North Korea's Kaesong Clamor

It's hard to believe a nation seeks talks to increase wages in a joint industrial park with its neighbor shortly after warning that a war with that neighbor might be imminent. But that's exactly what North Korea is doing just as the U.N. takes final steps to endorse sanctions for the country's May nuclear test. On June 11, South Korean negotiators, responding to a call for talks by Pyongyang, crossed the heavily fortified demilitarized zone to sit with their North Korean counterparts at the Kaesong Industrial Complex just north of their border.

The paradoxical approach sums up North Korea's precarious existence. The regime of ailing leader Kim Jong Il appears bent on maintaining the Kim family's Communist dynasty at all costs, but the country's rickety economy can hardly support the subsistence of its 23 million population. "If North Korea is totally cut off economically from the South, its hardship will be pushed to the brink within years," figures Koh Il Dong, who heads research on North Korea at the government-funded Korea Development Institute in Seoul.

Sure, since the fall of the Berlin Wall and the disintegration of the Soviet bloc 20 years ago, North Korea has defied predictions of the regime's demise. Koh and many North Korea watchers in Seoul believe the reclusive nation will again muddle through for a couple of years even in the face of international sanctions unless China, its main ally, pulls the plug.

The wild card, however, is South Korea. It has emerged as Pyongyang's second most important trading partner thanks to a decade of the "Sunshine" engagement policy that ended last year with the inauguration of conservative President Lee Myung Bak. Probably the most concrete sign of the 10-year period is the Kaesong complex. There, managers from more than 100 South Korean companies are working with a Communist Party workforce of nearly 40,000 who are employed at factories making clothes, shoes, watches, and other labor-intensive products.

Border Closures Take Toll on Output

Now, after more than a year of worsening relations and the North's second detonation of a nuclear device on May 25, the fate of the Kaesong complex is thrown into question. The pilot project is operated by a South Korea-run committee under a 50-year lease that began in 2004, but many in the South are now asking how much longer it can survive. The dangers to the viability of the industrial park weren't really posed by the recent belligerence of the North. After all, South Korean entrepreneurs who have lived with communist threats since the end of World War II are so accustomed to the North's rancor that it's been business as usual, despite the tensions. "As far as the production goes, nothing much has changed at Kaesong," says Yoo Chang Guen, president of South Korea's SJ Tech, which employs 430 North Korean workers there to make rubber and plastic parts for cars and semiconductor manufacturing equipment. "North Korean workers don't even know what's really going on outside Kaesong."

The real problem, rather, dates from December, when the North Korean military imposed restrictions on passage through the border. Pyongyang's action came after South Korean human rights groups dropped leaflets criticizing the Kim Jong Il regime from balloons. Three day-long closures of the border followed while the U.S. and South Korea carried out a major joint military exercise in March. The North also detained a South Korean man working at Kaesong in March for allegedly criticizing the Northern system.

The border closures and detention sent alarm bells ringing among some businessmen, particularly buyers of goods made in Kaesong. "Lots of contract work is drying up at Kaesong because companies dealing with seasonal products are afraid that orders can't be met in time and they will lose business opportunities," notes Yoo at SJ Tech; the company's monthly output value at Kaesong has dropped to $7.5 million, from $15 million last year. In 2008, SJ Tech managed to break even after investing $10 million in its Kaesong plant over the four previous years. Yoo says his company's Kaesong operation is now losing some 30 cents on every dollar of revenue.

What's more, North Korea in May declared it was canceling all wage, rent, and tax agreements with South Korea over the Kaesong complex. It has also warned that Southern companies should pull out unless they are willing to respect new rules and terms to be set by the North. "The recent steps at Kaesong will pose huge risks for North Korea among international investors as they destroy fundamental trustworthiness in business dealings with the country," says Jeong Hyung Gon, a researcher at the Korea Institute for International Economic Policy, a Seoul-based state-funded think tank.

Asking for a 400% Raise

Already, falling exports by factories operating at Kaesong underlines waning confidence in the industrial park. Exports plunged 56% in the first four months of this year, to $7.15 million from $16.3 million in the 2008 period, even though the number of companies operating there jumped to 104 at the end of April, from 69 a year earlier, according to data compiled by the South's Unification Ministry. Total output, however, fell only 6.6% to $74.54 million in the four months as many factories managed to replace exports with cheaper local assembly work to minimize losses.

North Korea piled more bad news on the companies on June 11. During the Thursday talks at Kaesong, the North notified the South that it wants to increase the average monthly wage to $300, from about $75 now. "Such a wage level will spell an end to the Kaesong complex," says Jung Seung Eui, director of manufacturing at Samduk Tongsang, which employs 2,800 North Korean workers at Kaesong to make 80,000 pairs of shoes—mostly for running and hiking—per month. Chung notes Kaesong operations could easily be replaced with contract workers in China at a wage of $150 a month.

Backing down from an earlier take-it-or-leave-it declaration, the North left a door open for compromise. Before ending Thursday's meeting, North and South Korean officials agreed to further negotiations on June 19. Watchers of the North say given that North Korea earned cash worth between $500 million and $600 million annually through trade, aid, and cooperative projects such as Kaesong with South Korea, the stakes are high in its gambit with the South. Nevertheless, "the key to North Korea's survival is held by China," says Lee Young Hoon, North Korea specialist at Bank of Korea, the South's central bank. Lee points out that China's trade with North Korea nearly quadrupled from $740 million in 2002 to $2.79 billion in 2008—a pace that could make up for North Korea's losses resulting from its isolation.

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