I haven't written about Kaesong since November 2006, and its been even longer since my case study on the site, so I figured there should be some updates online in regards to its status and progress. Basically, I had the following questions when looking around:
- Will Kaesong be part of the Korea-US FTA?
- Have logistics between Kaesong and South Korea improved?
- Have there been any official policy changes since South Korea's President Lee has taken office?
- What are the current forecasts/expectations for the next few years?
First, the Korea-US FTA Blog has a collection of posts on Kaesong's part in the development of the FTA. It points to a document here, titled "The Kaesong North-South Industrial Complex", updated in February of this year describing Kaesong and how it is to be treated by the FTA. Below is the section on its treatment:
"The text of the Korea-U.S. Free Trade Agreement (signed by representatives of each government but not yet approved by Congress) does not provide for duty-free entry into the United States for products made in the Kaesong Industrial Complex.
"Annex 22-B to the proposed FTA, however, provides for a Committee on Outward Processing Zones (OPZ) on the Korean Peninsula to be formed and to “identify geographic areas that may be designated outward processing zones,” determine whether any such zone “has met the criteria established by the Committee,” and recommend them to the respective governments, which “shall be responsible for seeking legislative approval for any amendments to the Agreement with respect to outward processing zones.” The Committee also is to “establish a maximum threshold for the value of the total input of the originating final good that may be added within the geographical area of the outward processing zone.” Decisions of the Committee would require unified consent (this arguably provides the U.S. side with veto power over any recommendation of the committee).
"The criteria to be met include but are not limited to “progress toward denuclearization of the Korean Peninsula; the impact of the outward processing zones on intra-Korean relations; and
the environmental standards, labor standards and practices, wage practices and business and management practices prevailing in the outward processing zone, with due reference to the situation prevailing elsewhere in the local economy and the relevant international norms.” The OPZ committee is to meet at least annually beginning a year after the agreement goes into effect."
The rest of the section goes on to site concerns over labor standards and final goods from South Korea that use smaller components from Kaesong.
The report reminds us of aspects of logistics that I have mentioned in my previous posts and case study on Kaesong:
"South Korea also aims to become a hub of East Asia. In order to accomplish this, it would like to be connected to China, Russia, and to Europe via railways that pass through North Korea. As part of the KIC project, North and South Korea have reconnected a railroad line connecting the north and south and have conducted a test run on it. (A second line on the opposite side of the peninsula also was connected.) In terms of logistics, a shipment by rail from South Korea via Kaesong to Hamburg, Germany would take about 27 days by ship, 10 days via the Trans-Siberian Railway, and 7 days via the Trans-China Railway."
The second diagram:
Moving on, the report also very nicely provides an example of where trade advantages might occur, mentioning a lower total logistics cost:
"The experience of some of the early investors in Kaesong may be indicative of the economic viability of the project. ShinWon (clothing) established operations in the KIC to take advantage of the dexterity and lower cost of North Korean workers, favorable logistics, and to avoid nontariff barriers in China and Southeast Asia. By manufacturing about 16% of five of its clothing lines there, it expects to accrue considerable savings in production costs. It considers its Kaesong factory to be optimal when compared with those it has in China, Indonesia, Vietnam, and Guatemala."
Obviously, for South Korean companies, Kaesong is closer, has equally lower costs of labor and lacks any language barriers as compared with the above typically mentioned low cost countries for manufactured garments. Basically, this has to be measured against the risk factor of sourcing from the DPRK. I think manufacturing a percentage of their total sourcing volume there is reasonable given there are multiple companies invested into Kaesong at this point.
One of the significant steps forward in terms of logistics is the opening of a shared rail link between North and South Korea. The Economist Intelligence Unit discusses this link in detail in an article from December 2007 titled, "The two Koreas once again share a rail link" and considers what Kaesong may gain from this:
"In purely economic terms, the new freight service is likely to provide a modest boost to the Kaesong industrial complex. The zone already has an output worth more than US$200m—ranging from wrist-watches, shoes and die-cast models to liquid-crystal-display monitors—much of which is exported to non-Korean markets. The new, daily service will to some extent obviate the need for firms operating in Kaesong to truck supplies across the border, reducing delivery times and logistics costs. This, in turn, may attract further South Korean investment into the complex, which is only a few miles north of the demilitarised zone.
"By adding to the industrial park's attractions, the rail link is another step towards South Korea's vision of Kaesong as a regional hub for manufacturing goods for export and for attracting foreign investment—similar to the city of Shenzhen in China's Guangdong province—with industrial, commercial and residential infrastructure."
There is some additional speculation on expansion, but I expect this to come quite slowly:
"With this goal in mind, the modest economic impact of the new 25-km service could eventually be multiplied many times over by planned expansions of the rail network. The two Koreas are set to discuss repairs of the Kaesong-Sinuiju railway and Kaesong-Pyongyang expressway for their joint use. Sinuiju in north-west North Korea abuts Dandong, in China, so this raises hopes of recreating a unified transport grid not only on the peninsula, but also in wider north-east Asia. The rail infrastructure that is being built could also, in theory, carry passengers as well as goods—fostering closer ties between the two sides."
As shown in my diagrams above illustrating the Incheon sea port's role in an overall logistical advantage for Kaesong development, I can believe additional port development on the North Korean side in conjunction with Kaesong being within the immediate future, and The Economist mentions this within the agreement rendered at the time:
"The new railway is also only the first step in what is by far the most detailed agreement ever between the two Koreas, which was endorsed at the prime ministers' meeting. The agreement involves upgrading institutions and infrastructure, creating several new committees, and, crucially, setting dates or deadlines for two dozen separate future meetings or activities in a host of fields, mainly practical economic co-operation. This includes upgrading the North’s roads and railways, shipbuilding, a joint fishing area, and a new special economic zone in the North Korean port of Haeju, in effect extending the Kaesong zone. Such a range and depth of activity is unprecedented, implying that at long last North Korea is ready for serious and sustained partnership with the South."
Current Policy Stance
The most recent article I have found so far on Kaesong is a nice update from August 24 of this year provided by Martin Fackler, journalist with the Business Scotsman. The article is titled, "Global Monitor: South's park aims to bring capitalism to Stalinist North" and was written from Kaesong in North Korea:
"The US eased sanctions against North Korea earlier this summer, after the country destroyed the cooling tower at nuclear facilities in Yongbyon, but import restrictions remain, making the Kaesong park less appealing to large South Korean and foreign companies. Indeed, South Korea's own conservative president, Lee Myung-bak, initially suggested he would not honour his predecessor's agreements to expand economic cooperation.
"Despite all that, 72 smaller South Korean companies have built factories here, looking to tap the North's supply of low-cost, Korean-speaking labour. So far, only one foreign company has come."
It is probably good small businesses are the majority in Kaesong as they can provide a solid foundation for the incubator-like economy there.
On October 1, the first North-South military level meetings were supposedly held since President Lee took office. But the North's sensitivity to even the most indirect and subtle announcements or words used by South Korean leaders, combined with the recent event of a South Korean woman being shot at Mt. Kumgang by a North Korean soldier, illustrates how fragile the relationship still is despite Kaesong's dramatic and dynamic growth in such a harsh business environment. There is a great article titled "Will Inter-Korean Project in Gaesong Survie?" in the Korea Times that highlights many of the challenges that remain. See here for more articles on Gaesong from the Korea Times.
Mr. Hackler goes further by delving into the site's aspirations for the future:
"Despite its prison-like feel, Kaesong Industrial Park is booming. The park's operator, South Korean developer Hyundai Asan, hopes to expand it into a mini-city in the next 12 years, with high-rise flats and hotels, a lake and three golf courses.
"By that time, the company hopes there will be about 2,000 factories employing 350,000 North Koreans and producing $20bn (£11bn) worth of goods a year. That compares with an output of only $366m in the first half of this year, according to South Korea's unification ministry. In the six months to June, the flow of goods in and out of the industrial park accounted for 42% of the $881m in trade between the two Koreas, the ministry said."
It's always easier to understand Kaesong's impact when there are existing case studies to learn from, as Hackler describes below:
"This piecemeal brand of change is seen in the experience of SJ Tech, a South Korean maker of car and cellphone parts, which built a $4m factory here four years ago. The company's first North Korean employees had never even seen a keyboard, much less a computer, said SJ Tech president Yoo Chang-geun. Yoo jokingly calls his factory "North Korea's first business school". But now, SJ Tech's 430 North Korean employees can run the factory without South Korean supervisors. They have even cut their hair to look more South Korean. "The North Koreans are like sponges," Yoo said."
The pro-business, South Korean government has realized how important the site has become if there is any hope in successfully engaging the North and easing it towards a market economy:
"This is exactly the sort of result the South Korean government is hoping for. Even Lee, elected in December, has lately indicated he will back economic cooperation. Supporters of engagement in Seoul say their long-term aim is to prepare the North for unification with the wealthier South. For the North, the economic links mean hard currency for a moribund economy that cannot feed its 23 million people."
But The Economist highlights the difficulties involved:
"...the task ahead remains extremely daunting in purely economic terms. There are few reliable statistics on North Korea's economy, but the best available estimates suggest that it is tiny and exceptionally backward. According to the Bank of Korea, South Korea's central bank, North Korea's nominal gross national income was equivalent to less than 3% of South Korea's in 2006. On other measures, such as trade and infrastructure, a similarly huge disparity exists.
"Closing this massive economic gap is a project that could take decades. Creaky railroads, dilapidated roads and threadbare power lines are not the only woes afflicting North Korea. There are no mass consumer markets operating under market forces in North Korea, other than local farmers' markets and neighbourhood black markets. The basic means of communication in a modern-day economy, such as mobile phones and the Internet, are virtually non-existent and practically prohibited as part of the totalitarian state control. North Korea has pledged to allow Internet and mobile-phone facilities in Kaesong as part of the agreement that has led to the new rail connection. That this small move would be a huge step forwards for the North Korean regime shows the importance of the Kaesong experiment. But it also provides a glimpse into the enormous remaining challenges of the two countries' unification."
Obviously, from a business perspective, the above represents significant opportunities for new projects and investment and would result in a significant increase in employment for North Korean labor, assuming a peaceful reunification or cooperation agreement. Of course, it would be exciting to someday be part of the first major supply chain projects in the North. But any project should be to ultimately benefit the people of North Korea and as long as Kim Jong-Il, his family, or his surrogates are in power, there is a greater certainty that any benefit will remain only for a select few, including the select few that actually are working in Kaesong. In the meantime, the Kaesong project should not be underestimated in terms of importance, and I believe it should be viewed as one of the "fronts" from which to integrate North Korea into the systems and practices of the modern, global economy.