May 31, 2007

South Korea’s Incongruous Engagements: The U.S. FTA and the Kaesong Industrial Zone

South Korea’s economic policy is reaching out in two directions, cementing a free trade agreement (FTA) with the United States and jointly developing the Kaesong Industrial Zone with North Korea. Ostensibly, both initiatives aim to boost national GDP. However, according to Thomas Byrne, vice president and senior credit officer of Moody’s sovereign risk group, only one of these two engagements is practical.

South Korea’s drive to reach an FTA with the United States is a straightforward measure likely to yield great benefits for both countries, Byrne said. Numerous studies have predicted that once ratified, the FTA will be an important shot in the arm for Korea’s exporters and overall economy. Success with a U.S. FTA will also pave the way for an equally beneficial FTA with the European Union.

The economic rationale for developing the Kaesong Industrial Zone, which allows small- to medium-sized South Korean manufacturing companies (SMEs) to utilize low-priced North Korean labor, is to increase competitiveness in the SME sector. Currently, 10,000 to 12,000 North Korean workers are employed by South Korean companies at Kaesong. The zone would have to reach its projection of employing 350,000 North Korean workers, however, for it to have an appreciable impact on the South Korean economy. That, said Byrne, is unlikely to happen as long as North Korea and its neighbors remain at an impasse over its nuclear program.

More important than its economic rationale, he continued, are Kaesong’s political goals. South Korea’s leaders initiated the project with the hope that it might eventually spur the DPRK to adopt economic reforms just as China and Vietnam relied on special economic zones (SEZs) to spur wider liberalization in the 1980s. If the DPRK did reform, and enjoyed healthy economic growth as a result, South Koreans wouldn’t be stuck with as great a financial burden of raising North Korean living standards during an eventual reunification process.

So far, Kaesong’s policy architects haven’t articulated a plan of how the project will spur economic reform nor created benchmarks for its political success. There are also important differences between Kaesong and the Chinese and Vietnamese precedents. In those cases, the SEZs were meant to foster the development of local companies which had backward linkages to the larger national economy. Kaesong operates as a special preserve for South Korean companies, walled off from the rest of the North Korean economy. Furthermore, it’s unlikely that Kaesong will create a new class of capitalist-oriented North Korean managers, accountants and professionals who could serve as agents of reform. Because of Kaesong’s proximity to their home offices, South Korean companies operating there have no need to provide North Koreans with any training for higher positions.

Byrne closed his remarks with the caveat that Kaseong could indeed achieve its political goals if North Korea’s leadership made the decision to reform. At this point, he believes it hasn’t. And in comparison to its economic engagement with the U.S., South Korea’s goals at Kaesong remain elusive and quixotic.

About the speaker

Thomas J. Byrne is a vice president-senior credit officer in Moody’s Sovereign Risk team, where he serves as the regional credit officer for the Asia-Pacific region. His work focuses on the creditworthiness of, and economic challenges faced by, Moody’s-rated nations like Japan, China, Korea and Vietnam. A Moody’s observer since 1997, Byrne has also worked at the Institute of International Finance in Washington D.C. as a senior economist in the Asia department. He served in Korea for three years as a U.S. Peace Corps volunteer and holds an M.A. in international relations with an emphasis on economics at the Johns Hopkins School of Advanced International Studies.

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Business Roundtable

with

Thomas Byrne
Vice President & Senior Credit Officer
Moody’s Financial Institutions & Sovereign Risk Group

Thursday, May 31, 2007
11:30 AM - 12:00 PM ♦ Registration and Reception
12:00 PM - 2:00 PM ♦ Luncheon and Presentation

Korean Consulate General in New York
335 E. 45th Street (between 1st & 2nd Avenues)
2nd Floor Conference Room

Two major projects currently dominate South Korea’s economic planning: cementing a U.S.–Korea FTA and developing the Kaesong Industrial Zone with North Korea. Both are vital the country’s long term economic health. But each is pulling Seoul in a different direction, presenting South Korea’s policymakers with a series of complicated decisions. Thomas J. Byrne will discuss the economic and political forces that are pushing the U.S.– Korea FTA and the Kaesong Industrial Zone to culmination, and those that are working against them. He will also examine what both projects might mean for the North Korean economy, and their potential for becoming the first small steps towards systemic reform.