Economic factors from the case study that Park Jeehee may have considered when setting up his shop in KIC

1. Identify and critically discuss the key economic factors from the case study that Park Jeehee may have considered when setting up his shop in KIC. Substantiate your answer with arguments from credible academic sources.

Problem of origin of economic resources

KIC was formed through integration of economic projects between North and South Korea. The complex was formed as an agreement on the basis that capital injection was contributed by the South while the North provided labor and land to create economic benefits for both of them. The proceeds from companies’ sales at the complex are inclusive of tax levied by both North and South Korea. However, the cost of running the business increases, making it difficult for new small and medium sized businesses in the complex to begin their operations and to expand the market of their products outside the country.

Rules of origin in Inter-Korean trade

Products manufactured in Kaesong Industrial Complex and products of North Korea have their origin of Inter-Korean Trade Goods judged by goods produced as a whole. The impact of such tariff classification has led to enterprises doing business in non-qualifying operations. The new tariff was implemented to be a special regulation to promote good relationships between the North and the South by ensuring products satisfy a certain requirement. In particular, the two divisions passed a requirement that owners having shares in their companies at the KIC had to produce goods worth 60% of the accepted standards to be accepted as made in Korea, or else, the business would be seized from operating. In addition, the two regions imposed a restriction that 60% of input of direct material should originate from the South, increasing the cost of entrepreneurs starting businesses in the complex. In spite of the fact, the KIC was formed by technology and capital of companies originating from the South, the North and the South further proposed establishment of free economic zones, a factor that prevented businessmen from starting sole proprietorship forms of businesses.

Tariff barriers when exporting goods outside

Apart from goods made in KIC being labeled as Made in Korea, there have been definite limitations for the goods of Inter-Korean Trade. For goods manufactured in KIC and exported in Japan, United States and other countries, the origin of prices of Kaesong products is affected by the tariffs of importing countries. As a result, the customs policies of imported goods have been the barriers to promotion of goods originating from the KIC complex which causes them to lose competitiveness in the other markets compared to other goods with lower tariff rates. With North and South Korea in consideration, they pose difficulties to companies exporting their products due to the restrictive regulations formed by the corporation between the two regions.

Preferential trade agreements

The government of North Korea is yet to reach agreements with countries especially United States, Japan and European Union as main partners on elimination of tariff for goods from North Korea. For instance, North Korean products are not included in the Generalized Systems of Preferences (GSP). The non-preferential rule for goods from North Korea affects goods made in Kaesong Industrial center; consequently, they are rejected in other countries due to the agreement of the two regions to establish the inter-trade union.

a) The United States tariff agreement

Under the basic regulations of the Kyoto convention, United State considered, for example, considers agricultural and marine products as produced wholly, or originally produced. For example, a company of a given country making products using imported material, a new item code is assigned to the product. The rule depends on whether the product is produced by assembling several materials or through a working process. United States provides a specific tariff depending on the tariff preferences of a given product to promote economic growth of the country and to gain a competitive advantage in the international markets. However, products originating from North Korea do not apply the preferential program, sidelining the country from entering the multilateral trade customs. As a result of the communist regime, a woman’s dress has an assessment of 14.9% US tariff, while the same item in North Korea has 90% tariff. Even if the Free Trade Area were to be initiated between South Korea and the United States to eliminate tariff of the product from South Korea, North Korea would still maintain their products at 90% tariff rates. The Implication of unequal tariff rates discourages investors from starting a business at KIC since the North Korea will raise the cost of producing goods, leading to low demand of their product in other markets outside Korea.

b) European Union countries tariff agreements

The European countries apply non-preferential and preferential rules of origin. The rules use complicated procedures such as value-added tests, processing tests and changes in classification of tariffs. The European Union countries also have the variety of rules for products imported in relation to the trading partners. As a consequence, products from North and South Korea face barriers to entering the European Union markets. Therefore, even though North Korea agrees to comply with the EU trade agreements, products from South Korea will go through several tests before they qualify to enter the EU market, creating a barrier to entrepreneurs planning to expand the market for their goods in the European countries.

c) Japan tariff agreements

Japan also uses similar rules of origin of tariff classification on imported goods. As such, wholly produced tests and processing tests for imported commodities are their substantial standards of tariff classification. Except for jewels, textiles, conferred as domestic products, imported goods from non-preferential trade countries have to pass through the tests, hampering the market expansion for goods being produced in Korea, and in particular, the Kaesong Industrial Complex.

Necessity of Kaesong to operate as a closed market

As noted above, the Kaesong’s products do not have the leverage of preferential treatment to enable them to sell their goods to other trading partners. The main reason for the cause is the high tariff rates maintained by the countries to Kaesong’s products. As a result, in the absence of the preferential treatment, the prices of theirs products exported keep on fluctuating in the world markets. Moreover, United State no longer maintains good trade relations with North Korea due to its manufacture of nuclear weapons. Instead, the US has imposed high tariffs for products manufactured from North Korea as well as from Kaesong area. Problem has made South Korea face difficulties in negotiating trade agreements for products from Kaesong’s origin under the FTA. In addition, Japan is yet to make a conclusion of its preferential tariff agreement with North Korea. Therefore, goods entering Japan’s market from Kaesong complex meet unfavorable conditions compared to products from other nations that receive equal treatment.

Management problems

The central planning economic system of North Korea has led to the elimination of production incentives for its local manufacturer, creating no room for facility managers to use the modern technologies in order to achieve efficient production. Appointment of manager at the KIC often relies on political appointments rather than competence qualities. There have been no developments of indigenous technologies since the managers have little training on maximization of economic resources. Moreover, the workers employed in the complex have little knowledge of educational and are not successful in handling complex manufacturing facilities. Most of the theses workers originate from North Korea based on the agreement of the two regions. As a result, new-emerging companies will be forced to employ the North Korean worker some of whom are unskilled and semi-skilled, leading to low returns compared to the capital injected in the production process.

Legal barriers

The legislative process of expanding KORUS FTA must pass Annex 22B for approval by the Korean government before being allowed to import goods from the United States. However, there is pessimism that creating an outward processing zone will affect intra-Korean relations, wages, business and management practices, and labor and environmental standards. The KORUS FTA criticism against North Korean business causes Kaesong to fall under the legislative objection against making it an outwards processing zone. In addition, the central governance of the North Korea has limited businesses at the Kaesong complex to operate. All the revenue collected from the companies in the KIC is shared by the government on the basis of the communist economy. The lack of independence prevents many investors from opening their premises at KIC. Furthermore, laws have been enacted to ensure that wages from workers are paid to the government before being deposited into employees’ accounts. The companies incur higher wage bill than when they would be paying wages to the employees directly due to the requirement of law to provide insurance cover and other reliefs to the workers, raising the total amount of wage per a given type of job.