Paying heed to the geopolitical risks

Most Koreans are not good at comprehending the intriguing connection between geopolitics and economics and the impact of geopolitical events on the economy.

Kim Byung-yeon

The author is a professor of economics and head of the Institute for Future Strategy at Seoul National University. No one at the end of the 20th century would have anticipated the arrival of the 21st century like this. Contrary to “The End of History,” which declared the final victory of democracy and market economy over socialism, the early 21st century has morphed into an era of unceasing upheavals mingled with uncertainties from a new round of civilizational clashes linked to geopolitics and economics. A recent report titled “Geopolitical and Geoeconomic risks Korea faces,” published by the Institute for Future Strategy at Seoul National University, concluded that a number of volatile issues defying predictions about the future affect the Korean Peninsula. Korea’s fate hinges on how to overcome the complicated crises.

Nevertheless, most Koreans — particularly international relations and security experts — are not good at comprehending the intriguing connection between geopolitics and economics and the impact of geopolitical events on the economy. Government ministries dealing with economic affairs and think tanks predict the economy largely based on ceteris paribus — or, under the condition of “all other things being equal” — regardless of ever-growing geopolitical risks for the country. Besides, our political circles are divisive and government organizations are fragmentary. Politicians with superb expertise in transforming trivial issues into political disputes hamper a thorough diagnosis and preparations for geopolitical risks. They are just sitting on their hands even when the risks can trigger a perfect storm if coupled with a financial crisis.

The Ukraine War will continue for a while. An early armistice will be the best scenario, but the possibility is slim. The United States and Europe started to draw up economic sanctions on Russia from late 2021 to brace for its invasion of Ukraine. But they stopped short of preparing arguably the most crucial countermeasures such as a ban on importing Russian oil and gas or a scheme to lower their prices below the production cost — a stark difference from their earlier sanctions on North Korea aimed at banning imports of its minerals. The U.S. and Europe had to consider the ban’s impact on the European economy and also could not stop China, India and Turkey — major importers of Russian oil and gas — from importing them. Unless Russian oil prices fall below $40 per barrel, the cost of production, Russia has no trouble funding the war for quite a while. Therefore, the war will not likely end this year. Instead, the war will probably bring about an even bigger geopolitical crisis.

The war in Ukraine will affect Korea’s interest rates in the second half of the year. Russian President Vladimir Putin bet his destiny on the war, whereas the West has no intention to surrender to Moscow after defining the invasion as a standoff between democracy and autocracy. The Ukrainians also do not want a ceasefire. As a result, international energy prices could soar.

Another variable is weather. If an extreme heat or cold wave sweeps Europe this year, energy prices can jump further. In case the war expands to the rest of Ukraine or the fertile grounds of Russia on the border, international grain prices will skyrocket. In that case, the Bank of Korea will have to stop raising the benchmark rate to help control inflation.

Reopening of China will not bring about positive effects as expected, due to the structural, policy and geopolitical factors. First, China’s technological advancement has reduced its demand for Korean products. Second, Beijing’s so-called “dual circulation strategy” focused on expanding domestic demand will put the brakes on Korea’s export growth. Third, the ongoing Sino-U.S. battle over semiconductors, Korea’s mainstay export item, will deal a critical blow to the Korean economy. If Seoul faithfully complies with Washington’s demand for Korea’s suspension of chip exports to China and investments there, China can retaliate against Korea with a methodical ban on exports of raw materials for second batteries or other rare earths. It is a serious mistake to expect a China-led rebound of the global economy as in the 2007-08 financial crisis. China has changed, and so did the rest of the world.

North Korea’s nuclear test constitutes a “confirmed variable.” The test itself will have a limited impact on our economy. But its last-minute provocation can give an asymmetrical shock to our economy when coupled with deepening global risks and their repercussions on the economy. Pyongyang’s uninterrupted blackmail can compel foreign investors to leave Korean markets. If the won’s value plunges as a result, our financial authorities are required to raise interest rates to stop it. An inevitable increase in import prices will also pressure the authorities to lift the rate. But the rate hikes will help shrivel the economy and prompt a financial crisis. Korea’s economic policy will have to walk a tightrope up in the air.

Expectations for a drastic recovery of our economy in the second half are too optimistic. The International Monetary Fund’s outlook for Korea’s economic growth for this year at 1.5 percent seems overly generous. The government and the corporate sector need to pay attention to a new ESG to survive. In the era of turbulent geopolitics, you need to stick it out rather than jump.

Translation by the Korea JoongAng Daily staff.