Implications for North Korea of the China-South Korea FTA agreement

December 16, 2015 7:00 AM

Last Friday, three of my colleagues, Jeff Schott, Euijin Jung, and Cathleen Cimino-Issacs released a highly informative policy brief, An Assessment of the Korea-China Free Trade Agreement. While most of the attention rightly is focused on what the agreement means for China-ROK trade relations and its broader implications for the regional trade architecture, Jeff, Euijin, and Cathleen also touch on the implications for North Korea.

As I noted in an earlier post, the agreement provides for preferential treatment of a specified list of 310 goods produced in outward processing zones (OPZs) such as the Kaesong Industrial Complex (KIC). The new policy brief provides the details:

“The originating status for goods produced in OPZs will be considered under two conditions: (1) “the total value of non-originating materials shall not exceed 40 percent of the FOB price of the final goods for which originating status is claimed;” and (2) “the value of originating materials exported from the Party concerned shall not be less than 60 percent of the total value of materials used in the processing of those goods.” As the Kaesong Industrial Complex (KIC) is recognized as an OPZ, this means some products made in the KIC will qualify for preferential treatment. In particular, the fact that the “value of non-originating materials” does not include the wages of OPZ will also help facilitate products made in KIC to meet the two conditions to qualify [emphasis in the original].”

This treatment is more expansive than in South Korea’s previous FTA agreements with the US and EU; in the case of the KORUS agreement, KIC products are not eligible for treatment—the extraterritorial extension of FTAs gives the US Congress serious heartburn—instead the KORUS agreement sets up a face-saving binational commission to study the issue, but which could also be used as a mechanism to jump start trade relations in the case of a North Korean collapse.

The policy brief argues that the provision in the agreement could be helpful to South Korean producers insofar that China is a growing market for South Korean exports. The question is whether Chinese producers will find the North Korean OPZs attractive.

As my colleagues note, “The appeal of the KIC to Chinese and potential foreign investors can be found in its low wages, proximity to South Korea, and infrastructure and tax benefits.” As Steph and I have noted in previous posts, South Korea wants foreign investors in KIC essentially as hostages to constrain North Korean behavior, both in terms of physical security and the sanctity of economic contracts.

Which brings us to the issue of political risk. These have included arbitrary shutdowns by the North Korean authorities and an essentially extortionate attempt to re-write the wage arrangements unilaterally. A fourth nuclear test would surely bring pressure on South Korean and other investors to cease operations at KIC (and any other OPZs that might be operational).

The great hope is that increased Chinese investment in North Korea might nudge Pyongyang toward more rational economic policies. The China-ROK FTA agreement can be regarded as a modest incentive for such an outcome to eventuate. Like so much on the Korean peninsula, whether it will do so rests largely on the preferences and capacities of the leadership in Pyongyang.

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Marcus Noland Senior Research Staff