North-South integration: socializing risk

June 4, 2012 6:45 AM

In a recent post announcing the release of a new paper based on a survey of 300 Chinese enterprises doing business in North Korea, we emphasized how, in the absence of strong business enabling institutions in North Korea, the Chinese firms had adopted various hedging strategies to navigate the challenging environment, and how the weaknesses of its institutions harmed North Korea’s economy.

We have just put out what amounts to a companion paper based on a survey of 250 South Korean firms.  The results obtained from the two surveys differ in some interesting ways.  While most of the Chinese enterprises feel that they are “on their own” obtaining little direct or implicit support from the Chinese government, in the case of North-South economic integration, the South Korean government plays a much more central role. We find that direct and indirect South Korean public policy interventions influence the different modalities of exchange (traditional arm’s-length trade and investment, processing on commission (POC) trade, and operations within the Kaesong Industrial Complex (KIC)) that South Korean firms adopt in their interactions with the North.  We find that these modalities of exchange matter greatly in terms of implied risk. For example, firms operating in the KIC are able to transact on significantly looser financial terms than those outside it.  South Korean policy consequently affects entry, profitability, and sustainability of South Korean business activities in the North. In effect, the South Korean government has substituted relatively strong South Korean institutions for the relatively weak Northern ones in the KIC, thus socializing risk. As a result, the level and type of cross-border integration observed in the survey is very much a product of South Korean public policy, and debates within South Korea about the government’s role in promoting cross-border integration have a basis in reality.

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Marcus Noland Senior Research Staff

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