03 0.71 1.24 1.04 1.36 0.98 1.74 3.13 0.49 0.51 2.11 0.22

25.8 0.9 0.4 4.0 10.6 8.5 1.3 20.4 2.2 7.2 5.8 0.2 5.0 18.7 5.4 0.2 2.8 0.8 9.7 31.6 25.4 2.1 1.0 3.2 1.5

39.2 0.2 0.3 9.0 11.0 15.3 2.4 35.2 3.2 10.2 13.6 0.2 8.0 17.3 6.4 0.1 2.4 0.6 7.7 8.8 6.1 1.1 0.6 1.0 0.4

1.33 0.28 0.26 0.91 3.62 2.31 0.39 0.60 0.59 0.99 0.50 0.35 0.46 1.45 5.77 0.30 1.15 0.52 1.30 1.44 2.99 0.35 0.22 1.03 0.18

1.63 0.11 0.11 1.73 2.30 3.19 0.65 1.10 0.77 1.26 1.33 0.29 0.91 1.43 8.45 0.20 0.96 0.44 1.12 0.49 0.92 0.20 0.19 0.35 0.03

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2004, however, China made a signicant change in its export structure, making a large increase in the exports of mediumhigh technology and high-technology products, especially in information and communication technology (ICT) products. Among the ICT products, the share of computers and ofce products and radio, TV and communication equipment increased the most in 19922004. The combined share of these exports increased from less than 6 percent in 1992 to more than 26 percent in 2004.3 Between 1992 and 2004, Korea also experienced a steady increase in the export shares of both high-technology and mediumhigh-technology products: from 25.8 to 39.2 percent and from 20.4 to 35.2 percent, respectively. In the high-technology group the largest increase took place in radio, TV and communication equipment: from 8.5 to 15.3 percent; while in the mediumhightechnology group it was the exports of autos, the share of which more than doubled. In contrast, the shares of both low-technology and mediumlowtechnology products decreased, with the steepest decline taking place in lowtechnology products. Indeed, the export share of textile, apparel and foot-wear alone, which had been major exports up until the early 1990s, decreased from 25.4 percent in 1992 to 6.1 percent in 2004. The change in Chinas export structure suggests that it has been following Korea in the catching-up product cycle development that began in Japan some years ago, and Korea itself had been following Japan. With China catching up with Korea in economic development, we would expect export competition between the two to increase, with exports from the former displacing those from the latter in many of the world markets, in particular in Japan and the USA, two major markets for Korean exports. In Figure 1 we present the shares of imports from China and Korea in the world, Japan, the USA, and the European Union for 1992 and 2004. It is clear that China made signicant gains in the market share in Japan and the USA at the expense of Korea, becoming its competitor in world markets. This took place mostly in labor-intensive, low-technology industries, but even in mediumlow-technology industries Korea has lost some of its market share to China (Figure 2). Korea has nevertheless managed to increase its share of total world exports: from 2.0 percent in1992 to 2.8 percent in 2004, by increasing its market share in high-technology and mediumhigh-technology products, although it was increasingly challenged by China in almost all the major markets of the world (Figure 3). That Korea has increased its share of total world exports, including those to China, especially by increasing its market share in high-technology and mediumhigh-technology products, suggests that the increase in Korean exports to China was large enough to more than offset the loss of its export market share to China in the rest of the world.
3. Although computers and ofce products and radio, TV and communication equipment are classied as high-technology products, the technology involved in their production in China may be of simple assembly type used at plants of foreign multinational enterprises. The fact that the high-technology products are Made in China does not necessarily mean that they are Made by the Chinese.

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Figure 1 Share of imports from China and Korea in major markets

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Note: Chinas and Koreas shares in world market refer to the ratios of their respective exports to world exports.

Figure 2 Share of imports from China and Korea in major markets: low-technology and mediumlow-technology industry

Figure 3 Share of imports from china and Korea in major markets: high-technology and mediumhigh-technology industry

Note: ICT, information and communication technology.

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Table 2 Growing trade interdependency between China and Korea: share (%) and trade intensity (in parentheses) 1990 Chinas share in Koreas exports Chinas share in Koreas imports Koreas share in Chinas exports Koreas share in Chinas imports 2.1 (1.4) 2.1 (1.1) 2.0 (1.0) 1.3 (0.7) 1992 3.5 (1.6) 4.6 (2.0) 2.8 (1.3) 3.3 (1.6) 1994 6.5 (2.4) 5.3 (1.8) 3.6 (1.5) 6.3 (2.7) 1996 8.8 (3.3) 5.7 (1.9) 5.0 (1.7) 9.0 (3.6) 1998 8.3 (3.2) 6.7 (1.9) 3.4 (2.0) 10.7 (4.2) 2000 10.7 (3.1) 8.0 (2.0) 4.5 (1.8) 10.3 (3.7) 2002 14.6 (3.2) 11.4 (2.2) 4.8 (2.0) 9.7 (3.6)

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2004 19.6 (3.2) 13.2 (2.0) 4.7 (1.9) 11.1 (3.7)

II.2

Expanding bilateral trade

As noted above, while Korea has been losing its market share for some of its exports in third markets to China, its exports to China have been expanding. In fact, the increase of Korean exports for the last decade was mainly due to an increase of its exports to China. As presented in Table 2, Chinas share in Korean exports has increased from 2.1 percent in 1990 to 19.6 percent in 2004. This is as to be expected because rapid economic growth in China has led to a rapid increase in its trade with the rest of the world, including that with Korea. What is thus of greater interest is whether trade between the two has increased more rapidly than their respective trade with the rest of the world. To answer this question we calculate the export and import intensity indices for China and Korea, respectively, for the period 19902004 (Table 2).4 Between 1990 and 2004, Koreas export intensity with respect to China rose from 1.4 to 3.2 while its import intensity rose as well, but at a more modest pace from 1.1 to 2.0. These increases in the export and import intensities indicate that bilateral trade between Korea and China has expanded more rapidly than their respective trade with other countries in the world. During the same period Chinas import intensity with respect to Korea increased from 0.7 to 3.7, indicating a growth rate of Chinese imports from Korea that is much higher than that from the rest of the world and the growing importance of Korea as a source of Chinas imports. Chinas export intensity with respect to Korea also increased rapidly from 1.0 to 1.9, again pointing to a bilateral trade that is expanding faster than their respective trade with other parts of the world.

4. The export intensity of country A with respect to country B is the ratio of Bs share of As total exports to Bs share of world total imports. If it is greater than 1 it suggests closer economic ties between the two. The import intensity index is similarly calculated and would have the same implication.

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Table 3 China 1992 Total trade Export Import 2004 1992 Koreas major parts trade partners (%) Japan 2004 1992 USA 2004 1992 EU-15

385

2004

3.5 4.6

19.6 13.2 26.9 12.2

15.1 23.8 10.5 40.3

8.5 20.6 9.2 27.3 5.4 13.8 5.8 40.6

23.7 22.4 31.4 29.8 41.8 34.0 22.1 12.2 58.8 38.2 19.6 22.5 27.9 14.9 26.5 30.7

16.9 12.9 13.4 20.1 18.1 11.4 6.3 9.1 3.2 20.8 14.4 9.0 16.8 12.8 13.7 21.8

12.8 12.8 12.7 12.0 26.6 3.7 16.9 9.6 9.0 17.9 13.8 15.4 18.2 15.9 16.0 22.9

13.3 10.5 9.8 12.2 16.3 4.2 10.2 7.6 1.6 20.6 5.0 12.3 8.3 38.3 10.6 28.1

Total parts trade Export 0.9 Import 0.4

Parts for computers and ofce products Export 1.5 31.1 11.2 Import 2.7 42.6 46.5 Parts for radio, TV, communication equipment Export 1.0 39.0 17.4 Import 1.1 24.4 65.4

Parts for precision, medical, optical instruments Export 0.9 82.5 18.4 5.7 Import 0.2 3.0 39.8 45.0 Parts for electrical machinery Export 1.8 38.1 Import 0.5 30.5 16.8 53.2 9.6 38.2 6.3 33.9

Parts for motor vehicles and trailers Export 0.9 29.7 20.2 Import 0.3 2.2 62.9

Parts for Home appliance and machinery equipment Export 1.9 23.9 15.7 13.9 Import 0.4 7.5 39.4 33.7

II.3 Growing production networks and trade in parts The rapid increase in the export and import intensities discussed above, a measure of expanding bilateral trade between China and Korea, might be due to the geographical proximity of the two countries. Obviously, distance alone cannot account for the increase in bilateral trade, and here we examine whether expanding production networks between the two have contributed to the increase in their bilateral trade. Expanding production networks, which might be a consequence of international fragmentation of production processes, imply increasing parts trade between the two countries (Ando and Kimura, 2003; Gaulier et al., 2005). Tables 3 and 4 report the destinations and sources of parts trade for Korea and China in 1992 and 2004 for the industries in which there is much parts trade. In 1992 China accounted for a meager 0.9 percent of Koreas total parts exports,

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Table 4 Chinas major parts trade partners (%) Korea 1992 Total trade Export Import 2004 Japan 1992 2004 Hong Kong 1992 2004 USA 1992 2004

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EU-15 1992 2004

2.8 3.3

4.7 11.1 5.2 12.3

13.7 17.0 7.2 22.3

12.4 16.8 11.3 21.2

44.2 25.5 54.7 33.8 73.4 49.8 73.7 53.9

17.0 2.1 25.9 2.5 32.1 2.3 27.7 3.8 25.3 1.6 24.9 2.8 1.7 0.0 5.4 0.9

10.1 11.0 8.8 10.2 10.5 7.2 2.3 4.2 13.0 19.1 3.8 5.6 27.9 6.2 17.0 13.8

21.1 8.0 16.3 6.1 19.8 4.4 11.1 3.2 16.3 12.5 15.7 5.8 36.4 4.4 21.2 12.3

9.4 13.5 5.5 19.1 10.7 3.1 1.8 14.9 8.5 12.1 2.0 18.1 11.9 38.7 7.9 34.3

16.8 12.2 13.4 11.6 18.1 3.0 12.3 11.0 13.1 11.2 12.0 19.7 11.4 33.2 18.4 39.4

Total parts trade Export 1.3 Import 1.7

Parts for computers and ofce products Export 1.6 1.7 2.6 7.9 Import 1.5 9.1 32.9 18.4 Parts for radio, TV, communication equipment Export 2.1 9.5 13.2 14.1 Import 2.3 18.8 15.2 20.9

Parts for precision, medical, optical instruments Export 2.3 2.8 11.9 25.0 53.8 Import 0.1 9.8 26.2 30.4 28.0 Parts for electrical machinery Export 0.6 5.8 11.1 Import 0.7 8.3 18.0 Parts for motor vehicles and trailers Export 1.5 1.9 6.6 Import 0.2 13.8 46.6 14.1 30.6 14.5 34.8 53.7 42.4 11.0 1.0

Parts for home appliance and machinery equipment Export 1.7 4.2 6.2 15.4 30.7 Import 1.1 5.9 23.4 24.8 14.8

but in 2004 its share jumped to 26.9 percent (Table 3). Particularly signicant increases took place in computers and ofce products; in radio, TV and communication equipment; in precision, medical and optical instruments; and electrical machinery. These increases are a sign that China has become a major assembler of parts and components manufactured in Korea for many of its highand mediumhigh-technology products. This contrasts with Koreas meager share of Chinas parts exports, which increased only slightly from 1.3 to 5.2 percent between 1992 and 2004 (Table 4). In 1992, Korea imported parts and components mostly from Japan (40.3 percent) and the USA (29.8 percent) while importing only a miniscule amount from China (0.4 percent). By 2004, however, the share of imports from the former decreased considerably while that from the latter increased signicantly to 12.2 percent. The most dramatic increase was in computers and ofce products;

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radio, TV and communication equipment; and electrical machinery. These changes took place while the share of parts imports in those groups from Japan and the USA declined, indicating growing production networks connecting China and Korea. During the same period, Chinas parts imports from Korea as a proportion of its total parts imports also increased from 1.7 to 12.3 percent, whereas its parts exports to Korea as a proportion of its total parts exports increased from 1.3 to only 5.2 percent (Table 4). These increases are again a sign of growing interdependence between the two economies but also suggest that for China, Korea has become relatively more important as a supplier of its parts and components than as a destination of the same produced in China. In fact, while the share of parts imports of China from Korea increased, the shares of its parts imports from Japan, Hong Kong, the USA, and the European Union all decreased during the period. Except for Hong Kong, their share of parts exports from China increased, suggesting the growing importance of China as a parts supplier for the world. How Koreas foreign direct investment (FDI) in China might have contributed to this process is explored in the following section. III. Koreas Investment in China, Bilateral Trade and Trade Patterns of Korean Afliates Foreign direct investment may have a positive or negative effect on bilateral trade or it might have no effect at all. There will be a positive effect if FDI is for exploiting natural resources that the home country lacks, leads to reverse importing of the products manufactured by afliates, or brings about an international fragmentation of production processes and trade in parts and components (Jones, 2001). As discussed above, one notable development in economic relations between Korea and China has been the growing importance of parts exports from Korea to China, China having replaced the advanced industrialized countries such as the USA as the largest destination for Koreas parts exports. Foreign direct investment will have a negative effect on bilateral trade if it leads to a partial or full displacement of home-country exports to the host country with the goods produced locally by the afliates. It may even have no effect at all if FDI simply creates an export platform in the host country for third markets. Even in these cases FDI will have a positive effect on bilateral trade if it leads to imports of parts and components from the home country. It is clear from this brief discussion on the effect of FDI on bilateral trade that we can make some reasonable inference about the effect of FDI on bilateral trade from the information on investment motives. If the motive is, for example, to take advantage of low-cost labor in the host country or to exploit its natural resources, FDI is likely to have a positive effect on bilateral trade, because it would lead to reverse imports or imports of natural resources. If the motive is to exploit host-country markets FDI is likely to have a negative effect, because it would lead to the substitution of afliate products for imports from the home

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country (although this effect might be offset by imports of parts and components from the home country).5 III.1 Motives for Korean investment in China To nd out the motives for Korean investment in China we examine the results of two surveys of Koreas overseas direct investment carried out in 1996 and 2003 by the Korea Institute for Industrial Economics and Trade (KIET). The 1996 KIET survey (Ha and Hong, 1998) was done on a sample of 615 Korean companies (216 large rms and 399 small and medium-size enterprises (SME)) and their 952 offshore afliates. The 2003 survey was carried out on 748 companies all in manufacturing (89 large rms and 659 SME) and their 1050 offshore afliates (KIET and MOCIE 2004). In the 2003 survey the sample rms were asked to pick the most important reasons for investing overseas: natural resource or raw materials, low-cost labor, market access, high technology, and others. Out of 706 rms with investment in China, 42.6 percent reported low-cost labor and 33.0 percent market access as the most important reason for investing in China. These motives are quite different from those for investing in North America and Europe, where, according to the survey, market access is the most important reason for investment.6 According to the 2003 survey, the most important motive for overseas investment in textiles and apparel and footwear and leather industries was, not surprisingly, the low-cost labor in host countries. This is not surprising, given that these labor-intensive industries are the sectors in which Korea began losing its comparative advantage in the mid-1980s due in part to rapid increases in labor costs. FDI in such industries would lead to reverse imports to Korea and exports to third country markets from Korean afliates in China. Low-cost labor in China was also an important factor in Korean rms decision to invest even in capital-intensive, heavy industries such as electronics and telecommunications equipment and fabricated metals (Table 5). This apparent contradiction with the theory of comparative advantage (i.e. investment in capital-intensive industries in labor-abundant China) can readily be explained, however, if the investment is only for labor-intensive parts of production as in international fragmentation of production processes. Such cross-border production sharing would have a positive effect on bilateral trade as parts and components are shipped from parent to afliates, or the reverse.
5. Kim and Lee (2003) found that for the large rms the market access is the most important reason for investing in China, whereas for small and medium-size enterprises it is the low-cost labor. They also found that Koreas FDI in China in 19931997 was concentrated in the coastal areas and the areas with a high concentration of ethnic Koreans such as Jilian, Heilongjiang and Liaoning provinces. 6. These survey results are consistent with the results of the Fung et al. (2002) study that shows that investors from Hong Kong and Taiwan tend to use China as a platform for manufacturing laborintensive products and export these products to the industrialized countries.

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Table 5 Motives for Korean FDI in China by industry (2003) (%) Natural resource or raw materials Manufacturing Food and beverage Textiles and apparel Footwear and leather Paper and printing Petroleum and chemical Non-metallic minerals Basic metals Fabricated metals Machinery and equipment Electronics and telecomm equipment Motors and freight Other manufacturing 3.4 16.1 2.5 4.1 0.0 2.4 15.4 4.3 0.0 2.7 0.6 3.7 4.2 Low-cost labor 42.6 12.9 62.2 63.3 37.5 25.0 50.0 43.5 46.7 27.0 46.3 16.7 58.3 Market access 33.0 51.6 16.8 20.4 37.5 53.6 19.2 43.5 33.3 47.3 23.8 46.3 33.3 Others

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Total (number of rms) 100 100 100 100 100 100 100 100 100 100 100 (706) (31) (119) (49) (8) (84) (26) (23) (30) (74) (160)

21.0 19.4 18.5 12.2 25.0 19.0 15.4 8.7 20.0 23.0 29.3 33.3 4.2

100 (54) 100 (48)

Note: The gures are the percentage of the rms indicating the most important motive for investing abroad in total number of surveyed rms. Source: KIET and MOCIE (2004).

The above discussion suggests that by learning about the sources of parts and components for afliates and the sales destinations of their products we would shed some light on the linkages between FDI and bilateral trade. That is, if FDI leads to imports of parts and components by afliates from the home country and exports of their nal products back to the country, it would have a positive effect on bilateral trade. III.2 Trade patterns of Korean afliates in China Here we examine the procurement and sales patterns of Korean manufacturing afliates in China, as reported in the KIET surveys. As shown on Table 6, between 1996 and 2003 the share of parts and components imported from Korea by its manufacturing afliates decreased from 64.7 to 36.9 percent while the share of their local procurement increased from 26.5 to 45.6 percent, suggesting an increasing localization of parts supplies and the extension of backward linkages within China. The decrease in the share of imports from Korea in total procurement occurred in all but food and beverage, paper and printing, basic metals, and motors and freight. The share for electronics and telecommunication equipment, in particular, decreased from 86.0 percent in 1996 to 36.3 percent in 2003. Except for machinery and equipment, the industries that experienced a decrease in the share of imports from Korea inversely experienced an increase in the share of local procurement. The increase is most noticeable in industries such as footwear and

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Table 6 Sources of procurement by Korean afliates in China by industry (% of total procurement) Local procurement Korea 1996 Manufacturing Food and beverage Textiles and apparel Footwear and leather Paper and printing Petroleum and chemical Non-metallic minerals Basic metals Fabricated metals Machinery and equipment Electronics and telecomm equipment Motors and freight 26.5 78.3 46.0 2.6 91.8 1.0 49.0 88.6 0.5 40.9 13.9 78.8 2003 45.6 59.6 63.3 18.2 51.5 37.1 93.0 9.0 41.7 28.9 56.5 40.8 1996 64.7 19.2 53.8 94.9 8.2 62.9 51.0 11.4 99.5 49.4 86.0 21.2 2003 36.9 21.9 25.7 65.6 31.7 47.3 3.2 90.8 56.9 8.9 36.3 59.2 Imports from Third Countries 1996 8.8 2.6 0.2 2.5 0.0 36.1 0.0 0.0 0.0 9.8 0.1 0.0 2003 17.5 18.4 11.0 16.1 16.8 15.6 3.8 0.2 1.4 62.2 7.2 0.0

Sources: Ha and Hong (1998), KIET and MOCIE (2004).

leather, petroleum and chemicals, non-metallic minerals, fabricated metals, and electronics and telecommunication equipment. It thus appears that Korean FDI in China has led to either an increase in the exports of parts and components from Korea to China or an expansion of production networks in China, either way strengthening economic interdependence between the two economies. Sales destination for the output of Korean afliates in China varied widely from industry to industry, although for manufacturing as a whole the local sales accounted for an increasing share: from 22.6 percent in 1996 to 34.2 percent in 2003 (Table 7). Specically, in paper and printing, petroleum and chemical, basic metals, and motors and freight the local sales expanded signicantly during the period, accounting for more than half of the afliate output in 2003. In contrast, in textiles and apparel, footwear and leather, fabricated metals, machinery and equipment, and electronics and telecommunication equipment, more than 60 percent of output was exported, although in some of these industries the local sales increased. Reverse imports (exports back to Korea) accounted for 17.8 percent of the entire manufacturing output in 2003, a decrease from 25.8 percent in 1996, and were especially large in footwear and leather, non-metallic minerals, and basic metals. Total manufacturing exports to third markets also decreased from 51.6 to 48.1 percent between 1996 and 2003, but in footwear and leather, machinery and equipment, and electronics and telecommunication equipment at least as much as half of the output was exported to third markets. These are industries

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Table 7 Sales destination of Korean afliates in China by industry (% of total sales) Local procurement Korea 1996 Manufacturing Food and beverage Textiles and apparel Footwear and leather Paper and printing Petroleum and chemical Non-metallic minerals Basic metals Fabricated metals Machine and equipment Electronics and telecommunication equipment Motors and freight 22.6 51.2 47.5 1.2 13.1 0.6 40.0 51.3 3.5 51.6 30.5 0.5 2003 34.2 43.4 22.4 8.7 97.3 78.4 49.6 62.8 36.6 16.1 32.1 93.4 1996 25.8 27.4 8.2 29.5 51.2 46.6 57.8 23.1 25.7 47.0 60.7 3.7 2003 17.8 35.3 28.4 31.5 0.0 10.4 46.4 35.3 17.4 6.4 12.8 6.4 Imports from Third Countries 1996 51.6 21.5 44.4 69.3 35.7 52.8 2.2 25.6 70.7 1.4 8.9 95.8 2003 48.1 21.2 49.2 59.8 2.7 11.3 4.0 1.9 46.0 77.5 55.1 0.3

Sources: Ha and Hong (1998), KIET and MOCIE (2004).

that are either labor-intensive or assemblers of imported parts and components. Because many of the parts and components were imported from Korea, exports to third markets contributed indirectly to Koreas overall export expansion. This positive effect might be short-lived, however, if the localization of parts supplies continues as it did in a number of those industries in 19962003. IV. Concluding Remarks Rapid changes in Chinas manufacturing sector since the Four Modernization reforms of the late 1970s have had both a positive and a negative effect on the Korean economy. Chinas export structure has become increasingly similar to that of Korea, turning it into Koreas major competitor and challenging it in many of the world markets for manufacturing exports. At the same time China has become a major market for Korean exports and an important source of its imports, thus expanding bilateral trade between the two. Notable is the fact that parts trade between the two, especially parts exported from Korea to China, has increased signicantly. Korean FDI in China has had the effect of expanding trade and production networks between the two economies. Granted that China has taken away some of the world markets from it, Korea has gained indirectly from Chinas export expansion by increasing its exports of parts and components to China. Korean FDI in China has promoted the extension of this production network and thus the deepening of economic ties between the two East Asian economies.

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