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Economy > Focus ]
 nter-Korean economic cooperation may be said to have begun with the South Korean government’s 1988 “North/South Exchange and Cooperation Act” that was enacted in 1990. In the 1990s, the expansion of economic relations between North and South was mostly at the instigation of South Korea. The South Korean government laid the groundwork for pursuing North/South exchange and cooperation within the framework of the 1988 act through a suite of related legislation. Since then, the Southern government has continuously reformed and improved those laws to reflect changes in conditions surrounding the implementation of the inter-Korean initiative.
The volume of goods shipments between North Korea (officially, the “Democratic People’s Republic of Korea,” or DPRK) and the South increased rapidly until the mid-1990s in spite of the periodic ignition of political and military tensions by, for example, the North’s nuclear threats, the infiltration of a Northern submarine into Southern territorial waters and the North’s continued rejection of dialogue with the South. However, trade volumes peaked in 1995 and remained flat in 1996 and 1997 due to economic deterioration in the North and lack of institutional structures to support mutual economic cooperation. In 1998, trade nose-dived under the Arial of the Asia-wide financial crisis. In particular, the volume of goods imported from the North slumped by 52.2 percent from the previous year. When the South Korean economy entered a recovery phase in 1999, inter-Korean trade began an upswing. Trade volume surpassed the $400-million mark in 2000 and hit $641.73 million in 2002.
The record shows that trade between the Koreas is determined more by their economic situations rather than by political and military tensions on the Korean Peninsula. Here’s why.
First, the shipment of goods between North and South is mainly done via indirect routes, using the intermediation of a third countries such as Hong Kong or the overseas operations of South Korean companies. In this way, it is possible for inter-Korean trade of goods to avoid being influenced directly by political circumstances. Instead, it tends to be determined by economic factors such as supply and demand within North and South Korea and whether or not it will profit the companies involved.
Second, despite North Korea’s backward economy and economic difficulties, South Korean companies have economic motives for continuing to “trade” with the North. Such trade is of the processing-on-commission type whereby Southern companies send basic materials or semi-finished products north for further assembly or finishing. Often based on outmoded, labor-intensive machinery shipped north expressly for this type of processing, some 80 percent of companies involved in this trade reported making a profit last year. Moreover, the companies consider the trade as an economic bridgehead prior to greater market opening in the North or, long-term, eventual reunification.
Third, the North tightly controls direct shipments of South Korean consumer goods into its territory because of the internal political and social Arial they may have. On the other hand, it eased restrictions to allow processing-on-commission trade as a way of earning foreign currency since the goods so finished are often sold to third countries.
LOW-RISK TRADING In particular, processing trade has continuously expanded both in terms of size and the business areas involved, helping to facilitate the complementary between the disparate economies of the two sides. From the perspective of North Korea, processing trade has the following advantages. First, it serves to increase exports by using only the limited amount of plant it currently possesses. Second, the North can maintain managerial control, thereby impeding the spread of free market principles. Third, it is an easier way of earning foreign currency than any other type of economic cooperation project available given that there are restrictions on DPRK exports. Lastly, it enables the North to acquire technologies through cooperation with advanced corporations despite its inability to invest in plant or social overhead capital (SOC).
The processing trade with the North also has advantages from the viewpoint of South Korean and foreign companies. First, it is less risky compared to direct investment. Second, it offers a lowcost means of expanding their overseas trade activities. Third, it serves as a kind of pilot marketing for direct investment in the North. In particular, inter-Korean processing trade enables South Korean enterprises to identify the skill levels of North Korean workers and the potential for further industrial development and cooperation in the DPRK.
Processing trade is based upon North Korea upgrading primary products such as textiles, clothing and electronic products and exporting them to third countries like China, generating demand for high-quality imports of raw and subsidiary materials from the South. This is demonstrated by the fact that the share of textiles, electronic products and electrical appliances in shipments to the North has recently been on the rise.
SEPARATION OF ECONOMY & POLITICS Beginning with minerals and steel, “brought-in” products to the North have gradually become more diversified in type to include agricultural/marine, textile and chemical products so promoting the complementary of the Northern and Southern economies. If North/South economic cooperation intensifies, through, for example, initiatives such as the Gaeseong Industrial Complex project (see “Where to Invest”) it is expected that it will spur the shipment of further electrical and electronic appliance manufacturing plant northward and expand the areas of industrial cooperation.
A cursory examination of South Korean citizens who visited the DPRK over the past 10 years indicates that the highest proportion worked for private companies involved in some form of economic cooperation with the North. The chief object of public sector visits, on the other hand, concerned the light water reactor construction project. This indicates that the North has developed a somewhat flexible attitude toward projects that guarantee economic gains. It can thus be inferred that North Korea is encouraging, acknowledging or otherwise condoning a “separation of economy and politics.”
Whatever its origins of this written or unwritten policy, it has enabled Southern companies to gain progressively easier access to the North.
The DPRK’s pattern of approval for applications by Southern companies seeking to do business in the North indicates that the North places a higher priority on projects that will earn hard currency or shipments of badly needed fertilizer. Beside processing-on-commission work, these include projects involving the granting of certain exclusive commercial rights. The North, for example, has allowed South Korean companies to launch regional and tourism development projects (the most famous being the Mt. Geumgang project, see “Where”) on its territory in return for hard currency.
Less favorably looked on are projects involving direct investment in joint ventures that are potentially profitable, but in local currency. The North has maintained a highly cautious attitude toward South Korean direct investment and joint venture projects in manufacturing although cooperation in this area is considered inevitable and desirable since it would serve to link the North’s internal economy and the South’s industrial base.
With the end of the Cold War era and Soviet support to the DPRK, North and South Korea began pursuing bilateral economic exchange and cooperation in earnest from the end of 1980s as a way of promoting inter-Korean relations in general. Incredibly, this process has continued virtually unabated even throughout periods of political and military tension, underlining the importance of economic motives as the determining factor. Thus, North/South economic relations to date have been built around trade, with companies from the South being the prime movers. In 2001, 432 companies were involved in inter-Korean trade with the number of items traded amounting to 572. As a result, South Korea has become the third-largest trading partner and the second-largest export market for the North. The South mainly imports agricultural and marine products from the North, which account for 36.8 percent of total imported goods for 2002. As previously indicated, the chief exports to the North are a variety of raw materials for commissioned processing.
In 2002, inter-Korean trade reached an all time high of $641.73 million. With the exclusion of non-commercial trade that includes the Mt. Geumgang tourism project, the light water reactor construction project and the Southern provision of goods for humanitarian aid, the figure is reduced to $342.96 million.
AN ACCESS TO HARD CURRENCY The DPRK has profited from North/South exchange. The North recorded a commercial trade surplus of $197.42 million in 2002. After remaining stagnant within the $250-million to $300-million range since 1995, the volume of commercial trade increased by a remarkably 45.1 percent on the year in 2002. This was due to an increase in processing trade, improvement of the Northern economy and a pro-active attitude toward economic cooperation with the South.
Processing trade has increased rapidly since it began in 1992, accounting for 26.7 percent of all trade and 49.9 percent of its commercial component. The rapid growth in processing trade can be attributed to the fact that it holds advantages for North and South alike. On the part of North Korea, it has advantages in that it enables the North to prevent the inflow of information from the South since production processes can be rigorously controlled. Furthermore, it also offers an easy means for the North to earn foreign currency by using idle facilities and manpower. On the part of companies from the South, the chief advantage is that they can utilize the North’s cheaper labor without making large-scale investments. Textile products accounted for an overwhelmingly high proportion of all processing trade items, amounting to 64.1 percent of exports and 74.3 percent of imports in 2000.
Let’s look at the items that comprise trade between North and South Korea. At the beginning of inter-Korean trade, brought-in items to the South were mainly primary products: minerals such as gold bullion, together with steel and metal products including zinc ingots and pig iron. The share of mineral products, which amounted to an annual average of 34 percent of total shipments from the North from 1991 to 1997, decreased sharply in 1998 and has remained depressed. Also, the proportion of steel and metal products, which accounted for an annual average of more than 40 percent, dropped to 10 percent in 1999.
On the other hand, with the expansion of processing trade that began in 1992, the share of textiles gradually grew to represent 36.1 percent of total imports from the North. Agricultural and marine commodities, whose share accounts for the bulk of brought-in products, claimed 36.8 percent of total imports for 2002. Agricultural and marine products have maintained a high share of imports since trade began. They accounted for 39.4 percent in 1999 and 47.2 percent, their highest point to date, in 2000. Agricultural/marine and textiles products combined represented 76.8 percent of total inbound shipments from the North in 1999, and 82.4 percent in 2002, indicating that imports are concentrated in a relatively few areas.
Items shipped north from the South have mainly been petrochemical products focused on vinyl materials for agricultural purposes. However, the share taken by textiles has continued to grow with the start of shipments of raw and subsidiary materials for processing-on-commission in 1993 and now claims a major portion of northbound exports. Since 1995, the share of non-metal mineral and primary product exports has been on the rise due to the supply of heavy oil and food by the Korean Peninsula Energy Development Organization (KEDO) under the 1994 Agreed Framework. As a result, the share of textiles has decreased somewhat since 1997. In the meantime, the share of machinery and transportation equipment has risen to more than 10 percent since 1997.
A DIVERSIFIED PRODUCT MIX Meanwhile, the share of chemical engineering products reached 20.2 percent in 1999 and 35.0 percent in 2000 due to construction of the light-water reactors (also part of the Agreed Framework), shipment of supplies for the Mt. Geumgang tourism project, and delivery of fertilizer aid. In 2002, chemical engineering products and textiles were major exports items, representing 24.2 percent and 18.2 percent of the total, respectively, and their share becomes even much higher if machinery and transportation equipment for the reactors and the Mt. Geumgang tourism project are excluded.
Apparel accounts for the majority of brought-in products processed on commission and bags, shoes and toys are also part of the product mix. As from 1996, the scope of processed-on-commission items diversified to include color TVs, TV speakers, and automobile wires. In 1998, computer display parts, audio equipment, electronics parts, railroad cars, and cassette tapes joined the list and radio/cassette players, wire-line phones and computer displays in 2000.
Concurrently, South Korean company technicians regularly visit the North to help improve the skills of Northern workers in the processing-on-commission trade. Technicians from Daedong Chemical made the first of such visits in 1995, followed by a similar mission from Elcanto Co., Ltd. in 1998, Sungnam Electronics Co., Ltd. and five other companies in 1999, and IMRI Co., Ltd. and nine other companies in 2000.
Moreover, in 2000, two officials from the Korean Agency for Technology and Standards visited North Korea to inspect a local factory, the first such visit of its kind.
While there has been significant expansion of processing-on-commission trade into electronic and electrical products as well as a rise in numbers of participant companies, it is a struggle for them to be profitable. Some have managed to be profitable after rigorous process management and skill building has increased their productivity, but most have a hard time staying in the black. In the textiles, only long-established companies with hard won experience have managed to break-even.
In the meantime, direct investment in North Korea by Southern companies remains sluggish. Up to April 2003, 49 companies had obtained approval to work as “economic cooperation partners” in ventures other than light-water reactor related projects, but business license applications have only been completed for 20 projects and just 10 are currently underway.
Both Koreas are the sponsors of the large-scale Gaeseong Industrial Complex project and are working to boost tourism in the area. In October 1999, North Korea agreed in principle to Hyundai’s proposal to create an industrial complex and tourism development in Gaeseong and on-site inspection took place in August 2000. In the following November, Hyundai and Korea Land Corporation (KOLAND) agreed to jointly participate in the complex development and as an initial step, undertook a survey of an initial 1-million pyeong area designated specifically for factory use. After the inter-Korean summit meeting of June 2000, the two Koreas agreed to restore the (Southern) Munsan and (northern) Gaeseong sections of the cross-border Gyeongui railway line that was severed at the outbreak of hostilities in 1950. A symbolic re-linking ceremony was held in the Demilitarized Zone (DMZ) on June 14th 2003. A similar event was held at the eastern end of the DMZ for the severed Donghae line. Road links will be restored along with the railways allowing eventually land routes to Gaeseong and Mt. Geumgang. THE NEED TO PROTECT INVESTMENT Capping this flurry of cross-border activity, a groundbreaking ceremony for the Gaeseong Industrial Complex was held June 30th. Once the Gyeongui railway and highway between Gaeseong and Munsan are reopened through the DMZ, Gaeseong is expected to become both an industrial supply center for Seoul Metropolitan Area industry and a forward base for Southern companies looking to expand in the North. However, extra measures are needed to address electrical power, water and seaport-access demands of locating Southern companies. Further, before settlement of the complex can begin in earnest (only Southern companies will be permitted in Phase I of the development) the government of the South should ensure that legislation is in place to guarantee investment and prevent double taxation.
Humanitarian support by both the Southern government and the private sector in response to the food shortages in North Korea since the mid-1990s also serves as a critical axis of inter-Korean economic relations. Government aid to North Korea began in 1995 when it directly provided 150,000 tons of rice, and totaled $534.46 million as of end of April 2003. Combined with $235.4 million provided by the private sector, the entire Southern aid contribution to North Korea now stands at $770 million.
Growth of commercial goods exchange between the two Koreas has slowed since 1995 when it surpassed the $200-million mark. Total trade includes shipments for the Mt. Geumgang tourism project as well as of heavy oil under the 1994 Agreed Framework while the light-water reactors are under construction. If this amount is excluded from the total, though, trade between the two Koreas varied from $250 million to $350 million from 1995 to 2002 except in 1998 when the South Korean economy was plunged into crisis.
Conventional wisdom suggests that the slow-down of commercial exchange between the two Koreas after 1995 could be due to North Korea’s industrial production capability reaching its limits. However, capacity limits can seemingly be resolved when Southern companies order processing of components and raw materials on commission.
More probably, stagnation in trade between the two Koreas since 1995 can be attributed to an inability to supply sufficient product due to the economic crisis in North Korea, excessive logistical costs of indirect trade, lack of information required to expand commerce, and risks that small and medium businesses can barely handle due to a lack of infrastructure.
Reduction of logistical costs, in particular, is one of the most urgent issues in need of addressing to revitalize economic exchange between the two Koreas. Lack of SOC in North Korea, the high risks of inter-Korean cooperation and delay associated with the restructuring and opening of the North Korean economy are responsible for the excessive logistical costs the North faces. For example, a round-trip sea journey from Incheon to the Northern port of Nampo should take six days but actually it takes 13 to 14 days due to waiting times plus delays in port entry and departure processes resulting in an average of seven to eight days of delay. In addition, a 2,500-ton vessel must pay some $9,500 in port fees at Nampo, double the Dalian, China port fee of $3,500 to $4,000. Moreover, shippers to North Korea face higher logistics costs since Nampo operates an average of only 100-container handling days per year and has a container loss rate of almost 10 percent.
A cooperative effort to improve the loading capability of North Korean ports in addition to establishing overland transportation routes is essential to substantially facilitating cross-border economic exchange. Also, all trade should be handled directly instead of indirectly as soon as possible to reduce logistical costs and improve the quality of service.
TOWARD A PROFITABLE BUSINESS MODEL Systems to insure efficiency and safety of transactions should be put in place to ameliorate the high risks and uncertainty involved in North/South trade. Establishment of passage and customs clearance, communications, docking, loading procedures for maritime, railway, land and air transportation should go top of the agenda in any discussion on building trade.
Furthermore, South Korean businesses will find it difficult to operate profitably under the current North Korean labor law. Hiring in a timely fashion is a challenge and it is impossible for employers to choose the particular workers they want. Neither can they fire workers at will, nor reassign them as they choose since the North Korean authorities control all labor matters. It is also forbidden to provide incentives to North Korean workers based on their ability and performance. Therefore, there is a pressing need to allow investing companies to make independent decisions on hiring, assignment of workers and payment of wages.
Economic cooperation between the Koreas passed through a transitional period where functions of the Southern government and business were not clearly defined. The upshot was that government exerted influence behind the scenes to the point where business relied on state support for its participation in unprofitable projects. This phenomenon produced a situation where North Korea didn’t feel the need to create a “profitable business model.”
Ideally, the inter-Korean economic relationship should be based on the North’s recent market-oriented policy changes, the improvement of relations between North Korea and its neighboring countries, and the need for industrial restructuring in both Koreas due to changes in the Northeast Asian economic order. However, relations cannot make significant headway without resolution of the North Korean nuclear crisis.
The pace of progress in the nuclear issue and the economic vibrancy of the two countries will determine the actual direction of relations. If a resolution of the nuclear issue appears in sight, the only option open to putting the North Korean economy back on track will be expanding inter-Korean economic relations.
Deepening the cross-border relationship will enhance the international competitiveness of the Korean economy and in the process, redefine the economic landscape of Northeast Asia. Against this backdrop, combining the productive elements of both Koreas and utilizing complementary economic structures are essential to maintaining growth momentum in the South and restoring the North Korean economy. In this context, the Korean government’s strategy to create a Northeast Asian hub meshes seamlessly with the drive to enhance inter-Korean cooperation.
In the meantime, the expansion of relations depends on positioning South Korea as a “partner” for economic reform in the North, and promoting further opening of its economy. Relations based on unilateral, i.e., one-way, support cannot be sustained financially and will ultimately lose pubic confidence in the South. Therefore, creation of a viable profit model based on the reform/opening of the North Korean economy and North/South economic cooperation is critical.
By Oh Seung-Yul(syo@kinu.or.kr)
Senior Research Fellow
Division of Economic Cooperation
Korea Institute for National Unification (KINU)
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