Trading With North Korea

With the ongoing sabre-rattling in the Korean Peninsula ramping up and down on a daily basis, it is time to take a look at the economic relationship between North and South Korea, a tie that is much deeper than it would appear at first glance.  

The Kaesong Industrial Complex (KIC), a joint economic development between the two Koreas, was founded in 2003, led by an initiative from the Hyundai Group, and began operation at the end of 2004.  Hyundai paid North Korea $12 million for a fifty year lease on the Kaesong site.  This collaborative economic development is located a mere six miles from the Demilitarized Zone (DMZ) and is about 43 miles or a one hour drive from Seoul as shown on this map:

Here is a screen capture showing the physical layout of the KIC:

The project was intended to allow North Korea to liberalize and reform its economy and reduce tensions along the DMZ and gives South Korean companies access to a nearly endless source of very cheap labour.  At the end of 2010, over 120 medium-sized South Korean companies employed over 47,000 North Korean workers.  Production includes watches and jewelry, footware, clothing and textiles, kitchen utensils, auto parts, toner cartridges and semiconductor parts.  Here is a look at the growth of the KIC from its inception until the end of 2011:

By the end of 2010, 55 percent of the value of the goods produced in the KIC consisted of textiles and clothing followed by electronics and electric products (18 percent). All products manufactured in the KIC are shipped to South Korea for sale or export to Australia, the EU, Russia and China.  Most of the raw materials and intermediate goods used in production are not locally sourced, rather, the inputs are shipped from South Korea to Kaesong for final assembly.

The first phase of the KIC, which cost $374 million of which $223 million was provided by the South Korean government, covers an area of 300 acres and the roughly 300 foreign manufacturers (i.e South Korean) that could ultimately open for business could potentially employ up to 100,000 North Koreans.  Several hundred South Korean workers are also employed at the complex.  One of the co-developers of the project anticipates that the KIC will eventually cover an area of over 6000 acres and will include high tech zones, shopping districts, residential areas and tourism facilities.  Here is a chart showing the Master Plan for the KIC:

Thus far, the project has been largely funded by South Korea with the official backing of the United States.  South Korea's government has attracted companies to the KIC by offering low interest rate loans and a corporate tax rate of 10 to 14 percent with an exemption for the first five years after generating profits.  As well, South Korean law breakers in the KIC are not to go on trial in the North, a version of "diplomatic immunity".  The South Korean government also provides insurance against political risk, covering financial losses up to 90 percent of a company's investment in the KIC up to a maximum of $5.4 million.

If the entire Kaesong Industrial Complex were developed, Hyundai estimates suggest that North Korea could receive $9.55 billion in economic gains over a nine year period,  including $1.4 billion in corporate taxes.  While this may not appear to be significant when compared to Western economies, in 2005, North Korea exported only $1.8 billion worth of goods before the KIC was built.

An issue that is of some concern to outside nations relates to labor issues inside the KIC.  North Korean authorities take as much as 45 percent of workers' wages.  The minimum base monthly wage of $60.78 or between $2 and $3 per day is higher than the wages in the rest of North Korea but as a whole, total labor costs in the KIC are only 8 percent of those in a South Korean metropolitan area.  The North Korean government claims that they deduct 15 percent of a worker's base pay for social insurance and 30 percent for a socio-cultural policy that goes for the rental of state-owned housing, education, social welfare and medical services.  The balance is paid to workers in cash or as chits that can be exchanged for food and other necessities.

The KIC provides a critical revenue stream to North Korea's government, an issue that results in a diplomatic dilemma for both Koreas and the United States.  It is estimated that in 2010, the North Korean government collected monthly revenue of $2 million from workers' salaries.  It's interesting to see that, even though there has been ongoing political and military tension in the Korean Peninsula since the KIC was built, the KIC has continued to operate and even expand.  Since the KIC is a key revenue source for Kim Jong-un, he must be aware that social unrest would result if the 200,000 people living in the Kaesong area were deprived of work.  That said, this March 30th news release from North Korea's official news agency, the Korean Central News Agency of DPRK, suggests that the future of the KIC is in jeopardy:

Yes, we will follow the ongoing saga between North Korea and "the puppet group", particularly now that it appears that access to the KIC has been limited by the DPRK.