The Kaesong North-South Korean Industrial Complex

The Kaesong North-South Korean
Industrial Complex
Updated February 14, 2008
Dick K. Nanto
Specialist in Industry and Trade
Foreign Affairs, Defense, and Trade Division
Mark E. Manyin
Analyst in Asian Affairs
Foreign Affairs, Defense, and Trade Division

The Kaesong North-South Korean Industrial Complex
Summary
This purpose of this report is to provide an overview of the role, purposes, and
results of the Kaesong Industrial Complex (KIC) and examine U.S. interests, policy
issues, options, and legislation. The KIC is an industrial park located in the
Democratic People’s Republic of Korea (DPRK or North Korea) just across the
demilitarized zone from South Korea. Currently, over 50 medium-sized South
Korean companies are using North Korean labor to manufacture products in
Kaesong, but projections are for as many 2,000 firms to locate there. The complex
was planned, developed, and financed largely by South Korea, and it has become a
symbol of the growing level of engagement between the North and the South. The
United States officially supports the KIC.
The KIC enters into the U.S. policy debate because: (1) South Korea would like
the United States to consider products made in the KIC as South Korean in origin for
purposes of the Korea-U.S. Free Trade Agreement (KORUS FTA); (2) the KIC has
become a growing source of foreign exchange for the communist government in
Pyongyang; (3) the KIC is part of the strategy by South Korea to ease tensions with
North Korea; (4) the KIC is a part of the DPRK’s economic reforms (similar to
China’s special economic zones) that could lead to greater liberalization in the rest
of its economy; (5) the KIC raises issues of security, human rights, and working
conditions in North Korea; and (6) U.S. government approval is needed for South
Korean firms to ship to the KIC certain U.S.-made equipment currently under U.S.
export controls.
The language of the proposed KORUS FTA (signed but not yet approved by
Congress) does not provide for duty-free entry into the United States for products
made in Kaesong. Annex 22-B to the proposed FTA, however, provides for a
Committee on Outward Processing Zones (OPZ) to be formed and to designate
zones, such as the KIC, to receive preferential treatment under the FTA. Such a
designation apparently would require legislative approval by both countries.
The fundamental issue with respect to the KIC is whether the United States
should support a project that provides revenue to the Kim Jong-il regime in
Pyongyang — considering the regime’s nuclear and human rights policies — and that
includes questionable labor practices, even though the project seems to be enhancing
cooperation between South Korea and the DPRK, lowering labor costs for Korean
businesses, and providing a possible beachhead for market reforms in the DPRK.
U.S. policy options include maintaining the status quo of supporting, but not
actively promoting, the KIC, using the debate over the KORUS FTA to focus
attention on labor and other conditions in the KIC, encouraging reforms in the KIC,
providing close oversight to the Committee on Outward Processing Zones (if
formed), tightening or loosening sanctions and export controls with respect to the
DPRK, encouraging or prohibiting U.S. companies from doing business in the KIC,
placing restrictions on South Korean companies that do business in North Korea, and
encouraging other countries to (or not to) include the KIC in their respective FTAs
with South Korea. This report will be updated as circumstances warrant.

Contents
The Development of the Kaesong Industrial Complex.....................3
Issues Related to the Kaesong Industrial Complex........................9
Labor Issues..................................................9
Financial Benefits for Pyongyang................................12
Kaesong and the Proposed Korea-U.S. Free Trade Agreement..........13
The Control of Exports to Kaesong...............................15
Long-Term Geopolitical and Economic Issues..........................16
U.S. Interests and Policy Options....................................19
Legislation ......................................................22
List of Figures
Figure 1. Location of the Kaesong Industrial Complex....................1
Figure 2. Leased Space Factory Building to be Constructed in the
Kaesong Industrial Complex....................................12
Figure 3. Kaesong's Potential Logistical Role..........................19
List of Tables
Table 1. Hyundai’s Original Concept of the First Three Phases of the Master
Plan for the Kaesong Industrial Complex...........................5
Table 2. Number of Firms and Workers in the Kaesong Industrial Complex...6
Table 3. Production by Category in the Kaesong Industrial Complex.........7

The Kaesong North-South Korean
Industrial Complex
The Kaesong Industrial Complex (KIC) is an industrial park located in the
Democratic People’s Republic of Korea (DPRK or North Korea) just across the
demilitarized zone from South Korea. As of November 2007, over 50 medium-sized
South Korean companies were using North Korean labor to manufacture products
there, employing around 20,000 workers. The complex was planned, developed, and
financed largely by South Korea, and it has become a symbol of the growing level of
engagement between the North and the South.
Figure 1. Location of the Kaesong Industrial Complex

This purpose of this report is to provide an overview of the role, purposes, and
results of the KIC and examine U.S. interests, policy issues, options, and legislation.
The KIC enters into the U.S. policy debate because: (1) South Korea would like
the United States to consider products made in the KIC as South Korean in origin for

purposes of the Korea-U.S. Free Trade Agreement (KORUS FTA);¹ (2) the KIC has
become a growing source of foreign exchange for the communist government in
Pyongyang; (3) the KIC is part of the strategy by South Korea to ease tensions with
North Korea and lower the eventual costs to South Korea of a hoped-for reunification
of the two Koreas in the future; (4) the KIC is a part of the DPRK’s economic
reforms (similar to China’s special economic zones) that could lead to greater
liberalization in the rest of its economy; (5) the KIC raises issues of security, human
rights, and working conditions in the DPRK; and (6) U.S. government approval is
needed for South Korean firms to ship to the KIC certain U.S.-made equipment
currently under U.S. export controls.
The United States currently has an embargo on trade with the DPRK.² Even
without the embargo, the United States has not granted North Korea normal trade
relations status (most favored nation status), so products made in North Korea
currently are assessed the high tariff rates of the 1930s (column two in the U.S.
Harmonized Tariff Schedule) when they enter the U.S. market. For example, a
woman’s cotton suit (H.S. code 6204.12.00) from South Korea currently is assessed
a U.S. tariff of 14.9% while the tariff on a comparable item from North Korea is
90%. Under the proposed KORUS FTA, the tariff on this item for South Korea
would be eliminated, but even if it were allowed to be imported from the DPRK, its
tariff rate would remain at 90%.
The language of the KORUS FTA (signed by representatives of each
government but not yet approved by Congress) does not provide for duty-free entry
into the United States for products made in Kaesong. The Office of the U.S. Trade
Representative has been clear that the Agreement does not include goods from the
KIC.³ Annex 22-B to the proposed FTA, however, provides for a Committee on
Outward Processing Zones (OPZ) to be formed. This committee is to meet annually
to consider identifying geographical areas that may be designated as outward
processing zones and whose products could qualify as goods originating in South
Korea. The committee would establish criteria to be met to include but not be
limited to “progress toward denuclearization of the Korean Peninsula; the impact of
the outward processing zones on intra-Korean relations; and the environmental
standards, labor standards and practices, wage practices and business and
management practices prevailing in the outward processing zone with due reference
to the situation prevailing elsewhere in the local economy and the relevant
international norms.” Decisions reached by the unified consent of the committee are
to be recommended to the Parties to the Agreement which shall be responsible for
seeking “legislative approval for any amendments to the Agreement with respect to
outward processing zones.”

¹ For information on the FTA, see CRS Report RL34330, The Proposed U.S.-South Korea
Free Trade Agreement (KORUS FTA): Provisions and Implications, coordinated by
William H. Cooper.
² For more, see CRS Report RL31696, North Korea: Economic Sanctions, by Dianne
Rennack.
³ Korea, U.S. Still at Odds Over Kaesong Goods, Digital Chosun Ilbo (English Edition),
April 4, 2007.

The fundamental issue with respect to the KIC is whether the United States
should support any project that provides revenue to the Kim Jong-il regime in
Pyongyang — considering the regime’s nuclear and human rights policies — and that
includes questionable labor practices, even though the project seems to be enhancing
cooperation between the DPRK and South Korea, lowering labor costs for South
Korean businesses, and providing a possible beachhead for market reforms in the
DPRK.
The future course of the Kaesong Industrial Complex could undergo some
changes as a result of the December 2007 victory of Lee Myung-bak in South
Korea’s presidential election. Lee, who will take office at the end of February 2008,
has indicated he generally will seek more reciprocity from Pyongyang in non-
humanitarian inter-Korean cooperation programs, and that he will link future large-
scale economic programs to progress on the North Korean nuclear issue and will also
weigh heavily the financial costs of these programs. Statements from his transition
team members indicate that the new administration plan to continue projects that are
commercially viable. Both President-elect Lee and his transition team have been
somewhat vague on what these principles would mean for the KIC. However, the
incoming administration has indicated it will not suspend the KIC.⁴ If this proves
to be the Lee government’s policy, a major question for the future will be whether the
Lee government would support a major expansion of the KIC. One policy shift that
may occur, according to some South Koreans who have contacts with the transition
team, is that Lee may seek to raise the commercial focus of the KIC by reducing the
government’s involvement in running the complex.⁵
U.S. policy options include maintaining the status quo of supporting but not
actively promoting the KIC, using the debate over the KORUS FTA to focus
attention on labor and other conditions in the KIC, encouraging reforms in the KIC,
providing close oversight to the Committee on Outward Processing Zones (if
formed), tightening or loosening sanctions and export controls with respect to the
DPRK, encouraging or prohibiting U.S. companies from doing business in the KIC,
placing restrictions on South Korean companies that do business in North Korea, and
encouraging other countries to (or not to) include the KIC in their respective FTAs
with South Korea.
The Development of the Kaesong Industrial
Complex
The KIC resulted from an initiative led by the Hyundai Group beginning in 1998
that coincided with the Republic of Korea’s (ROK) “sunshine policy” that attempted
to improve relations between South Korea and the DPRK. The KIC is located about

106 miles southeast of Pyongyang and 43 miles north of Seoul just across the

⁴ Ahn Yong-hyun, “Lee Gov’t to Postpone Some Inter-Korean Mega Projects,” Chosun
Ilbo, January 8, 2007.
⁵ Conversations with South Korean government officials and think tank researchers, January
and February 2008.

demilitarized zone (DMZ) in the DPRK. The purposes of the KIC as stated by South
Korea have been to develop an industrial park in which South Korean businesses
could manufacture products using North Korean labor, provide an opening for North
Korea to liberalize and reform its economy, and ease tensions across the DMZ.
Although begun primarily as a private sector venture, both governments are heavily
involved in the project. Groundbreaking occurred in June 2003 and again in April
2004. Hyundai Asan and the Korea Land Corporation (both from South Korea) have
been developing and managing the complex.
South Korean companies operating in Kaesong receive certain incentives from
the ROK government and have certain rights as determined by negotiated agreements
with the DPRK. The KIC is a duty-free zone, with no restrictions on the use of
foreign currency or credit cards and no visa required for entry or exit. Property and
inheritance rights are ensured. South Korean law breakers in Kaesong are not to go
on trial in the North.⁶ The corporate tax rate is 10 to 14% with an exemption for the
first five years after generating profits and a 50% reduction for the ensuing three
years. The South Korean government (through its Inter-Korea Cooperation Fund)
offered companies that established their operations in the KIC (in the pilot project
and first phase) loans with low interest rates equal to those applied to public works
projects. These loans totaled about $40 million as of the end of 2005.⁷ Out of the
first 26 firms to either begin operations or contemplate beginning operations in the
near term, 25 of them applied for loans from the Inter-Korea Cooperation Fund.⁸
South Korea also provides political risk insurance that will cover financial losses up
to 90% of a company’s investment in the KIC up to five billion South Korean won
($5.4 million). Under a South Korean law passed in April 2007, South Korean small
and medium-sized firms operating in the KIC are eligible for state subsidies and other
benefits equal to their counterparts at home.⁹
Table 1 shows the first three phases of the master plan for the project. The first
phase encompasses 800 acres with as many as 300 South Korean firms operating in
the complex. At the end of phase 3, the plan calls for as much as 4,800 acres in the
industrial zone with as many as 1,500 firms employing 350,000 North Korean
workers and producing $16 billion worth of products per year. It also includes 2,200
acres in a supporting zone with residential facilities (dorms), commercial
establishments (hotels, restaurants, offices, conference rooms), and tourist facilities
(golf course, peace park, theme park). The Master Plan also includes an Expansion

⁶ Under the Agreement Regarding Admission and Staying in the Kaesong Industrial
Complex and Mt. Kumgang Special Tourism Zong (a.k.a. the Passage Agreement), the
principle of compulsory repatriation of offenders was acknowledged by Pyongyang. This
was important for South Korean businesses because under North Korean law, even
crumbling a newspaper that displays Kim Jong-il’s picture is considered a criminal act. (See
Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and Outlook, Seoul:
Haenam Publishing Company, 2006, pp. 42-43.)
⁷ Hyundai Asan. Kaesong Industrial Park, brochure. c. 2006. ROK. Ministry of
Unification. Gaesong Industrial Complex: Frequently Asked Questions (May 21, 2006).
⁸ Lim, Eul-chul. Kaesong Industrial Complex, op. cit., p. 172.
⁹ South Korean Assembly Passes Bill on Inter-Korean Industrial Complex. Yonhap News
Agency, April 27, 2007. Reported by BBC Monitoring Asia Pacific.

Zone of 1,600 acres for industrial use and 4,000 acres for support. This would be
used after phase 3 and would accommodate an additional 500 companies, 150,000
employees, and estimated production of $4 billion per year. Counting the expansion
zone, the grand totals for the Master Plan would be 6,400 acres for the Industrial
Zone (10 square miles), 6,200 acres for the Supporting Zone, 2,000 companies,
500,000 workers, and $20 billion per year in products. The industrial and supporting
zones together cover an area roughly one-fifth the size of Washington, DC.
Table 1. Hyundai’s Original Concept of the First Three Phases
of the Master Plan for the Kaesong Industrial Complex
Phase 1Phase 2Phase 3
Year(includes pilot)2006-20092008-2012
2002-2007
800 acres in 2,000 acres in 4,800 acres in
Total Land atIndustrial Zone.Industrial ZoneIndustrial Zone
Completion of StageKaesong City as a800 acres in1,600 acres in
Supporting ZoneSupporting ZoneSupporting Zone
Total ROK Firms
at Completion of300 8001,500
Stage
Total DPRK Workers
at Completion of100,000 200,000 350,000
Stage
^Source:^{ROK, Min}ⁱ^str^y^o^f^Un^if^icatioⁿ^.
The development of the KIC has been subject to some modifications and delays,
such as the moratorium on new factories that the South Korean side imposed for
several months after North Korea test-fired medium and long-range missiles in July
2006. As of late 2007, the 800 acres of the industrial zone envisioned in phase 1 had
been prepared. The South Korean government estimates that this site will be fully
operational at the end of 2010, with about 450 manufacturers and about 100,000.¹⁰
As of mid-2006, 1,800 companies had applied for entry into the KIC and had
requested 5,112 acres. Of these 1,800 companies, 365 were in mechanical
manufactures (auto parts, bolts, etc.), 298 in garments, 261 in textiles, 198 in
electronics, and 112 in chemical materials (rubber, plastic, etc.). Other products to
be manufactured include shoes, bags, toys, accessories, and other products.¹¹
The KIC aims to attract South Korean companies, particularly small and
medium sized enterprises, seeking lower labor and other costs for their manufactured
products as an alternative to establishing subsidiaries in China or other low-wage
markets. As indicated in Table 2, by November 2007, over 50 companies had begun
operations in Kaesong and were employing about 20,000 North Korean workers. As

¹⁰ Ministry of Unification. Current Status of Operation in the Gaeseong Industrial Complex.
November 23, 2007.
¹¹ Hyundai Asan. Kaesong Industrial Park, brochure. c. 2006.

of September 2007, about 2,000 North Korean workers were engaged in the
construction of the complex, over 500 were working in managing the complex, with
the remainder employed by South Korean tenant firms.¹²
Table 2. Number of Firms and Workers in the Kaesong
Industrial Complex
End 2005End 2006November
2007
No. of South Korean Manufacturing111552
Firms
Approx. No. of North Korean Workers6,00011,00020,000
Approx. No. of South Korean Workersn.a.700800
^Sources^:^R^O^K^,^Miⁿⁱ^s^t^ry^of^Uⁿⁱ^fⁱ^catⁱ^oⁿ^,^U^pdat^e^on^t^h^{e G}^aes^eon^g^In^du^s^t^ri^al^C^o^m^p^l^e^x^(A^s^of^F^e^bru^a^ry
^{17, 2006);}^K^e^y^S^t^atⁱ^s^tⁱ^c^s^f^o^{r G}^aes^eon^g^In^du^s^t^ri^al^C^o^m^p^l^e^x^(A^s^of^Jan^u^a^ry^31,^2007);^C^u^rren^t^S^t^at^u^s
^of^O^p^eratⁱ^oⁿⁱⁿ^t^h^{e G}^aes^eon^g^In^du^s^t^ri^al^C^o^m^p^l^e^x^,^N^o^v^e^m^b^{er 23, 2007.}
Of the $374 million initial cost for the first stage, $223 million was to be
provided by the South Korean government. The supporting infrastructure is
gradually being built. In December 2006, the Korea Electric Power Corporation
connected North Korea and South Korea by a 100,000 kilowatt power-transmission
line and in June 2007 began transmission of high-voltage electricity for use by the
companies in the KIC. This was in addition to low-voltage electricity that had been
in use since March 2005.¹³ In December 2007, the two Koreas started daily train
service across the demilitarized zone. The plan is for the trains to connect the KIC
to South Korea in the south and to China in the north. Currently, the trains terminate
south of Kaesong, in Bongdong, which does not have loading facilities.¹⁴
Meanwhile, Kaesong is connected to South Korea by a road that has more than 100
vehicles per day passing through the checkpoints.¹⁵
The 15 companies operating in the Pilot Industrial Complex in Kaesong in 2006
and their products include Sonoko Cuisine Ware (kitchenware), SJ Tech
(semiconductor component containers), Shinwon (apparel), Samduk Trading
(footwear), Bucheon Industrial (wire harness), Taesung Industrial (cosmetics
containers), Daewha Fuel Pump (automobile parts), Munchang Co. (apparel),
Romanson (watches, jewelry), Hosan Ace (fan coils), Magic Micro (lamp assemblies
for LCD monitors), JY Solutec (automobile components and molds), TS Precision

¹² Ministry of Unification. Key Statistics for Gaeseong Industrial Complex (as of September

30, 2007).

¹³ S. Korea Starts Large-scale Supply of Power to N. Korea’s Kaesong Complex. Yonhap,
June 21, 2007.
¹⁴ Economist Intelligence Unit. South Korea Country Report. January 2008.
¹⁵ Republic of Korea. Ministry of Unification. Key Statistics for Gaeseong Industrial
Complex, as of March 31, 2007.

Machinery (semiconductor mold components), Yongin Electronics (transformers,
coils), and JCCOM (communication components).¹⁶
Twenty additional companies have purchased lots for the First Phase Industrial
Complex. By 2007, six of them had begun operations: Cotton Club (underwear),
Pyongan (textiles), Korea Industry Complex Corp. (garments), Good People
(underwear), Pyonwha Distribution (shoes), and Manson (garments). By June 2007,
23 companies (including the Korea Land Corporation and Hyundai Asan’s Kaesong
Head Office) were operating in the KIC and more were preparing to start operations.
The additional companies intended to produce items of apparel, bags, shoes, and
paragliders.¹⁷
As shown in Table 3, in 2006, the KIC-produced goods totaled $73.7 million,
up from $14.9 million worth in 2005. Production for the first nine months of 2007
was on course to be more than double that in 2006. As of the end of September
2007, 43.2% of the cumulative production total had been in textiles, 25.2% in metals
and machinery, 19.2% in electronic products, and 12.4% in chemical products.
Currently, all products made in the KIC are shipped to South Korea for sale
there or for export after clearing customs in the ROK. The primary export
destinations are China and Russia. Other than labor, land, and site construction
materials, there now is no local procurement of inputs into the manufacturing
processes in the KIC nor are products manufactured in the KIC sold in North Korean
markets. Most companies there use labor-intensive manufacturing processes with
raw materials and intermediate goods from South Korea shipped to Kaesong for final
assembly. As the KIC is expanded, however, companies could procure some of their¹⁸
manufacturing inputs locally.
Table 3. Production by Category in the
Kaesong Industrial Complex
(US$1,000)
Electric and
TextilesChemicalProductsMetals andMachineryElectronicTotal
Products
2005 6,780 1,768 5,250 1,108 14,906
2006 27,793 10,900 20,853 14,261 73,737
Jan.-Sept. 200757,72613,89327,87225,720125,211
Total 92,29926,56153,97541,089213,854
^Source:^{ROK, Min}ⁱ^str^y^o^f^Un^if^icatⁱ^oⁿ^,^Key^{Statistics f}^o^r^Gaeseoⁿ^g^Iⁿ^d^u^strⁱ^{al Co}^m^p^lex⁽^a^{s o}^f
^S^e^pt^em^{ber 30, 2007).}

¹⁶ Republic of Korea. Ministry of Unification. Gaeseong Industrial Complex Project —
Status and Tasks, June 2005.
¹⁷ Hyundai Asan. Kaesong Industrial Park, brochure. c. 2006.
¹⁸ ROK. Ministry of Unification. Gaesong Industrial Complex: Frequently Asked Questions
(May 21, 2006).

It is not yet clear whether South Korean companies operating in the KIC are
doing so primarily for political purposes or whether their operations in the complex
are economically viable. Also, it is not clear whether companies in the complex
would be economically viable without South Korean government support in
providing infrastructure and loans with below-market interest rates. The KIC does
provide small and medium-sized businesses access to labor costs lower than those
in China or Vietnam, a workforce that speaks the same language, and proximity to
large markets in South Korea. Some companies appear to be using production in
Kaesong to replace that in China, South Korea, or elsewhere, but others may be using
government-subsidized loans and political risk insurance to invest in politically
popular projects. The long list of companies that have applied to enter the KIC,
however, indicates that investments there likely are seen as profitable for most
businesses. It also should be noted that an estimated 40% of the small and medium-
sized South Korean companies that established operations in China have not been
successful there. Many have withdrawn from that market. The KIC is viewed as
essential for survival by some of these companies.¹⁹
The experience of some of the early investors in Kaesong may be indicative of
the economic viability of the project. ShinWon (clothing) established operations in
the KIC to take advantage of the dexterity and lower cost of North Korean workers,
favorable logistics, and to avoid nontariff barriers in China and Southeast Asia. By
manufacturing about 16% of five of its clothing lines there, it expects to accrue
considerable savings in production costs. It considers its Kaesong factory to be
optimal when compared with those it has in China, Indonesia, Vietnam, and
Guat em al a.²⁰
Samduk Trading Company produces high-quality shoes in the KIC. Start-up
costs were high because of the need to train workers. It took eight months for some
production lines to reach 60% of the productivity level of South Korean companies.
The Romanson company (watches) finds the KIC superior to production in China
because of the common language and low labor costs. It reportedly plans to move
75% of its watch production to the KIC. The Moonchang company (uniforms, seat
covers, leisure clothes) faced a rough start in dealing with its North Korean workers
but feels it is now on the right track. The Woori Bank is in a difficult situation
because of the limited customer base and low demand for personal or business loans.
Its main business is currency exchange. It provides zero interest rates on deposits
because there are no means to make profits by investing deposits elsewhere in North
Korea.²¹

¹⁹ Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and Outlook,
Seoul: Haenam Publishing Company, 2006, pp. 68-69.
²⁰ Ibid., pp. 101-103.
²¹ Ibid., pp. 108-126.

Issues Related to the Kaesong Industrial Complex
The KIC has raised several issues with U.S. policy makers. These include labor
conditions, financial benefits for Pyongyang, the KIC in the KORUS FTA, and the
control of U.S. exports to Kaesong.
Labor Issues
A question with respect to the KIC has been the conditions for North Korean
workers there and whether they are being exploited.²² In January 2007, Jay
Lefkowitz, President Bush’s special envoy for human rights in North Korea, wrote
that one of the concerns he had with the Kaesong Industrial Complex is that
authorities take a portion (as much as 45%) of the wages paid by the South Korean
companies. He noted that verified details are elusive, and neither the DPRK nor
South Korean government, nor any company, has been able to state definitively how
much of his or her wage a Kaesong worker is allowed to keep.²³
According to South Korean officials, average wages and working conditions at
Kaesong are far better than those in the rest of North Korea.²⁴ The monthly minimum
wage is $50 ($57.50 including the cost of social insurance) or $2 per day. Increases
in the minimum wage are capped at 5% per year. General workers receive $50, team
leaders receive $52-$55, and heads of companies receive $75 per month. Workers
also receive overtime pay of about $10 per month and average about six hours per
week in overtime. The normal workweek is 48 hours. For extended working hours,
the overtime premium is 50% of the hourly wage rate. For public holidays and
nighttime work (10 p.m. to 6 a.m.), the overtime premium is 100% of the hourly
wage rate. In some cases, North Korean workers have asked for additional night shift
or weekend work in order to qualify for additional pay.²⁵ Companies also may pay
cash rewards as a special incentive. KIC employees receive 14 days per year in
vacation time. At first, North Korean workers were reluctant to ask for leave time,
but now they do.²⁶ Female employees receive 60 days paid maternity leave.²⁷ Labor

²² Rights Body Criticizes South Korea Over Refugee Protection, Inter-Korean Complex.
Yonhap News Agency, Seoul. Reported by BBC Monitoring Asia Pacific. London, January

12, 2007.

²³ Lefkowitz, Jay P. For a Few Dollars More, Wall Street Journal, January 10, 2007. p.
A16.
²⁴ The DPRK has ratified no International Labor Organization conventions.
²⁵ Kaesong Industrial Complex Management Council. Survey of North Korean Workers
from Fifteen Different Companies. February 2007. (Partial translation by the ROK
Embassy in Washington, DC.)
²⁶ Ibid.
²⁷ ROK. Ministry of Unification. Gaesong Industrial Complex: Frequently Asked Questions
(May 21, 2006).

costs in Kaesong are approximately 8% of those in a South Korean metropolitan
area.²⁸ South Korean labor laws extend to South Korean workers in the KIC.²⁹
In April 2007, Unification Ministry officials confirmed that the DPRK had
requested pay raises of 30% and 10% for members of the North Korean workforce
who are graduates of four- and two-year colleges, respectively. The two categories
make up about 11% each of North Korea’s workforce in the KIC.³⁰
The wages of North Korean workers are paid in dollars (or other hard currency
other than South Korean won) first to the Central Special Direct General Bureau, a
North Korean government agency. Article 34 of the Labor Law of the Kaesong
Industrial Complex, however, states that wages must be paid directly to employees
in cash. The DPRK claims that this is not being implemented now because of the
lack of foreign exchange centers in the KIC.³¹ The ROK Ministry of Unification has
stated that of the $57.50 minimum monthly salary, $7.50 or 15% of the base pay goes
for social insurance (providing for unemployment and occupational hazards). The
government also deducts $15 or 30% for a socio-cultural policy fee that goes for
rental of state-owned housing, education, medical services, social insurance, and
social welfare and reportedly is given to the Kaesong City People’s Committee.
According to the Ministry, the remaining $35 is paid to the workers in cash (upwards
of 5% in North Korean won) or as chits that can be exchanged for daily supplies
(food and necessities).³² At the exchange rate of 140 North Korean won per dollar,
the $35 translates into 4,900 won. (A kilogram of rice costs about 44 won if bought
from North Korea’s public distribution system but as much as 1,000 won if bought
on the open market. The average family consumes about 60 kilograms of rice per
month.)³³ Companies provide the workers with a way to verify their wages by having
them sign a ledger or provide a pay slip when they receive their pay.
The ROK Ministry of Unification announced in November 2006 that it was
working with an Australian-South Korean company (Lobana Trading Company) to
provide basic necessities to Kaesong. These items are sold primarily at the Kaesong

²⁸ Hyundai Asan. Kaesong Industrial Park, brochure. c. 2006.
²⁹ South Korean Assembly Passes Bill on Inter-Korean Industrial Complex. Yonhap News
Agency, April 27, 2007. Reported by BBC Monitoring Asia Pacific.
³⁰ South Korea Considers Expanding Joint Industrial Complex in North. Yonhap News
Agency, Seoul. Reported by BBC Monitoring Asia Pacific. London, July 26, 2006. Ministry
of Unification (South Korea). The Gaesong Industrial Complex. Status of North Korean
Workers. November 14, 2006. North Korea Economy: Kaesong Zone Expansion to
Resume. Economist Intelligence Unit ViewsWire. New York: May 8, 2007.
³¹ ROK. Ministry of Unification. Gaesong Industrial Complex: Frequently Asked Questions
(May 21, 2006).
³² Ko, Gyoung-Bin. All the Salary Goes to the North Korean Workers at the Gaeseong
Industrial Complex (GIC), January 31, 2007. Ministry of Unification document #uni4101.
³³ North Korea Today, No. 38, September 2006. Good Friends: Centre for Peace, Human
rights and Refugees. September 27, 2006.

Department Store.³⁴ Since the government distribution system covers only part of a
family’s needs for items such as rice and sugar, the rest of the basic necessities are
obtained by barter or purchased at the department store, even though prices are higher
there.
North Korean workers commute to the KIC by bus provided by the Kaesong
Industrial Complex Management Council and by some 1,000 bicycles also provided
for workers living closer to the complex. According to the KIC Management
Council, the health condition of workers at the KIC has visibly improved as they
have had access to better nutrition.³⁵
The actual recruitment of workers is done by North Korea’s Central Guidance
Agency on Special Zone Development, a cabinet level administrative body. The
South Korean hiring company, however, may reject any recruit provided or if the
recruit does not demonstrate the requisite skills (e.g., sewing), hire the worker as a
trainee at 70% or less of the minimum wage. Employers cannot freely punish or fire
incompetent workers. They must give instructions through North Korean mid-level
managers. Directly scolding employees is regarded as humiliation and prohibited.³⁶
The experience of many companies, however, is that labor management is a
challenge during the start-up phase of a factory in the KIC. Gradually, however,
North Korean workers begin to identify with the company, and a level of trust is
developed between the South Korean executives and the North Korean managers and
workers.³⁷
Currently, North Korean workers do not have the right to change employers.
This promises to keep labor costs from escalating as they have in other developing
markets as foreign firms bid for skilled workers. This also provides companies in the
KIC with a stable (though aging) workforce.³⁸ This practice, however, conflicts with
what would be consistent with internationally accepted workers’ rights.

³⁴ Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and Outlook,
Seoul: Haenam Publishing Company, 2006, p. 148.
³⁵ Kaesong Industrial Complex Management Council. Survey of North Korean Workers
from Fifteen Different Companies. February 2007. (Partial translation by the ROK
Embassy in Washington, DC.)
³⁶ Lim, Eul-chul. Kaesong Industrial Complex, op. cit., p. 144.
³⁷ Ibid., p. 98ff.
³⁸ Ibid., p. 103.

Figure 2. Leased Space Factory
Building to be Constructed in the
Kaesong Industrial Complex

^Source:^{ROK, Min}ⁱ^str^y^o^f^Un^if^icatioⁿ^.
Financial Benefits for Pyongyang
A key aspect of the KIC for U.S. interests is how much the North Korean
government derives in hard currency from the project, including leasing fees and its
share of the wages of North Korean workers. The wages are first paid in hard
currency (dollars) to a North Korean government agency that deducts for certain
items before paying the North Korean workers in won or in chits to be exchanged for
food and necessities. If the government collects about $22.50 per month (in social
insurance taxes plus the socio-cultural fee) for each of the 12,446 workers at Kaesong
in March 2007, its monthly take from wages would amount to approximately
$280,000 per month or $3,360,000 over a year (although the socio-cultural fee
reportedly goes to the Kaesong city, not the central government). In addition, there
are land lease fees and other payments to the North Korean government. When the
project was initiated, Hyundai Asan paid North Korea $12 million for a 50-year lease
on the entire Kaesong site. Hyundai Asan and the Korea Land Co. also purchase
sand and gravel and other raw materials from North Korea for use in site³⁹
development at Kaesong. Companies in the KIC also pay North Korea’s job
reference agency (recruiting agency) a commission of $17 per employee sent.⁴⁰
Under an agreement on taxation, businesses in the KIC are subject to a 10% to
14% corporate income tax, but the tax has an exemption for five years after first
generating profits and a 50% deduction for the ensuing three years. This compares
³⁹ Communication from the Office of Korean Affairs, U.S. Department of State to the
Congressional Research Service, June 7, 2007.
⁴⁰ Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and Outlook,
Seoul: Haenam Publishing Company, 2006, p. 144.

favorably to corporate tax rates in South Korea (12% to 28%), China (15%), and in
Vietnam (10% to 15%).⁴¹ In 2007, the companies in Kaesong had not been operating
long enough there to have to pay corporate income taxes to the DPRK.
In 2004, the Hyundai Research Institute estimated that North Korea could
receive $9.55 billion in economic gains over the course of nine years if the KIC were
to be developed fully and operated successfully. This would include $4.6 billion in
foreign currency earnings with $700 million derived directly from the operation of
the KIC, $2.5 billion from sales of raw materials and other industrial products, and
$1.4 billion from corporate taxes.⁴² Considering that in international trade in goods
in 2005, North Korea exported $1.8 billion and imported $3.6 billion, the estimated
total gains of $9.55 billion over nine years associated with the Kaesong Industrial
Complex would be quite significant (provided it progresses according to plan).
Kaesong and the Proposed Korea-U.S. Free Trade Agreement
During the negotiations on the KORUS FTA, South Korea requested that
products exported from the complex be considered to have originated in South Korea
in order to qualify for duty-free status under the proposed FTA. Under the South
Korea-ASEAN FTA, for example, preferential tariffs are applied to 100 items
manufactured in the Kaesong Industrial Complex.⁴³ The Korea-Singapore and
Korea-European Free Trade Association (EFTA) FTA agreements also include
products from the KIC.⁴⁴ Singapore accepts 88.6% of the traded products from the
KIC as long as no products are directly exported from the DPRK. The Korean FTA
with EFTA limits coverage to 2.9% of the total trade and only for those exports that
have first been brought into the South Korean territory and which have 60% of the
total materials cost as South Korean.⁴⁵ In the current negotiations between South
Korea and the European Union, Seoul has similarly requested products from Kaesong
be covered by the proposed FTA. In 2006, the European Union (15 nations)
imported $185.7 million worth of goods from North Korea. Switzerland imported
$0.8 million and Singapore $6.6 million.
For the United States, however, from the beginning of the FTA negotiations, the
U.S. position was that only products originating in South Korea would be included.⁴⁶

⁴¹ Ibid., pp. 73-74.
⁴² Ibid., p. 61.
⁴³ Merchandise FTA with Five ASEAN Countries to Take Effect Next Month. Yonhap
News (Seoul), May 30, 2007.
⁴⁴ Channel News Asia, Singapore. South Korea, Singapore Initial Free Trade Accord, April
17, 2005. EFTA includes Iceland, Liechtenstein, Norway, and Switzerland. ROK, Ministry
of Foreign Affairs and Trade. Korea-European Free Trade Association (EFTA) FTA, June

16, 2007.

⁴⁵ Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and Outlook,
Seoul: Haenam Publishing Company, 2006, p. 189.
⁴⁶ For details, see CRS Report RL34330, The Proposed U.S.-South Korea Free Trade
Agreement (KORUS FTA): Provisions and Implications, coordinated by William H. Cooper.

At a U.S. House International Relations Committee hearing on July 20, 2006,
Assistant U.S. Trade Representative Karan Bhatia indicated that the proposed FTA
would not cover goods made in a free-trade zone in North Korea.⁴⁷
The text of the Korea-U.S. Free Trade Agreement (signed by representatives of
each government but not yet approved by Congress) does not provide for duty-free
entry into the United States for products made in the Kaesong Industrial Complex.
Annex 22-B to the proposed FTA, however, provides for a Committee on Outward
Processing Zones (OPZ) on the Korean Peninsula to be formed and to “identify
geographic areas that may be designated outward processing zones,” determine
whether any such zone “has met the criteria established by the Committee,” and
recommend them to the respective governments, which “shall be responsible for
seeking legislative approval for any amendments to the Agreement with respect to
outward processing zones.” The Committee also is to “establish a maximum
threshold for the value of the total input of the originating final good that may be
added within the geographical area of the outward processing zone.” Decisions of
the Committee would require unified consent (this arguably provides the U.S. side
with veto power over any recommendation of the committee). The criteria to be met
include but are not limited to “progress toward denuclearization of the Korean
Peninsula; the impact of the outward processing zones on intra-Korean relations; and
the environmental standards, labor standards and practices, wage practices and
business and management practices prevailing in the outward processing zone, with
due reference to the situation prevailing elsewhere in the local economy and the
relevant international norms.” The OPZ committee is to meet at least annually
beginning a year after the agreement goes into effect.
A question has arisen with respect to language in Annex 22-B pertaining to
labor standards and practices in the KIC with due reference to the “situation
prevailing elsewhere in the local economy and the relevant international norms.” Is
the local economy in this case that of the DPRK or that of South Korea, and can
products from the KIC be produced under conditions contrary to International Labor
Organization agreements that lay out basic international standards or worker rights
yet still be recommended by the OPZ Committee to be included under the FTA?⁴⁸
Another issue raised by the KORUS FTA is whether intermediate products
made in the KIC can enter the United States under the provisions of the FTA if they
are incorporated into products that are manufactured in South Korea and that qualify
as originating in South Korea. The same concern exists with respect to products
made in China or elsewhere if they have North Korean inputs. Currently, goods of
North Korean origin may not be imported into the United States either directly or

⁴⁷ Hyde Warns USTR to Keep Kaesong, Visas out of Korea FTA. Inside US Trade, July 21,

2006.

⁴⁸ See Letter, Rep. Sander Levin, Chair of the House Ways and Means Subcommittee on
Trade to Ambassador Susan Schwab, USTR. June 12, 2007.

through third countries, without prior notification to and approval of the Office of
Foreign Assets Control of the Department of the Treasury.⁴⁹
A further issue with respect to the KIC and the KORUS FTA is that if KIC
products made with the low-cost North Korean labor are allowed to be treated as
South Korean in origin under the proposed KORUS FTA, South Korean exporters
would enjoy a large cost advantage over their counterparts in the United States.
The Control of Exports to Kaesong
The United States maintains a comprehensive economic embargo against the
DPRK because of its designation as a state sponsor of international terrorism. The
Departments of Commerce and the Treasury jointly administer the trade embargo
under the Trading With the Enemy Act of 1917 and the Export Administration Act.
The Department of Commerce licenses U.S. exports and re-exports, while Treasury
grants general and/or specific licenses for financial transactions by U.S. persons with
DPRK entities. The Department of Commerce requires a license for the export to
North Korea of virtually all commodities, technology, and software, except for
technology generally available to the public and gift parcels (not exceeding $400).⁵⁰
In FY2006, the U.S. Bureau of Industry and Security approved two items for
export to the DPRK. They were glass (fiber optic) transmission items (5A991) worth
$213,919 and software (5D992) for $3,600.⁵¹ The transmission items were
telecommunications equipment used by Korea Telecom in setting up the
communications lines between the two Koreas and into the KIC.⁵²
The South Korean government also maintains strict controls over exports to the
DPRK. The restricted items include machinery and inspection equipment to produce
metal and machines, electronics, optics, laser-related equipment, microorganism
cultivating devices and chemical product facilities, and sophisticated high-technology
equipment and materials. Even the latest versions of personal computers, commonly
available in the South, are restricted and, if their export is approved, they have to be
kept under lock and key in the KIC.⁵³ New high-technology monitoring systems,
including tracking devices, are also being used for items with sensitive dual-use
technology.

⁴⁹ U.S. Treasury, Office of Foreign Assets Control. North Korea: What You Need to Know
About Sanctions. c. 2007. See Title 31, Part 500, U.S. Code of Federal Regulations.
⁵⁰ U.S. Bureau of Industry and Security. Embargoed Countries and Entities (Section 746),
Export Control Program Description and Licensing Policy. For information on U.S. export
controls, see CRS Report RL31832, The Export Administration Act: Evolution, Provisions,
and Debate, by Ian F. Fergusson.
⁵¹ Bureau of Industry and Security, U.S. Department of Commerce, Bureau of Industry and
Security Annual Report, Fiscal Year 2006. c. 2007, p. 93.
⁵² The export license was approved by the U.S. Export Administration on November 16,
2005. (See Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and
Outlook, Seoul: Haenam Publishing Company, 2006, p. 206.)
⁵³ Ibid., p. 204.

In the October 2007 summit between South Korean President Roh Moo-hyun
and North Korean leader Kim Jong-il, the North agreed to improvements in how
Kaesong operates, including swifter customs clearance for goods crossing its border,
and better computer and cell-phone communications connections between Seoul and
Kaesong factories. The transition team of incoming President Lee Myung-bak has
indicated that it likely will continue with these plans.⁵⁴
Long-Term Geopolitical and Economic Issues
The Kaesong Industrial Complex sits at the hub of spreading concentric sets of
economic and geopolitical interests and concerns. At its narrowest sense, the KIC
is a business venture in which participants are seeking profits and business
advantages. On the South Korean side, the KIC provides small and medium-sized
companies with a manufacturing platform and opportunity to access low-cost labor
without having to go overseas to establish subsidiaries or to outsource the assembly
of their products to China or other markets. On the DPRK side, the KIC provides
jobs for workers who can earn relatively higher wages without crossing their borders
illegally or working under contract in labor-scarce countries such as those in the
Russian Far East or in Middle Eastern countries.
At a somewhat wider set of interests, the KIC provides a channel for
rapproachment between the DPRK and South Korea. Kaesong developed partly from
South Korea’s sunshine policy of economic engagement with the North. It can be
viewed as a confidence-building measure between two countries whose hostility
toward each other has lingered since the 1950-52 Korean War. As has been the case
with the extensive economic interchange between China and Taiwan,⁵⁵ the KIC may
provide a bridge for communication and a catalyst for cultural interaction, and it can
create stakeholders in each other’s economies with a shared interest in stability,
liberalization, and increased communication across the DMZ.
At a still wider set of interests, the KIC may be the proverbial camel’s nose
under the tent in attempts to reform, liberalize, and modernize the North Korean
economy. In neighboring China in 1978, foreign businesses were first allowed to
operate in special economic zones. Now foreign invested businesses generate more
than half of China’s exports and imports. The Chinese speak of practicing socialism
with Chinese characteristics and, indeed, many state-owned enterprises still
encumber the Chinese economic system. The state-owned enterprises that are
successful, however, operate much like privately owned enterprises, and one is hard
pressed to find other significant differences between the Chinese brand of socialism
and market capitalism. In January 2006, Kim Jong-il paid his fourth visit to China
to see its special economic zones. There he observed modern high-technology

⁵⁴ Ahn Yong-hyun, “Lee Gov’t to Postpone Some Inter-Korean Mega Projects,” Chosun
Ilbo, January 8, 2007.
⁵⁵ For a discussion of this issue, see CRS Report RL32882, The Rise of China and Its Effect
on Taiwan, Japan, and South Korea: U.S. Policy Choices, by Dick K. Nanto and Emma
Chanlett-Avery.

factories — many of them foreign-owned — in operation.⁵⁶ Likewise, the KIC
exposes average North Koreans to modern business methods and to the
accouterments of Western industrial society.
According to the Economist Intelligence Unit, the decrepit North Korean
economy has “three crying needs: deeper market reforms, greater openness, and
above all, massive investment to modernize decrepit plant and infrastructure.”⁵⁷ The
KIC potentially addresses all three of these needs to a limited extent. However,
reports from North Korea indicate that the economic reforms there currently are
stalled — even being reversed. Unlike China’s reforms, moreover, the initiative for
the KIC came from abroad, is viewed with suspicion by many, and is an isolated
case. (Although, Pyongyang seems to be attempting to revive the Sinuiju Special
Administrative Region — a similar free trade zone — along the border with China.)⁵⁸
In sum, it is still too early to tell if Kaesong will succeed, much less have a large
effect on the rest of the North Korean economy.
At a geopolitical level, Kaesong is one part of the standoff between the DPRK
and the United States, China, South Korea, Japan, and Russia, over North Korea’s
nuclear weapons program. Under the rubric of the six-party talks lie a bundle of
strategic issues, such as the ability of North Korea to finance its nuclear program, the
need for humanitarian and energy aid, the stability of the Kim Jong-il regime, and the
enforcement of various economic sanctions being applied to North Korea. A major
goal of the United States in the six-party talks is to halt and verifiably dismantle
North Korea’s capability to produce nuclear fuel and nuclear bombs or to proliferate
nuclear material or technology to potentially hostile countries or groups. The U.S.
strategy to accomplish this is a combination of sticks (sanctions, diplomatic isolation,
name calling) and carrots (promises of aid, diplomatic recognition, security
guarantees) conveyed to North Korea through the six-party talks, bilateral meetings,
and occasional media blasts. Under this strategy, there is little reason to provide the
DPRK with any financial reward, even if it is to the benefit of South Korea, unless
it shows significant progress in its commitments under the six-party talks.
The South Korean goals with respect to North Korea, however, not only include
the denuclearization of the Korean peninsula but eventual reunification and
reconstruction of the DPRK’s economy. A major South Korean concern is the
potential cost of reunification either in the form of a flood of economic emigrants to
the South or in actual budgetary outlays to help rebuild the North’s civilian economy.
The high cost to West Germany of the integration of East Germany after the fall of
the Berlin Wall has provided little comfort to the policy makers in Seoul. The South
Korean strategy, therefore, has tended to be longer on carrots (promises of food, fuel,
and fertilizer) and shorter on sticks (sanctions) with a heavy reliance on engagement
across the interactive spectrum and on diplomacy to resolve the issue. Even after the

⁵⁶ See, for example, Onishi, Norimitsu. "On his Visit to China, Kim Traveled a Familiar
Path," The New York Times, January 26, 2006.
⁵⁷ The Economist Intelligence Unit. Country Report, North Korea, May 2007. p. 13.
⁵⁸ Institute for Far Eastern Studies. Interest Revived in the Sinuiju Special Administrative
Region. Reported by Nautilus Institute, Policy Forum Online 06-25A, March 30, 2006.

North Korean nuclear test in 2006, South Korea continued the KIC operations. It
only halted its plans to call for new applicants to enter the KIC. Existing production
facilities continued to manufacture, and existing applications moved forward.
Although incoming ROK President Lee Myung-bak has said he will seek more
reciprocity in Seoul’s dealings with Pyongyang, and he has been somewhat vague
about how he will treat the KIC, his statements to date have been widely interpreted
to mean that phase 1 of the complex, at a minimum, will continue operating.
Undoubtedly, the KIC would be a centerpiece of if Lee enacts his proposed “3,000
Policy” to help North Korea raise per capita income to $3,000 in ten years. Lee has
made this policy contingent upon progress in the denuclearization of North Korea.
For South Korea, not only does Kaesong provide entry into the decrepit DPRK
economy, but it is a key factor in building up and reforming the economy in the North
with an eye toward eventual reunification. Beijing’s strategy before the return of
Hong Kong in 1997 has been instructive to Seoul. A major reason that many of the
first economic reforms in China occurred in nearby Guangdong Province, particularly
just across the border from Hong Kong in Shenzhen city, was that Beijing tried to
stem pressures to immigrate to Hong Kong by raising the standard of living and
industrial development in the region abutting the returning territory. This strategy
has been so successful that some immigration, particularly of Hong Kong retirees,
has been going from Hong Kong to Guangdong Province and not the other way
around. Likewise, Beijing has broadened ties with Taiwan through allowing cross-
strait investments, travel, business visas, communication, and other business-based
activities. In some sectors, particularly in the manufacture of computers and other
electronic products, Taiwan and the east coast of China have become one integrated
economy. Kaesong arguably could begin a similar process with North Korea.
South Korea also aims to become a hub of East Asia. In order to accomplish
this, it would like to be connected to China, Russia, and to Europe via railways that
pass through North Korea. As part of the KIC project, North and South Korea have
reconnected a railroad line connecting the north and south and have conducted a test
run on it. (A second line on the opposite side of the peninsula also was connected.)
In terms of logistics, a shipment by rail from South Korea via Kaesong to Hamburg,
Germany would take about 27 days by ship, 10 days via the Trans-Siberian Railway,
and 7 days via the Trans-China Railway.⁵⁹ (See Figure 3.)

⁵⁹ Hyundai Asan. Kaesong Industrial Park, brochure. c. 2006.

Figure 3. Kaesong's Potential Logistical Role

^Source:^Hy^uⁿ^d^{ai A}^s^an
U.S. Interests and Policy Options
The three national interests of the United States that form the basis of all policy
discussion are security, economic well-being, and value projection. These three
national interests all play into consideration of the Kaesong Industrial Complex.
The main security concern for the United States is the location of the KIC in the
DPRK. U.S. security concerns with respect to North Korea center on two major
considerations: (1) the DPRK’s nuclear program and (2) potential conflict across the
DMZ separating North Korea and South Korea. The KIC has opposing effects upon
these security considerations. On one hand, since income in any country is fungible,
anything that increases revenue to the Pyongyang regime has the potential to
contribute to the DPRK’s military (including its missile and nuclear program). It is
likely, however, that the DPRK’s nuclear program has assured funding from the
government. Also, given Kim Jong-il’s “military first” policy, the North Korean
military has top priority in the allocation of scarce economic resources. It also has
call on certain economic activities and government subsidies for them. It is not clear
how much, if any, income (over that used to pay for expenses related to Kaesong) for
Pyongyang from the KIC currently is directed toward the DPRK military or nuclear
program. Since the KIC land formerly was a military base that had to be vacated,⁶⁰
some arrangement may have been made to compensate the military for relinquishing
a strategically important piece of ground. Even if the income from the KIC does not
⁶⁰ Lim, Eul-chul. Kaesong Industrial Complex, History, Pending Issues, and Outlook,
Seoul: Haenam Publishing Company, 2006. p. 37.

go directly into military purposes, it may bolster funds for civilian purposes that had
been cut because of the budgetary demands of the military. The Kim regime,
moreover, uses scarce foreign exchange to bolster the loyalty of its inner circle of
elites who use it to buy imported luxury goods.
U.N. Security Council resolution 1718 (adopted October 2006) explicitly
prohibits any member state from providing funds that go to support North Korea’s
nuclear weapons program. The resolution states in Section 8(d) that all Member
States shall, in accordance with their respective legal processes, ensure that any
funds, financial assets or economic resources are prevented from being made
available by their nationals or by any persons or entities within their territories, to or
for the benefit of persons or entities engaged in or providing support for the DPRK’s
programs related to nuclear weapons, other weapons of mass destruction, and
ballistic missile related programs.
As for tensions across the DMZ, the KIC already has played an important role
in increasing the level of engagement between the DPRK and South Korea and in
raising the priority of economic activity relative to security concerns. Even though
the border between North Korea and South Korea is heavily guarded and crossings
had been rare, the military on both sides have acquiesced to the daily traffic on the
North-South highway to Kaesong and the re-connection of two railways across the
DMZ (along with limited tourist visits and family reunions).
In terms of the second U.S. national interest of economic well-being, the KIC
currently has little relevance, although it has some effect through U.S. trade and
investment relations with South Korea. U.S. companies have no investments in
Kaesong and U.S. trade with North Korea in 2007 was virtually non-existent. South
Korea, however, is the seventh largest trading partner of the United States, and the
United States is South Korea’s third largest trading partner. If the six-party talks on
the denuclearization of the Korean Peninsula were to progress far enough, the United
States could re-establish diplomatic relations with the DPRK, lift economic
sanctions, and eventually grant that country normal trade relations (most-favored
nation) status. If so, trade with North Korea could be done on the same basis as trade
with most other countries of the world. Absent that development, South Korea’s
request to treat products made in the KIC as South Korean in origin would seem to
be the only way to bring the KIC into the set of industrial locations open to normal
or preferential trade with the United States. Meanwhile, South Korean companies
exporting KIC products likely will continue to avoid the U.S. market rather than face
economic sanctions and high U.S. tariffs. This may give countries that include the
KIC in their FTAs with South Korea (such as ASEAN and EFTA and possibly the
European Union) a possible small diplomatic advantage over the United States in
dealing with Seoul. Moreover, South Korea is likely to press the United States to
change its KIC policy. This could be a source of future U.S.-ROK tension even if the
KORUS FTA is passed.
The third U.S. national interest is projecting U.S. values such as a market-based
economy, representative government, and nations adhering to world standards for
working conditions, environmental regulation, and other humanitarian
considerations. In this respect, the KIC potentially could play a significant role as a
demonstration project to educate North Koreans on the workings of a market-based

economy. The KIC provides an opportunity for businesses to operate in North Korea
according to what may be higher labor and environmental standards than exist in the
rest of the country and to educate North Korean middle managers on how such
standards work.
Currently, the 20,000 North Koreans employed in the KIC are too few and the
project too small to have a significant impact on the development of the North
Korean middle class (a factor in the development of a more representative society),
and the number of the elites in the DPRK with an economic interest in the complex
probably is still relatively small. If the project continues to develop and the DPRK
opens other free-trade zones, however, something akin to the economic reforms in
China or the economic transformation that is now occurring in Vietnam⁶¹ could occur
in North Korea. This could weaken the hold by Pyongyang on the daily lives of
citizens and bring the country more into the globalized world. Such economic
liberalization also could reduce pressures on North Korea to engage in illicit trade in
order to cover its trade deficit⁶² and diminish the need for Pyongyang to saber rattle
in order to divert attention from its domestic problems.
In the short run, however, increased revenues strengthen the regime’s hand and
make it less vulnerable to outside pressure. Also, spillover effects will depend on
North Korea adding much more value to the production processes which it has yet
to do. Finally, there is some question about the extent to which KIC is commercially
viable, or whether incentives and supports given to South Korean firms are critical
as opposed to marginal in their profit and loss calculations. Trade between the
DPRK and South Korea tends to be government-based, in contrast to trade between
China and North Korea. This may blunt the lessons learned by Pyongyang.
The United States currently has a mixed policy with respect to the KIC. Since
South Korea is a close ally of the United States, Washington has been supportive of
efforts by South Korea to engage the North in inter-Korean projects that benefit
South Korea. On the other hand, the United States has been firm in predicating any
economic or other concessions on actions by the DPRK to curtail or eliminate its
nuclear program.
Major policy considerations and options for Congress, given the above U.S.
interests, include the following:
^!In considering whether or not to approve the KORUS FTA,
Congress may express its support or non-support of the exclusion of
the KIC from the FTA as negotiated. Congress may also specify the
conditions under which the KIC can or can not be brought under the
provisions of the proposed FTA. Congressional disapproval of the
proposed KORUS FTA likely would have a large negative impact on
prospects for the future of the KIC with respect to the United States.

⁶¹ See, for example, Bradsher, Keith, Vietnam’s Roaring Economy Is Set for World Stage,
The New York Times, October 25, 2006.
⁶² See, for example, CRS Report RL33885, North Korean Crime-for-Profit Activities, by
Liana Sun Wyler and Dick K. Nanto.

^!In the debate over the KORUS FTA, Congress may focus attention
on labor and other conditions in the KIC and encourage reforms.
^!If the KORUS FTA is approved, Congress may provide close
oversight of the Committee on Outward Processing Zones.
^!Since the United States already imposes a range of economic and
financial sanctions on the DPRK, the United States could either
tighten or loosen them. This could affect non-South Korean
businesses in determining whether to invest in the KIC or to
purchase products made there. The United States also could tighten
(or loosen) U.S. controls on the export of dual-use technology items
to the KIC.
^!The United States could impose restrictions on or provide
inducements to U.S. business activity in KIC.
^!The U.S. government could encourage other countries (or groups of
countries, such as the European Union) to (or not to) include the
KIC in their respective FTAs with South Korea.
^!If the DPRK takes the necessary steps to halt its nuclear program as
outlined in the six-party talks, support (or oppose) measures leading
toward normal trading relations status for the DPRK and the lifting
of economic sanctions.
^!The U.S. government could place restrictions on South Korean firms
that do business in North Korea.
Legislation
Legislation and other congressional action related to the Korea-U.S. FTA are
covered in CRS Report RL34330, The Proposed U.S.-South Korea Free Trade
Agreement (KORUS FTA): Provisions and Implications, coordinated by William H.
Cooper.
The following bills in the 110^th Congress may affect the KIC even though they
may not be specific to the KIC.
H.R. 571 (Tancredo). Would require additional tariffs be imposed on products of
any nonmarket economy country until the President certifies to the Congress that that
country is a market economy country.
H.R. 937 (Garrett). Expresses the sense of Congress that the United Nations
should: (1) ensure that the United Nations Development Program (UNDP) enforces
its rules regarding financing, staffing, accounting, and auditing of its activities in the
Democratic People’s Republic of Korea (North Korea); (2) authorize an external

investigation of all UNDP activities in North Korea; and (3) ensure that any UNDP
local staff in North Korea who committed crimes are prosecuted or who violated
regulations are sanctioned. Expresses the sense of Congress that the President should
use U.S. influence to ensure that UNDP: (1) ceases activities in North Korea that are
in violation of UNDP regulations; (2) conducts a full audit of UNDP activities in
North Korea since 1998; and (3) establishes regulations to ensure that no funds
allocated to UNDP activities in North Korea are provided to the government of North
Korea. Directs the Secretary of State to withhold U.S. contributions to the general
funds of UNDP until the Secretary certifies to Congress that UNDP meets such
provisions.
S. 527 (Feingold) Iran, North Korea, and Syria Nonproliferation Enforcement Act
of 2007. Amends the Iran and Syria Nonproliferation Act respecting the imposition
of sanctions under such Act to: (1) apply sanctions for a minimum two-year period;
(2) apply sanctions to an identified foreign person, a successor or subsidiary, and an
entity controlling more than 50% of such foreign person, successor, or subsidiary
(currently, such provision applies only to a foreign person); (3) include among
applicable sanctions under Executive Order 12938 certain exemptions for military,
medical, or humanitarian purposes; (4) establish investment, financing, and financial
assistance prohibitions; and (5) require publication of sanctions applicable to such
expanded entities in the Federal Register.