The Microeconomics of North–South Korean Cross-Border Integration

Economic integration between North and South Korea occurs through three modalities: traditional arm’s-length trade and investment, processing on commission (POC) trade, and operations within the Kaesong Industrial Complex (KIC). In order, these three modalities are characterized by decreasing exposure of South Korean fi rms to North Korean policy and infrastructure. Th rough a survey of 200 South Korean fi rms operating in North Korea we fi nd that these modalities of exchange matter greatly in terms of implied risk. For example, fi rms operating in the KIC are able to transact on signifi cantly looser fi nancial terms than those outside it. We fi nd that direct and indirect South Korean public policy interventions infl uence these diff erent modalities of exchange and thus impact entry, profi tability, and sustainability of South Korean business activities in the North. In eff ect, 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. JEL Codes: P3, F15, P33