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An Oasis of Capitalism

South Korean companies explore the possibilities of outsourcing to the North, in a new economic zone.

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By B. J. Lee
Newsweek International

Sept. 19, 2005 issue - As soon as the buses crossed the heavily fortified border of the Demilitarized Zone and entered North Korea, a vast open pit appeared before the wide-eyed South Korean tourists. Dozens of bulldozers were busy leveling the yellow brown earth, while construction workers in helmets measured land or erected fences. To one side of the field were a dozen newly built factories and buildings bearing the logos of South Korean companies—Hyundai, Shinwon and Woori.

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This sprawling 66 million-square-meter site in Kaesung is a small capitalist enclave in communist North Korea. Several South Korean companies are making clothes, watches and kitchen pots here, using cheap North Korean labor in what some southerners are hoping will be a new twist in outsourcing. Kaesung, scheduled to be completed in 2015, hopes eventually to attract as many as 3,000 southern companies, employing a quarter-million northern workers. And despite the failure of most South Korean investments in North Korea thus far, its prospects look relatively bright. "Kaesung Industrial Complex is a win-win game for both South and North Korea," says Kim Chul Soon, an executive director at Hyundai Asan, the Hyundai division hired by Pyongyang to develop and lease the land. "Both economies will complement each other through the project."

North Korea envisions Kaesung as its own version of Shenzhen, one of China's first "special economic zones," and is hoping that the area can jump-start the country's near-bankrupt economy. Previous moves to attract South Korean investments have been too timid to succeed: the opening of scenic but isolated Mount Kumgang seven years ago failed because the project was limited only to tourists. But Kaesung could be a different story. Seoul, eager for closer ties with Pyongyang, is likely to offer financial incentives for companies to invest in Kaesung. And the zone has an inescapable economic logic: cheap labor plus proximity makes for an attractive alternative to locating plants in China.

Of course, the venture poses risks for both sides. Kaesung is a major city with 150,000 people. Through the industrial zone, the locals will inevitably be exposed to what control-obsessed Pyongyang calls decadent Western culture. Already, hundreds of southern managers and engineers mingle with 4,000 northern workers at the factories. But Kim Jong Il, North Korea's leader, knows that his own hold on power depends on reviving the decrepit northern economy; in recent months he's introduced capitalist reforms, including price- and exchange-rate deregulations, in an attempt to generate growth. "Pyongyang wants to change," says Lee Sang Hyun of the Sejong Institute, a think tank in Seoul. "They realize opening is the only way out of their predicament."

North Korea originally wanted to develop along its borders with China and Russia. But the much-heralded Najin-Sunbong and Shinuijoo development projects failed due to lukewarm responses from those two countries, where unskilled labor was already relatively cheap. Hyundai completed the first section of Kaesung last year, and about 15 southern companies are either building or have built factories on the first plot. Nearly 100 more companies have applied to build plants in the second lot.

Only an hour's drive from Seoul, the site is attractive to South Korean companies because the average wage is only $57 per month, less than 5 percent of that in the South and half of what South Korean firms pay in China. In addition, the land is extremely cheap. "The project is an ideal marriage between the South's money and the North's labor," says Sejong's Lee.

Shinwon is a good example. The South Korean apparel maker started its Kaesung factory early this year, hiring about 300 northern workers. The shirts and other clothes made there are sold in South Korean department stores "very fast," says Shinwon president Lee Chang Yoon. "The quality is good because the northern workers are very productive. They learn skills much faster than we expected." What's more, the goods brought to the South aren't levied with import tariffs because the trade is seen as internal. Shinwon says that it plans to triple production at Kaesung.

The zone still faces major hurdles. The main problem is Washington's economic sanctions against Pyongyang, which prohibit the sale or shipment of key strategic goods, such as computers, to the North. For the same reason, high-tech firms don't invest in the zone. Telephone calls from Kaesung to nearby Seoul are expensive because they're patched through Japan. What the zone needs more than anything to succeed is a genuine political thaw between North Korea and the United States. Without that, its dreams of hot growth will cool fast.

© 2006 Newsweek, Inc.
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