Tag Archive | "Kaesong Industrial Complex"

Three Questions About the Korea-China FTA

By Troy Stangarone

South Korea’s ambition to become a regional free trade hub in East Asia took another step towards reality as South Korea and China announced the outline of a conclusion of their bilateral FTA negotiations at the opening of the 2014 APEC summit. Once the FTA has been implemented, Korea will find itself in the unique position of having an FTA with the two largest developed markets in the United States and the European Union, as well as the world’s largest developing market, China.

While a significant achievement, the Korea-China FTA is still a work in progress with details still to be finalized and the prospect that some provisions could be negotiated further in the future. Despite these issues, there are three questions that come to mind when considering the Korea-China FTA:

Is the Korea-China FTA part of a challenge to the U.S. led economic system?

With China playing an increasingly prominent role in East Asia and its recent establishment of the Asia Infrastructure Investment Bank (AIIB), questions are being raised about U.S. economic leadership in the region. The AIIB, which the United States has discouraged its partners in the region from joining unless it meets the standards of established international lending institutions, is seen by many as an effort by China to develop an alternative economic structure for the region in which it offsets the influence of the United States.  This narrative is further strengthened by the failure of President Obama to secure the Trade Promotion Authority needed to conclude the Trans-Pacific Partnership and establish an FTA covering much of the Asia-Pacific region. However, does the Korea-China FTA fit into this broader narrative of declining U.S. influence and increasing efforts by China to develop an alternative economic structure?

According to the Wall Street Journal Liu Qiao, assistant dean with the Guanghua School of Management noted that “Beijing wants to show it has friends in the region,” and the Korea-China FTA is … “is more symbolic. The advantage is, they want to bolster their trade partners in the region, starting with South Korea and then others.” While Andrew Collier, managing director of Orient Capital Research and former president of the Bank of China International’s U.S. office remarked that “China is eager to replace the U.S. trade clout and influence in the region and this deal with South Korea is another nail in the coffin”.

Additionally, the New York Times quotes Patrick Low, formerly chief economist of the World Trade Organization, “It’s a real attempt to exert leadership and to project a responsible image in wanting to lead the whole of Asia — they’re all very much linked politically,” in regards to the AIIB, the South Korea FTA, and other trade deals that China has pursued.

While perhaps understandable that some analysts might reach this conclusion given current trends in the region, it fails to understand the broader issues at play.  The Korea-China FTA rather than an effort to undermine the U.S.-led economic order is in fact an effort by China to draw even with the U.S. in its trading relationship with Korea. After the conclusion of the U.S.-Korea FTA, China immediately announced that it would like to begin negotiations with Korea on its own FTA. However, rather than enter into negotiations with Beijing, Seoul instead chose to open talks with the European Union on a free trade agreement. It was only after the KORUS FTA and the EU FTA had been approved by all of the respective parties that Korea engaged in its FTA with China, which it did so as part of its own strategic efforts to become a hub for FTAs in the region. Korea is now the only country with an FTA with the three major global trading powers.

At the same time, in contrast with its skepticism regarding the AIIB, the United States has consistently supported South Korea’s efforts to conclude a high quality FTA with China. Any agreement with China that moves Beijing closer to international standards on trade and investment, while further opening the Chinese market, reinforces rather than undermines the current global economic system.

How Does the Korea-China Compare with Korea’s FTAs with the United States and the European Union?

South Korea’s FTAs with the United States and the European Union are two the highest quality FTAs in the global trading system. How does the recent agreement with China compare to those two agreements?

In the first 10 years of the agreement, South Korea will eliminate tariffs on 79 percent of its products, while China is expected to eliminate tariffs on 71 percent of its products. After 20 years South Korea is expected to eliminate 92 percent of its tariffs and China 91 percent. In contrast, under the KORUS FTA 95 percent of all trade becomes duty free after 5 years with nearly all remaining tariffs being eliminated after 10 years. At the same time, Korea’s FTA with the EU immediately eliminated 82 percent of Korea’s tariffs and 94 percent of the EU’s tariffs. After seven years both South Korea and the EU will eliminate 98 percent of tariffs, with the EU eliminating 99.6 percent tariffs.

Beyond the quicker and more significant phase outs, there are additional details that make the agreement with China less ambitious than other agreements South Korea has signed. Under the KORUS FTA Korea eliminated 92.5 percent of its tariffs on agriculture and fisheries, while only 40 percent will be eliminated in the agreement with China. In addition, 30 percent of Korea’s tariffs by value on agriculture and fisheries have been permanently excluded from the agreement, something which South Korea has not previously done in its FTAs. While this reduces the ambition of the agreement, it likely will help to ease concerns among farmers who had been strongly opposed to the agreement.

Additionally, what makes Korea’s FTAs with the EU and the United States of such high quality is their provisions on services and investment. One of the key achievements of the Park Administration was the announcement at the 2013 Park-Xi summit that both sides would negotiate on these issues simultaneously with the negotiations on goods and seek a high quality agreement. Many of the details on services and investment have yet to be announced, but we should expect that as in goods that they will be significant, but not to the same level of standards as the KORUS or EU FTAs.

While no one expected Beijing to be ready for the standards of the United States FTA with South Korea or that are being negotiated in the Trans-Pacific Partnership, the initial Korea-China FTA reports do seem to indicate a significant step forward in trade policy for China. If later details indicate that South Korea secured significant provisions, even if not to the standards of KORUS and the EU FTA, the Korea-China FTA could be an important achievement for Korea in securing access to the Chinese market while also moving China closer to international standards on free trade.

What Does the Korea-China FTA Mean for North Korea?

As China is North Korea’s only significant partner, it is natural to ask what the agreement means for North Korea. Initial reports indicate that China agreed to South Korea’s request to include goods from the Kaesong Industrial Complex in the FTA.  Unlike many of South Korea’s other FTAs, the goods will not be limited to a select number or items or future approval as with Korea’s FTAs with the EU and the United States.

The inclusion of Kaesong in the FTA could serve as a boost to North and South Korean efforts to internationalize the complex as it removes any disincentive that China’s current tariffs may have on shipping goods from Kaesong and recognizes them as South Korean. While significant issues related to internet access and the political risk of operating in North Korea, but the prospect of duty free access to the Chinese consumer market from the zone could enhance its appeal to foreign investors.

One issue that is unclear at the moment is if China’s economic zones, such as in Rason, have been included in the agreement. If so, and the ability to produce across the zones is encouraged, it could serve as a catalyst for needed infrastructure investment in North Korea to move goods between the zones, while at the same time helping to reduce the political risk of foreign firms operating in Kaesong as a production halt in one zone would impact production in another. Hence, by coupling the zones together it raises the political risk for North Korea in shutting down Kaesong in the future as it could potentially impact Chinese firms operating in zones along the border with China.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are the author’s alone. 

Photo from Korea.net’s photostream on flickr Creative Commons.

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The Rationale for a German Firm’s Investment in the Kaesong Industrial Complex

By Troy Stangarone

A little more than a year after North Korea initially withdrew its workers from the Kaesong Industrial Complex, South Korea announced that German manufacturer Groz-Beckert has received approval to open an office in Kaesong to supply industrial needles to textile factories in the complex. This will make Groz-Beckert the second foreign investment in Kaesong and the first since the complex reopened last fall.

Attracting international investment to the complex has long been a goal of South Korean administrations, with the Lee Myung-bak administration reportedly having reached out to IKEA to invest in Kaesong. However, in the aftermath of Kaesong’s suspension last year, the Park Geun-hye administration has actively sought foreign investment into the complex to provide additional support for the complex and to provide disincentives for North Korea to engage in similar activities in the future.

However, as noted previously on this blog, it is not unsurprising that the first foreign firm to invest in Kaesong since 2008 is not a globally recognized firm. At the time we noted that the initial foreign firms to invest in Kaesong are likely to be those that “either have a high tolerance for risk or are already familiar with the business environment in North Korea.” With Groz-Beckert setting up a sales office rather than a production facility, the level of risk seems minimal. While a future shutdown would impact potential sales to South Korean customers in the complex, it would not more broadly impact the firm’s production or its ability to supply customers in other parts of the world. So, it will not face the prospect of canceled orders due to a shutdown as happened with Daewha Fuel Pump and its Indian customers last year.

Additionally, Groz-Beckert is unlikely to face the type of sanctions or reputational risk that likely led to the Japanese company Hata withdrawing from its joint venture, Taesung Hata, in 2008. Taesung Hata, a joint South Korean-Japanese venture, was one of the early firms in Kaesong and had been one of the showcase factories when I visited Kaesong in 2006 and 2008. However, by December of 2008, Hata, withdrew in the aftermath of North Korea’s nuclear test and a loss of sales to a U.S. firm that had recently learned of the goods production in North Korea. While Groz-Beckert is expected to employ two North Korean staff, because it is selling products to South Korean firms produced abroad rather than producing products in Kaesong, it should not face the same type of reputational or sanctions risk as Taesong Hata.

For these reasons, it makes sense that a company like Groz-Beckert would be one of the initial foreign firms to invest in Kaesong.

At the same time, while Groz-Beckert is not investing in a manufacturing facility in Kaesong, its role as a first mover into Kaesong is important. Because of the political and economic risks of investing in Kaesong, foreign firms have been reluctant to take the plunge. However, if Groz-Beckert’s investment is successful, while operations at the complex continue to normalize and progress on issues related to transportation and access to the internet and cell phones continues, it could help to encourage additional foreign firms to consider moving forward on investments in Kaesong.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are the authors alone.

Photo from the author’s visit to Taesung Hata in 2006.

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Internationalizing the Kaesong Industrial Complex and the Troubles of Orascom

By Troy Stangarone

In the aftermath of last spring’s shutdown of the Kaesong Industrial Complex, the Park administration has sought international investment to serve as a bulwark against future actions by North Korea that would endanger Kaesong’s operations. While finding ways to raise the cost of a future shutdown for North Korea is a sensible approach, the challenge is how do you convince foreign firms who are driven more by considerations of costs, profit potential, and stability rather than national aspirations to invest in a project with high levels of political risk driven by national concerns?

In a piece in Global Asia and at a conference in Seoul last November co-hosted by the Institute for Far Eastern Studies and the Export-Import Bank of Korea, I argued that attracting international investment to Kaesong would require a series of steps. These include the return of normal operations, the allowance of basic international standards for communications and transit, new South Korean investment in the complex, and insurance guarantees that go beyond those currently provided to South Korean firms to name a few.

The reasoning for this is fairly straight forward. To make Kaesong attractive for foreign firms they need to view it as investment where they have a reasonable opportunity to make a return on their investment. In order for that to be possible foreign firms will need access to basic utilities such as cell phones and the internet, along with assurances that North Korea will not withdraw their workers again in the near future, along with other incentives. At the same time, if South Korean firms are not willing to make new investments or increase their current investments in the complex, foreign investors may see it as a sign that the time is not right to invest in Kaesong due to the political risk.

In addition to those steps, the two Korea’s will probably need to seek investment by firms which either have a high tolerance for risk or are already familiar with the business environment in North Korea. In other words, the first foreign firms to invest in Kaesong will likely not be brand name Western firms like IKEA, which the prior South Korean administration courted for the complex. Rather, they are likely to be firms similar to Orascom, the Egyptian conglomerate, that already have a history and understanding of doing business in North Korea. Furthermore, if North Korea were to allow a cellular network to be set up in the Kaesong Industrial Complex, Orascom seemed the provider best placed to build and operate that network.

That may be less likely today. While the telecoms provider is the majority shareholder in North Korea’s Koryo Link service with some 2 million subscribers, speculation is growing that Orascom has halted further investment in North Korea due to an inability to repatriate $400 million in profits. While the firm issued a press release in December denying that it has halted investment, it has not denied its inability to repatriate profits and the Chosun Ilbo recently ran a story again indicating that Orascom has was not seeking further investments in North Korea.

Orascom’s current operations are dependent upon North Korea’s willingness to allow profits to leave, which were calculated at the official exchange rate by Deloitte in an audit last year. At market exchange rates those profits would be significantly less. In light of the small amount of international trade North Korea conducts each year and that Orascom’s estimated profits are more than four times the amount North Korea is estimated to have earned from the Kaesong complex in 2012, it is perhaps understandable that it would be reluctant to allow such a large amount of foreign currency to be repatriated. However, until firms regularly are able to repatriate profits, international firms will remain reluctant to invest directly in North Korea.

Fortunately, firms operating in Kaesong do not face the same obstacle, as their operations are not dependent upon the North Korean market for sales. Further, all tax and labor costs are paid to the North Korean government directly in U.S. dollars under the agreement arranged between North and South Korea. However, just as Orascom has had difficulty realizing a profit, few Korean firms to date have turned a profit in Kaesong ,while they have faced threats from North Korea in the past for unilateral tax increases and fines for unreported profits.

Despite the differences in the situation Orascom and Korean firms in Kaesong face, if Orascom has become reluctant to invest in North Korea it could have a negative follow on effect for internationalizing Kaesong. Orascom would have been a significant first mover for international investment and by its very nature would have helped to resolve one of the remaining challenges for attracting foreign investment – cellular and internet access.

Orascom and companies like it can play an important role in the early stages of internationalizing Kaesong. Because of their knowledge and comfort in dealing with the challenges of operating in North Korea, they can serve as first movers that demonstrate to foreign investors the viability of operations in Kaesong. However, if they become reluctant to make further investments in North Korea due to challenges faced by their current investment, finding initial foreign investors in the complex could become a more complicated task.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America. The views expressed here are the authors alone.

Photo from showbizsuperstar’s photostream on flickr Creative Commons.

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The Korean Peninsula in 2013 in Review

By Troy Stangarone

In a sense, the events of 2013 on the Korean peninsula began in December of 2012. In the days leading up to South Korea’s presidential election, North Korea successfully put its first satellite in orbit, defying UN prohibitions on long-range missile tests. Less than a week later, South Korea would elect Park Geun-hye as its first female president.

As we look back at the events that helped to shape 2013, we are also looking back at the predictions The Peninsula made in our annual “10 Things to Watch for on the Korean Peninsula in 2013” blog post. Looking back at the 10 issues we highlighted early in 2013 all 10 have had resonance on the Korean peninsula this past year. Of the ten issues, our commentary was largely on point on 6 of the issues, while the other 4 events intervened in leading to either different outcomes than expected or preventing the anticipated policies from being implemented.

Here’s a brief look back at the 10 issues and what happened:

  1. A New Approach to Foreign Policy: Despite coming from the same party as outgoing president Lee Myung-bak, we expected Park Geun-hye to look to put her own stamp on foreign policy. This is one issue where we have mixed results. While the terminology of “Global Korea” is gone as expected, it might be too soon to tell how South Korea has adjusted its middle power diplomacy and broader foreign policy. Much of President Park’s foreign policy in her first year has focused on dealing with North Korea by necessity. However, South Korea did join a new grouping of middle powers in September.
  2. South Korea’s Engagement with North Korea: President Park came to office hoping to engage North Korea under the banner of “trustpolitik.” The tensions with North Korea and the closure of Kaesong have largely precluded any attempts to engage with Pyongyang, though South Korea did attempt to restart the process of family reunions and resumed some humanitarian aide. North Korea agreed than canceled the reunions. This is still the administration’s policy, but it requires North Korea to be willing to engage which has been lacking to this point.
  3. North Korean Nuclear Test: Spot on in this regards – February 12, 2013.
  4. Reaching out to China: After a rocky relationship with China under Lee Myung-bak, Park Geun-hye was expected to reach out to China early on in her first year in office. After a successful summit in June with China’s new president, Xi Jinping, relations seem to be on the upswing. The one fly in the ointment in 2013 might be China’s decision to declare a new Air Defense Identification Zone that overlaps with South Korea’s own zone.
  5. South Korea’s Economy to Bottom Out in 2013, but Growth Outlook Uncertain: After facing a year in 2012 when expectations for economic growth were continuously downgraded, President Park faced a slowing economy as she came into office. In April, the administration responded with a fiscal stimulus package and GDP is expected to have grown at 2.8 percent in 2013. Growth is expected to near 4 percent of GDP in 2014.
  6. A New Approach to Trade Policy: The Park administration moved the trade policy functions from the former Ministry of Foreign Affairs and Trade to a new Ministry of Trade, Industry and Commerce as expected and put out a new trade policy roadmap. Changes in the new approach include an increased emphasis on helping small and medium sized businesses to export and a greater focus on regional trade agreements. This led to Korea’s expression of interest in the Trans-Pacific Partnership in late November, sooner than we had predicted.
  7. New Arms Purchases: South Korea was expected to place an order for a next generation fighter jet in the first half of 2013, but the purchase will now be delayed until 2014 after the earlier selection of Boeing’s upgraded F-15 Silent Eagle was criticized for its stealth capabilities. However, Seoul did move forward on a contract to upgrade the computers, sensors, and weapons on its F-16s.
  8. Negotiations for a new U.S.-ROK 123 Agreement: Seoul and Washington decided to extend the current agreement for two more years to buy time for the two sides to work out a mutually acceptable agreement.
  9. A Continuation of Historical Disputes: Tensions over historical issues remained high between South Korea and Japan in 2013 with Park Geun-hye commenting in November that there was no point in a summit with Japan and Shinzo Abe making a controversial visit to the Yasukuni shrine
  10.  No Repeat Of Gangnam Style: For any K-Pop song to hope to duplicate the success of Psy’s “Gangnam Style” was never really in the cards. Psy’s follow up, “Gentleman,” has only seen about a third of the views of “Gangnam Style” on Youtube, but did rise to #5 in the United States making him still the undisputed King of K-Pop in the United States.

Beyond the issues we expected to see addressed in 2013, some other key events in 2013 include:

  1. The Execution of Jang Sang Thaek: North Korea is developing a reputation for driving the news in December. In 2011, Kim Jong-il suddenly passed away raising questions about what comes next for the regime. In 2012, North Korea conducted its previously mentioned satellite launch. In an apparent rivalry over resources, Jang Sang Thaek was very publicly purged and executed by North Korea this December. The rivalry between Jang and Kim Jong-un was one The Peninsula previously identified as a key to watch in the transition shortly after Kim Jong-il’s death.
  2. The Suspension of the Kaesong Industrial Complex: As tensions increased between North and South Korea earlier this year Pyongyang withdrew its workers, essentially shutting the complex for five months before it reopened in September.
  3. South Korea’s First Indigenous Satellite Launch: On January 30, South Korea became one of 13 nations to develop its own rocket and put a satellite into orbit.
  4. Air Defense Identification Zones: Tensions were raised in Northeast Asia when China declared an Air Defense Identification Zone (ADIZ) in the East China Sea that overlaps with similar zones by South Korea and Japan, as well as territory disputed by China with each of its neighbors. South Korea responded to China’s declaration by expanding its own ADIZ.
  5. Mr. Rodman Goes to Pyongyang: In perhaps the biggest surprise of the year former Detroit Pistons and Chicago Bulls starting forward Dennis Rodman shocked the world by taking a trip to North Korea and striking up a friendship with Kim Jong-un. Rodman traveled twice more to North Korea in 2013, even shortly after the execution of Jong Sang Thaek.

Troy Stangarone is Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his own.

Photo from Korea.net’s photostream on flickr Creative Commons.

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North Korea Cancels Family Visits and Tries to Play the Blame Game

By Nicholas Hamisevicz

In their first two years, Kim Jong-un and the collective leadership in North Korea have found various ways to kill the momentum of positive interaction with North Korea’s neighbors. While Pyongyang has given with one hand with the recent return of its workers to the Kaesong Industrial Complex (KIC), it has taken away with the other by postponing the family reunions that were set to take place this week. If North Korea is attempting to regain some leverage in inter-Korean talks by stalling on family visits, the South Korean government could again face a difficult decision on whether trust can be built up with North Korea.

Pyongyang is attempting to blame the current impasse on Seoul. In a September 21st statement, North Korea’s Committee for the Peaceful Reunification of Fatherland (CPRF) said that inter-Korean relations were “inching close to a serious crisis” because of South Korea. The statement blamed the postponement on the South Korean government for suggesting that its principled stance toward North Korea was working and the arrest of the leader of a minor political party leader accused of ties with the North.

In many ways, the Park Geun-hye administration likely believes its principled stance has worked well so far with North Korea. North Korea unilaterally pulled its workers out of Kaesong, but ultimately signaled that it would return them after Seoul made moves that indicated that it was willing to shut the complex down for good. South Korea also got a new management structure with a joint commission to oversee the KIC, which the Park Geun-hye administration argues will help reduce the possibility of North Korea unilaterally shutting down the complex again. With these wins, it is likely the Park administration will stick to similar tactics and efforts it used for Kaesong when dealing with the cancellation of family visits.

For family visits, the South Korean government’s stance so far has been to undertake family visits first, and then start working with North Korea about opening up tourism at Mount Kumgang again. North Korea would like to have both of these projects occurring simultaneously. By cancelling the family visits, North Korea was likely trying to regain two important elements for the regime: prestige and cash. As the statement from the CPRF suggests, North Korean leadership probably didn’t enjoy Park Geun-hye getting praise for Kaesong and anticipated that the family visits would be another boost to her support as well.

Furthermore, the Park Geun-hye administration has been clear that it would not compensate North Korea for the family visits as had happened before. North Korea is also not receiving the full amount of money from Kaesong as the complex is still in the process of getting back to full operation. Major issues remain in getting inter-Korea cooperation on Mt. Kumgang; thus, North Korea can’t count on money from that project anytime soon. Consequently, the desire for North Korea to regain the prestige of pushing inter-Korea relations and gaining more money for the regime were likely factors of North Korea’s cancellation of the visits.

The indefinite postponement of the visits could be an attempt by North Korea to build domestic pressure on Park Geun-hye to be more accommodating to the North Korean position. During the Kaesong suspension, she was only a few months into her presidency, and in addition to pulling its workers from the complex, North Korea increased its threatening rhetoric toward South Korea. Currently, the rhetoric from North Korea is less heated. Moreover, Park Geun-hye has some domestic issues that impact her overall political capital and capabilities. Concerns with her pension proposal for seniors, scandals with the National Intelligence Service of South Korea, and the arrest of United Progressive Party lawmaker Lee Seok-Ki all contribute to the pressures and difficulties of presidential leadership. The Park Geun-hye administration will have to convince the South Korean public that North Korea postponed the visits for unimportant reasons and that South Korea’s negotiation efforts provide their country with better overall security, interaction with North Korea, and groundwork for future reunification. Although the family visits may seem like a small endeavor, handling the situation correctly could give Park Geun-hye even more support of her inter-Korea policies and provide more political room to deal with domestic issues.

By indefinitely postponing the visits, North Korea is looking for ways to increase its leverage in inter-Korean relations. North Korea is likely hoping that Park Geun-hye has less political capital because of domestic issues and that recent inter-Korea cooperation over Kaesong will lead the South Korean public to clamor for more interaction with their northern neighbors. However, because of its success so far, it doesn’t appear that the Park Geun-hye administration will diverge greatly from its previous tactics. South Korea seems to have navigated well through the Kaesong negotiations, so the postponement of family visits could follow a similar pattern. However, if the family visits are stalled and President Park doesn’t want to talk about Mt. Kumgang, will Kaesong and humanitarian aid be enough to build trust between the two Koreas?


Nicholas Hamisevicz is the Director of Research and Academic Affairs for the Korea Economic Institute of America. The views expressed here are his own.

Photo from cfarivar’s photostream on flickr Creative Commons.

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The Impact of Kaesong’s Suspension on Korean Companies & South Korea-India Economic Connections

By Nicholas Hamisevicz

The fear that North Korea’s suspension of activities at the Kaesong Industrial Complex would have broader implications began to materialize last week when Daewha Fuel Pump Industrial Ltd. announced it failed to deliver parts in time to its Indian customer. Other companies are beginning to publicize their setbacks as well. The economic challenges for businesses like Daewha from the suspension of operations at Kaesong could have spillover effects for future investments in Kaesong and South Korea’s trade negotiation strategy. Moreover, the announcement from Daewha puts another South Korea – India economic connection into the spotlight. President Park Geun-hye and the businesses involved in Kaesong need to have patience, luck, and some business acumen in order to regain confidence from investors, economic benefits for customers, and opportunities for expansion when Kaesong is reopened.

The announcement from Daewha about its inability to maintain a steady supply to a customer was the fear of many supporters of the Kaesong operation. Without the ability to constantly supply customers, the strategic and economic advantages for Kaesong begin to dwindle for many Korean companies.

As one of the last remaining inter-Korean connections, Kaesong also helped provide an avenue for South Korea to communicate with North Korea as well as try to lay the groundwork for peaceful unification. However, with Daewha’s loss and troubles beginning to emerge with other companies, the opportunities available in Kaesong have again been questioned.

A part of those strategic and economic advantages were the potential future opportunities. Because of Kaesong’s previous success, some experts recommended that South Korea build more complexes like Kaesong. The Park Geun-hye administration also had plans to try to internationalize Kaesong and attract firms from other countries to set up in the industrial zone. Recent events will be an impediment for that goal. To revive the potential for expansion at the complex the Park administration will need a combination of good public relations (PR) and economic successes to ease the concerns of investors once Kaesong is up and running again.

Further potentially complicated by the work stoppage and the Daewha news is South Korea’s trade negotiation strategy to include language allowing for goods from Kaesong to be part of their trade deals. Future partners are now likely more aware of the political risks of increasing access to goods from Kaesong. One potential outcome from could be countries asking for language similar to the KORUS FTA that points to the development of specific conditions on the Korean peninsula before access for goods from Kaesong would be granted [Annex 22B]. This may require South Korean negotiators to repackage how they convince their counterparts to allow clauses potentially permitting goods produced in Kaesong to be included in their bilateral trade deals.

The news from Daewha was also tough PR for South Korea-India relations. Economics has been a major avenue for the two countries to work together. However, the cancellation of the partnership provides another example of an economic opportunity being damaged by political difficulties. While the Daewha example is on a much smaller economic scale than POSCO’s investment in Odisha, India, both illustrate politics affecting economic interaction between South Korea and India.

Moreover, India and South Korea are trying to reach their stated goal of $40 billion in total trade by 2015. Yet two way trade was still just below $19 billion in 2012. Even though Daewha claimed the deal was less than one percent of its sales last year, misfortunes of this nature also hold back the expanding economic relationship.

North Korea’s threats and initial suspension of the Kaesong Industrial Complex raised questions about the ability of companies to complete their orders and the future of investment opportunities in Kaesong. Unfortunately, a couple of weeks into the suspension, the impact is becoming real and damaging economic interactions beyond South Korea. These setbacks have only heighted the scrutiny of the consequences of operating in Kaesong, making it more difficult for the Park Geun-hye administration to attract investors to the complex, support the businesses there, and create opportunities for expanding the strategic and economic possibilities of Kaesong.

Nicholas Hamisevicz is the Director of Research and Academic Affairs for the Korea Economic Institute. The views represented here are his own.

Photo from Korea Economic Institute of America.

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North Korea’s Economic Warfare

By Phil Eskeland

During the past several weeks, international viewers were treated to a series of broadcasts from major news outlets trumpeting every bellicose statement and video from Democratic People’s Republic of Korea (DPRK).  This culminated two weeks ago, in the run-up to two North Korean anniversaries where “something” was expected to happen, with one hour specials on possible war scenarios and sensationalizing the military threat, including an analysis by a retired U.S. Army general about the possibility of North Korea seizing Pyeongchang, the site of the 2018 Winter Olympic Games.  As a result of these and other reports, some foreign investors in South Korea were considering contingency plans for production and workers.  Other firms were rethinking plans to invest in South Korea.  Yet, if you walked the streets of any city in South Korea, you would find that business was going on as normal and most people brushed off the shrill rhetoric from North Korea as a part of a regular occurrence that happens every spring when the United States and the Republic of Korea (ROK) embark on their annual military training exercises.  Nevertheless, there was a huge gap between international media coverage of North Korea in early April (be worried! prepare! be ready to go to underground shelters! imminent missile launch!) and the view from the streets of South Korea (shrug).  Now that North Korean invectives have diminished in recent days, media attention has gravitated to the next story.

However, while North Korea would be overwhelmingly and quickly defeated in any military action against South Korea, what was behind North Korea’s heightened rhetoric and actions?  We know that because regime survival is North Korea’s primary objective, their leaders are not suicidal.  Why then does North Korea make these bizarre provocations?  Many have pointed to the need for the relatively new and young North Korean leader Kim Jong Un to assert his leadership credentials and toughness, particularly by continuing with the North’s military-first policy.  Perhaps the North Korean leadership believes that China will never substantively crack down on them.  Even so, some have raised questions about North Korea suspending work at the joint ROK/DPRK Kaesong complex, which employed 53,000 North Koreans, representing 1 out of 5 people living in Kaesong, and brought in an estimated $80 million of desperately needed hard currency in 2012 for the DPRK regime.  To these observers, suspending work Kaesong didn’t make any sense and was not in North Korea’s economic interest.  In fact, they believe it hurts the North by denying work opportunities for its citizens and eliminating a valuable source of hard currency.

However, North Korea’s recent actions, including the suspension of work at Kaesong, are a form of psychological and economic warfare against South Korea in response to heightened international sanctions against North Korea.  While South Korean citizens have become used to the threat from North Korea over the past 60 years and go about their daily lives, those who live outside of Northeast Asia were taken-aback by this augmented bellicose talk and action from the North.  This work-suspension order by the DPRK affects more than just the relatively small economic benefit of Kaesong.  Anything that North Korea can do to shake the confidence of foreign investors in South Korea is a political win for North Korea.  If North Korean words and actions cause any foreign investor to withdraw from South Korea for political risk concerns, that would be an immense victory for the North.  That’s why foreign investors should not be spooked by the shrill North Korean rhetoric because that only plays into the hands of the North Korean leadership.  These tactics are a non-kinetic way for North Korea to inflict damage on South Korea.  The North knows they cannot defeat South Korea militarily so the DPRK resorts to these unconventional and potentially untraceable methods.

On April 11, 2013, South Korean President Park Geun-hye met with representatives of foreign investors to reassure them that South Korea is a safe place to invest.  President Park told the participants that “a stable environment will continue to be made in which you can feel secure and make investment and conduct business.”

KOSPI

Whenever North Korea has embarked on their reckless course of action in the past, the South Korean economy has remained strong (see chart).  Sometimes, there was a temporary drop in the measurements of the strength of the Korean economy, but in every instance, the markets recovered and grew even stronger.  At no time did the international bond ratings of South Korea  drop as a result of North Korean threats.  The same occurred during this latest round of provocations from North Korea – in fact, the Korean Composite Stock index grew during the week of the highest tensions, and foreign direct investment reached $3.39 billion in the first quarter of this year, representing a 45 percent increase from a year ago.  Fortunately, the company representatives present at the April 11th meeting recognized these facts and reaffirmed confidence in the business environment in South Korea.  Some companies even outlined plans for expansion and growth.  But not every foreign company with a presence or plan to operate in South Korea was present at this meeting.  These firms need to look behind the saber-rattling special reports of cable news networks on North Korea and look at the big picture – while South Korea is sufficiently prepared to deter any DPRK provocation, it is also open for business and is still an attractive place for foreign investment. Now that belligerent North Korean rhetoric has dampened somewhat, it is important for foreign investors in Korea to remember this lesson for next time, particularly as another North Korean anniversary looms on the horizon with potentially more provocative behavior by the DPRK.

Phil Eskeland is the Executive Director of Operations and Policy for the Korea Economic Institute of America. The views expressed here are his own.

Photo from Luther Bailey’s photostream on flickr Creative Commons.

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Why North Korea Isn’t Interested in Economic Reform

By Troy Stangarone

As often happens with North Korea, there have recently been suggestions that the regime may be interested in engaging in economic reforms. The latest hopes spring from the appointment of Pak Pong-ju, a noted economic reformer, as prime minister and the replacement of most ministers of industry with officials believed to have been part of a task force established by Kim Jong-un to revive the economy. In conjunction with the appointments, Pyongyang announced a dual track policy of building the economy while also enhancing its nuclear weapons program. However, it would be premature to assume that these are true signs of a potential economic opening.

For years, the Chinese have been encouraging the North Koreans to follow their path to reform with little success. After the passing of Kim Jong-il, there were hopes that Kim Jong-un would embrace reform. Shortly after taking power, he remarked that North Koreans should “never have to tighten their belts again” and later that fall told a delegation from China that he was focused on “developing the economy and improving people’s livelihoods.”

However, in contrast to North Korea’s pledges to conduct this past December’s satellite launch and their third nuclear test, there has been relatively little follow through on the economic side. Over last summer and fall, expectations built that North Korea would engage in limited industrial and agricultural reforms. When North Korea announced that it would convene its parliament last September, there were hopes that it would announce economic reforms designed to introduce incentives for producers to increase   production and allowed select factories more say in what they produced and how. If successful, the reforms would be spread to the whole economy.

At the same time, North Korea mooted the possibility of agricultural reforms. A small number of farms would be allowed to sell portions of their harvest in markets. If successful, the experiment would be spread to the rest of the agricultural sector. However, the test cases did not take place, as harvests disappointed and feeding the military was seen as a priority. At best those reforms have been put off, if not shelved completely.

The prospects for current reforms also look doubtful. Shortly after announcing its new economic policy and shuffling cabinet officials, North Korea proceeded to close the border with South Korea and prevent the flow of goods and people into the Kaesong Industrial Complex.  While the tactic is not new, it is also not the step of a regime that takes economic development seriously.

Further complicating the situation at Kaesong, North Korea announced that it “will temporarily suspend the operations in the zone and examine the issue of whether it will allow its existence or close it.” This additional action, if North Korea follows through, is unprecedented. The current border closing had already forced at least 13 South Korean businesses to suspend operations, and if North Korea follows through and removes its workers, the other 110 companies located in the industrial zone would also have to suspend operations.

While all of the South Korean businesses operating in Kaesong face short term losses, North Korea’s actions could also impact the long term prospects of the industrial zone and its own economic reform measures. Businesses, especially the foreign investment that would be needed revive the North Korean economy; require stability and assurances that their access to goods and services will not be cut off at the whim of the government.

Prior to the announcement on Kaesong, there had been speculation in the South Korean press there were divisions within the regime on what steps to take next, with the press reporting that the military was strongly pushing for Kaesong to be closed, while the party supported maintaining the complex. Even if this is not the case, Pyongyang’s actions at Kaesong cast doubt on the prospects of there being a consensus to move towards reviving the economy in North Korea.

Additionally, Pyongyang’s unfriendly business policies do not just extend to South Korea. While North Korea has an investment law in place, it does not always apply even to its allies. Last fall the Chinese firm Xiyang Group went public with its story of being cheated out of a $37.1 million investment in North Korea. It claims that it is but one of dozens of Chinese firms that have experienced similar problems. Efforts at developing an industrial complex similar to Kaesong along the Chinese border have also been slow moving.

If North Korea is to take substantive steps to revive its economy and move towards normal economic growth, it will have to move beyond taking arbitrary and capricious actions. It will need to move towards the rule of law, which at the same time would constrain the power of the current regime. This would allow markets to take hold, for which the regime would have to commit to refraining from actions such as the 2009 currency reform that was designed reign in the markets and reduce the profits made by traders. The regime will also need to accept the development of alternative centers of power as lower and mid-level functionaries in the regime, and over time those not associated with the regime, acquire wealth and influence through their business ventures. This would also require Pyongyang to move beyond its tactics of using escalating tensions to illicit aid and concessions from other nations.

Under Kim Jong-il, these were steps the regime was unwilling to take for fear of suffering the same fate as the communist regimes of Eastern Europe and there were few signs of the regime being voluntarily willing to loosen its hold on the country. During periods of famine and when the public distribution system would break down the regime would tolerate the emergence of markets, but it also would push to scale them back as circumstances changed. It is unclear if Kim Jong-un and his advisors view the situation the same, but the pattern to date is much like his father’s, military strength is favored over economic reform.

If the regime is still reticent to undertake economic reforms, the recent move by Pyongyang to again stress the importance of reviving the economy may be a tactical move. Having previously written into its constitution that it is a nuclear weapons state and recently announced that its nuclear weapons are the “nation’s life” and will not be traded for “billions of dollars,” North Korea needs a means through which to deescalate the current crisis and a path for future talks with the United States, South Korea and others. If its nuclear weapons are truly off of the table, Pyongyang needs a basis for future negotiations. By restarting its nuclear facilities and offering the prospect of economic reform, North Korea may be trying to establish a baseline for future talks where it offers the prospect of a reformed economy for the price of its nuclear facilities, but not its weapons.

In light of North Korea’s past failures to follow through with real economic reform measures, the recent announcements by Pyongyang should be viewed more as a tactical move than a shift in policy. Rather than hope that North Korea has turned a corner on reform, a more prudent course would be to determine if North Korea follows through on proposed reforms and adjust accordingly. Unfortunately, the actions at Kaesong do not make this look likely. However, if Pyongyang were to implement genuine economic reform measures, the United States and South Korea should be prepared to take actions that would reinforce those reforms.

Troy Stangarone is Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his own.

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What Another Wage Hike at Kaesong Means

By Troy Stangarone

In what is becoming an annual tradition, North and South Korea agreed to raise the wages of workers in the Kaesong Industrial Complex by the maximum 5 percent allowed to $67.05 a month under the established agreements between the two Koreas.

While the increase in wages is clearly good the 51,000 or so North Koreans working there, it raises larger questions such as what is the future of the complex and what steps might make Kaesong more dynamic? For the moment the future of Kaesong looks fairly stagnant. If wages continue to rise over the next decade at 5 percent a year, they will only hit $109.22 a month which is still significantly below the average of $167 a month workers make in China today.

Additionally, it is still unclear how profitable South Korean firms at Kaesong are. It was only in 2010 that North Korea collected its first taxes from a firm in Kaesong, when a single firm paid $7,000 in taxes. Those numbers did rise to four firms and around $153,000 in taxes on profits in 2011, at the very least that implies that if firms are becoming profitable in Kaesong for most it is only in the last few years given exemptions on the first five years of profits.

In its current state, Kaesong will likely continue on, but not much different from what we see today. However, if the intent is to return to something like the original goal of making Kaesong a platform for North Korea to experiment with economic reforms that could help revive the economy, what kind of changes might be beneficial?

Considering the question of wages, it seems clear that some workers in Kaesong are likely worth higher wages than the average salary. Allowing firms to set wages based on the productivity of their workers could be a first step in experimenting in labor market reforms. At present North Korea still manages all of the hiring, and loosening control on wages could be a first step towards broader labor market reforms that would allow firms to hire and fire their own workers.

At the same time, it might be beneficial to consider joint ventures with North Korean firms in the complex. Much of China’s economic success was built on joint ventures, and this would be another means to transfer skills and knowledge about running a market based firm to North Koreans, which could be critical if the new regime is serious about making economic reforms.

However, the real challenge for changing Kaesong’s future is finding markets for the goods produced there. Without fundamentally addressing North Korea’s nuclear program, the United States and Europe are unlikely to open up their markets to goods from Kaesong under their respective FTAs with Korea anytime in the near future.

While challenges exist, if Kaesong can serve as a laboratory for North Korea to experiment with economic reforms it could serve a useful purpose even if it continues to grow at a slow rate. However, to induce real change in North Korea its influence will have to begin extending beyond the current complex itself. That being said, the real question is whether North Korea is finally ready for reform? We’ll save that question for another day.

Troy Stangarone is Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. He is currently on leave from KEI. The views expressed here are his own.

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Cross-Strait Détente: A Case Study for Inter-Korea Relations?

By Sarah K. Yun

At the recent talks between North Korea and the United States in Beijing, U.S. Special Representative for North Korea Policy, Glyn Davies, once again stressed the importance of restored inter-Korea relations in order to resume the Six-Party Talks to Kim Gye Gwan, North Korea’s First Vice Minister of Foreign Affairs.  Although the two Koreas are the parties most directly impacted by the security issues surrounding the Korean Peninsula, inter-Korea relations have been tense over the years, although some landmark accomplishments remain as symbols of inter-Korean cooperation.  On the other hand, the Cross-Strait relations have improved dramatically since 2008.  What caused such different outcomes?  What lessons from the Cross-Strait relations can be applied to inter-Korea relations?

Inter-Korea relations and Cross-Strait relations are inherently different in nature, history, and scope.  However, the two cases have interesting parallels from their Cold War split, largely driven by the ideological divide between capitalist democracy and communism.  They are also similar in that domestic politics plays an important role within the relations.  Additionally, the U.S. has played a key and complementary role in both relations through its support for Taipei’s engagement with Beijing and President Lee’s efforts to deter provocations by North Korea.

Despite these similarities, the two Koreas and the two China’s have taken divergent approaches to resolving their long standing separations. Experts have characterized Cross-Strait relations as “No Talks, Many Actions.”  There have been few official talks between the two sides but, a recent influx of trade, visits, investments, and exchanges.  However, these have been recent changes. Historically, communication between China and Taiwan ceased during the Cold War.  In 1979, after gaining confidence within the international community, China proposed the “Three Links” (trade, postal service, and transportation) and “Four Exchanges” (academic, culture, sports, and science and technology) to Taiwan.  Taiwan was not prepared to accept China’s offer at the time, therefore responded with the “Three Nos” policy of no contact, no negotiation, and no compromise.  In 1987 that changed. Taiwan began to allow visits to China and established two trade zones for Taiwanese companies in Fujian province in 1989.  During this period, Taiwan also renounced intentions to militarily recapture China.  In 1991, Taiwan officially declared end to hostilities and recognized the legitimacy of the Chinese Community Party.  Just when relations were on the road to improvement, then President Lee Teng-hui and his successor Chen Shui-bian argued for a Taiwan national identity separate from mainland China.

All of this was reversed dramatically by the election of president Ma Ying-jeou who argued for the improvement of Cross-Strait relations in six stages: 1) charter and direct flights, 2) economic and financial cooperation, 3) investment and trade, 4) Taiwan’s participation in international organizations and non-governmental organizations, 5) promotion of a Cross-Strait common market and Taiwan’s participation in the East Asian economic integration, and 6) a peace accord and confidence-building measure.  He also implemented his own “Three Nos” policy to include no unification, no independence, and no use of force.  The current challenge, however, is that the Cross-Strait relations are successful at cooperation and exchange, but unsuccessful at creating a linkage between economic relations and political transformation.  In other words, this framework is effective in maintaining status quo, but ineffective in creating political spillovers.  The ultimate goal is not reunification, but a comparative advantage that China and Taiwan are able to gain economically and diplomatically from improved Cross-Strait relations.  The Economic Cooperation Framework Agreement (ECFA) was the epitome of improved Cross-Strait relations based on the economy-first paradigm.

On the other hand, inter-Korea relations have been described as “No Actions, Talks Only.”  Although many official-level talks took place and declarations were announced between the two Koreas, it has had limited political spillover due to the fact that the Kim regime habitually exploited the cooperation projects.  Inter-Korea relations have for the most part been sustained by large-scale projects such as the Kaesong Industrial Complex, Mount Kumgang tourism, reunion of  separated families, and a few others.  A complete replication of the Cross-Strait framework would be difficult for the Korean Peninsula since North and South Korea have too much asymmetry of economic and political power as a result of North Korea’s military-first policy.  In essence, the current inter-Korea relations are focused on a framework of politics-first.

What if the inter-Korean model also focused on economic integration first by stabilizing economic and trade relations?  This could create a platform for North Korea’s economy to be integrated into the region and provide an opportunity for North Korea to rethink its position in the world economic order.  In return, South Korea could play the role of Taiwan in supplying needed capital to a reforming command economy and would be able to benefit from  lower labor costs, access to raw materials, and decrease future reunification cost by reducing the economic gap between the two Koreas.  This would require a framework change in a way that the two Koreas view the inter-Korea relations from a perspective of ideology to one of practical economic interest.  Focusing on the economic aspects would bring political spillover effects, as in the case of Kaesong Industrial Complex where more than 50,000 North Koreans are employed by the South Korea-run companies.  These North Korean laborers are empowered financially and economically compared to others across the country.  Overall, a comprehensive strategy like the Ma Ying-jeou’s six-step plan may be needed in Korea, but it would require two willing partners.

Whereas inter-Korea relations have undergone many challenges in the recent years, Cross-Strait relations have faced a dramatic détente.  The key point is that China reached out to Taiwan only after it gained status and confidence in the international community.  In other words, it did not feel threatened by Taiwan nor the international system, which was a product of China having a better economic foothold in the world.  From this, one can gather that unless North Korea’s economy is developing and industries being diversified, reconciliation and reunification may face more challenges.  Although  inter-Korean and Cross-Strait relations are not the same, a lesson learned from China and Taiwan’s experience is that economic cooperation is a key to closing the gap and improving inter-Korean relations.

Sarah K. Yun is the Director of Public Affairs and Regional Issues for the Korea Economic Institute. The views expressed here are her own.

Photo from  Beautiful Taiwan’s photo stream on flickr Creative Commons.

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The Peninsula blog is a project of the Korea Economic Institute. It is designed to provide a wide ranging forum for discussion of the foreign policy, economic, and social issues that impact the Korean peninsula. The views expressed on The Peninsula are those of the authors alone, and should not be taken to represent the views of either the editors or the Korea Economic Institute. For questions, comments, or to submit a post to The Peninsula, please contact us at ts@keia.org.