Experts are increasingly concerned over the possibility of a military conflict in the Korean peninsula. How will a war in the region affect the economic stability of East Asia?
North Korea has remained an isolated nation for decades. North and South Korea used to be one nation called Korea. It was annexed by Japan in 1910. After Japan suffered defeat in the World War II, Korea was divided into two regions – one under the control of Soviet Union and the other under the control of US. An invasion initiated by North Korea led to the Korean War (1950–1953). The two nations signed an armistice but never signed a peace treaty. North Korea has long regarded the US as an enemy of the state.
North Korea’s nuclear program has been a concern for the international community. It has not been a signatory of the Non Proliferation Treaty since 2003. From 2006, there have been multiple sanctions imposed on the country for its expansion of its nuclear program. Even though North Korea’s nuclear program can be traced back to the 1960s, it announced that it had successfully tested a nuclear weapon in 2006.
In 2017, North Korea has launched 22 missiles in the span of 15 tests. It has increased its military activity since July of 2017 when it test launched two intercontinental ballistic missiles (ICBM). In August 2017, North Korea flew two missiles over Japan. The nation called it the “first step” in its Pacific operations. In September 2017, the nation has conducted its sixth nuclear test to date. In retaliation, US and South Korea have conducted a number of military exercises and attack simulations. The international community has also condemned the actions of North Korea.
North Korea also threatened military action against Guam, which is a US territory.
War with North Korea could result in the death of fifty thousand or more Americans and more than two million Korean casualties. However, the economic cost would be massive, too, running into potentially trillions of dollars for the United States, while damaging Asia’s biggest economies.
The 1950–1953 Korean War caused 33,651 U.S. casualties and cost the United States an estimated $20 billion. For South Korea, it caused 1.2 million deaths and saw the value of its gross domestic product (GDP) slump by more than 80 percent.
However, the cost of a second Korean War would be far greater, according to Capital Economics.
At its peak in 1952, Washington was spending around 4.2 percent of U.S. GDP fighting the Korean War. While Pentagon officials believe another war on the Korean Peninsula could be finished far more quickly, reducing the likely casualties and cost, there is a risk that the conflict could last much longer.
The Iraq War that began in 2003 was predicted to last only a few weeks, but it was not until December 2011 that the last U.S. military personnel left the Middle Eastern nation. The total cost of the war, which was originally forecast at $60 billion, ended up at nearly $1 trillion (5 percent of U.S. GDP), according to estimates by the Congressional Budget Office.
The cost of reconstruction could also be “enormous,” Capital Economics argues.
“After the most recent wars in Iraq and Afghanistan, the US government spent around $170 billion on reconstruction. South Korea’s economy is around 30 times bigger than these two countries’ GDP. If the US were to spend proportionally the same amount on reconstruction in South Korea as it did in Iraq and Afghanistan, it would add another 30 percent of GDP to its national debt,” the London-based consultancy says.
“The upshot is that a prolonged war in Korea could significantly push up federal debt in the US, which at 75 percent of GDP, is already uncomfortably high.”
Increased U.S. federal debt would put pressure on Washington to cut spending or raise taxes, or a combination of both, which would counteract the plans of “Trumponomics” to deliver lower corporate taxes and greater infrastructure spending.
The U.S. Federal Reserve could also be forced to raise interest rates faster to counteract inflationary pressures, thereby further increasing the cost of government debt and dampening the nation’s economic recovery.
South Korea, Global Damages
North Korea’s conventional forces include seven hundred thousand men under arms and tens of thousands of artillery pieces, while it is also estimated to have around twenty nuclear bombs as well as chemical weapons. With Seoul located just thirty-five miles from the North Korean border, the South Korean capital could suffer substantial losses, particularly given that it accounts for about half the nation’s population and economy.
As the world’s eleventh-largest economy, South Korea is bigger than any other country that has experienced a military conflict on its own soil in the past seventy years. A 50 percent fall in South Korea’s GDP could knock a percentage point off global GDP, while there would also be substantial disruptions to trade flows.
South Korea is heavily integrated into regional and global manufacturing supply chains, which would be severely disrupted by any major conflict. Capital Economics sees Vietnam as the worst affected, since it sources around 20 percent of its intermediate goods from South Korea, but China sources over 10 percent, while a number of other Asian neighbors would be affected.
The worst hit industry would be electronics, since South Korea is currently the fourth-biggest producer of electronics products, including liquid crystal displays, where it accounts for 40 percent of the global total. South Korea is also the second-biggest producer of semiconductors, with a global market share of around 17 percent.
South Korea is also a major automotive producer, accounting for about 5 percent of global vehicle production, as well as being home to the world’s three largest shipbuilders. South Korean shipyards would likely be targeted by North Korean attacks, potentially crimping the supply of vessels to the world’s liquefied natural gas (LNG) and other industries.
For U.S. companies such as Apple, electronics supplies from South Korea could be badly disrupted by war, especially since many factories are within easy reach of North Korean artillery. About 12 percent of Apple’s suppliers are from South Korea, according to Bloomberg, while many other companies would face production difficulties should the flow of South Korean intermediate goods suddenly be blocked.
Capital Economics expects this to result in a sharp rise in the price of electronics, including smart phones, cameras and computers, which could add a percentage point to U.S. inflation while reducing consumer purchasing power. Central banks such as the Fed might be forced to hike interest rates in response to an inflation spike.
Energy markets could be hit, particularly oil, given that around 65 percent of Asia’s refining capacity is located in Japan, South Korea and China. Oil and gas markets would also be affected, according to consultancy Wood Mackenzie.
If a conflict was to break in the region, then the immediate consequence would be that trade in East Asia would be disrupted. Investors will also flock to safe havens as markets will suffer and dip as a consequence. Hence, the value of gold and Japanese currency Yen will likely go up as they are considered “safe haven” options for their stability. This will negatively affect weaker currencies of developing countriesn addition, Vietnam and Japan will also be affected with a hit on Japanese exports. If investors drive up the value of Yen, then Japanese goods will become more expensive abroad and will drive down the sales. Moody’s has noted that while there may be short-term exposure to US and China, in the long term, the two nations would not suffer economic fall-out from a war.
Our assessment is that a military conflict in the Korean peninsula not only puts the lives of millions at risk, it also threatens the economy of the region. Japan and South Korea are likely to face the brunt of an economic collapse. Additionally, the biggest concern will be the supply chain security. Japanese and South Korean companies both depend on China as a production base and also contribute high-end inputs to goods assembled in China such as iphones which are completed by Taiwanese firm Foxconn. We feel that there is a strong possibility of sinking equities, a rise in bond prices and a strengthening of the Yen. However this could change if Japan were to be targeted by North Korea. In this situation, the yen would depreciate and investments flow to regions of perceived safety like Europe