KDI Economic Outlook 2023-2nd Half Impacts of China’s Shrinking Construction Sector and Implications of Its Changing Mid-to-Long-Term Trade Structure November 08, 2023
KDI Economic Outlook 2023-2nd Half
Impacts of China’s Shrinking Construction Sector and Implications of Its Changing Mid-to-Long-Term Trade Structure
November 08, 2023
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Kyu-Chul Jung
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- Summary
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■ The analysis suggests that a decrease in China’s construction sector output significantly impacts Korea’s GDP through reduced exports of intermediate goods to China.
- A 10% decline in China’s construction production is projected to result in a 0.4% reduction in Korea’s GDP.
- Industries closely related to the production and transportation of construction materials, such as chemicals, mining, shipping, and metal and non-metal product manufacturing, are particularly affected by the contraction in China’s construction sector.
■ The international division of labor between Korea and China is eroding in tandem with China’s growing competitiveness in intermediate goods production, indicating heightened competition in overseas markets for intermediate goods.
- The share of Korean exports to China intended for re-export to third countries after processing is shrinking, while exports catering to China’s domestic demand are increasing.
- In Vietnam’s intermediate goods market, where Korean companies are actively expanding as an alternative to the Chinese market, the increasing market share of Chinese products implies a relative decline in Korea’s competitive position.
■ While devising immediate and clear short-term measures to respond to the evolving international division of labor with China may be challenging, it is necessary to consistently pursue risk diversification strategies, such as the expansion of export and investment markets.
- Corporate expansion into rapidly growing emerging markets in Southeast Asia and India, as well as into the Middle East and Eastern Europe, should be actively supported through government networks (e.g., KOTRA).
- Anticipating China’s shift from an investment-led to a consumption-led demand structure as its overinvestment is calibrated, sustained efforts to enter and tap into the Chinese consumer market are also crucial.
■ Concurrently, the drive for economic structural reforms to enhance Korea’s international competitiveness should continue.
- To smoothly navigate internal and external changes, it is imperative to enhance the flexibility of the Korean economy.
· A rigid economy is vulnerable to adverse spillover from shocks, whereas a flexible economy can absorb and adapt to such disruptions.
- Ultimately, the positive outcomes of market diversification hinge on securing corporate competitiveness. Therefore, maintaining ongoing efforts to invigorate economic vitality through structural reforms is necessary, including easing market entry barriers, increasing labor market flexibility, and overhauling the education system.
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China's real estate market is displaying alarming signs.
Evergrande, the world's most heavily indebted property developer, is reported to be sitting on a colossal debt pile of 443 trillion won.
Similarly, another property titan, Bi Gui Yuan, is also finanially strained.
Such a decline in China's property sector could, in the short term, adversely affect Korean exports.
For example, if China's specific industries like construction experience production setbacks, this could result in a dip in South Korea's exports of intermediate goods, like construction materials, to China.
KDI simulated a scenario where China's construction sector production drops by 10%, analyzing its ramifications on Korea's economy.
The findings are deeply unsettling.
The fallout is significantly felt in sectors tied to the production and transportation of construction materials, including chemicals, mining, and shipping, with South Korea's GDP taking a hit of 0.4%p.
But that's not all.
Aside from these immediate impacts, South Korea is grappling with more profound issues, notably changes in its longstanding relationship with China within the international division of labor.
Historically, China has been importing South Korean intermediates like semiconductors, utilizing them in domestic assembly and production, and subsequently re-exporting them.
This dynamic has been pivotal for South Korean exports.
However, there's been a marked reduction in China's reliance on South Korean intermediates for re-export.
This shift can be attributed to several factors, including rising labor costs in China.
Primarily, though, it seems to be driven by the shrinking technology gap between the two nations, leading China to increase its usage of domestically produced intermediates.
In response, South Korean firms are pivoting away from China, seeking to fortify ties with ASEAN nations, with the burgeoning Vietnamese market emerging as a focal point.
However, despite these efforts, South Korea's share in the intermediate goods market has been waning since 2017, while China is rapidly capturing more of Vietnam's market through swift technological upgrades and aggressive investments.
South Korea is thus confronted with the dual challenge of diversifying its export markets beyond China and simultaneously boosting the international competitiveness of its domestic firms.
(Interview)
China's enhanced competitiveness in intermediate goods is weakening the previously robust division of labor with South Korea.
To effectively manage these risks, it's essential to consistently pursue a diversification of both export and investment markets
The success of this market diversification strategy fundamentally depends on the competitiveness of Korean companies.
South Korea needs to energize its economy with reforms that reduce market entry barriers, enhance labor flexibility, and overhaul education system to drive growth.
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