Asia Logistics Wrap

Off to China!

Today I leave for China on vacation. Japan's Golden Week starts this weekend and so I am off!

Except for some potential posting from internet cafes during my trip, I don't intend to do any major posting until I return. I plan on doing a report on my experience in the four cities I will visit, hoping to provide an interesting picture of China today. Those cities are Shanghai, Beijing, Nanjing and Jiangyin, of which the latter two I have never visited previously. Shanghai I have visited four times since last August, and my girlfriend lives there, so that is much easier for me to report on. However, I haven't been to Beijing in almost two years; thus I hope to see how visibly preparations for the Olympics have progressed, in addition to city development in general. Nanjing is historically famous in modern history for the war atrocities committed by Japanese soldiers during WWII. But in terms of business, it is becoming an automotive hub of sorts as it builds up its position on the Yangtze River. From Nanjing, we move on to Jiangyin where I have made friends with city officials responsible for logistics development at its river port and industrial parks, especially in connection with the city of Wuxi to the south. I met the city officials while they were in Japan promoting investment opportunities in February, and now will have the chance to see their city and progress first-hand, as well as ask more questions.

Expect some nice pictures to go with the posts.

Also on my to do list is wrapping up Kaesong. I am going to see if the Jiangyin officials know anyone involved with it, as they have made a promotional trip to Korea this year, and the Chinese can traditionally more freely travel to North Korea. Either way, visiting a more inland special economic zone like Jiangyin (versus the coastal Shanghai), will be enlightening.

Have a great weekend!

Kaesong Industrial Complex Part V: Economic Flow Architectures

A Case Study on Globalization's Reach into North Korea

Analyzing Architectures

I have discussed the five supply chain architectures in several previous posts, but I believe I forgot to emphasize that only high-performance supply chains truly employ all five architectures successfully. Arguably, due to underdevelopment across a significant part of the region, the majority of supply chains running through East Asia are either unable to employ all five architectures or are doing so insufficiently enough to not be labeled "high-performance."

Thus, when discussing Kaesong's architectures across the four flows, it is necessary to understand some architectures might simply be non-existent depending on the flow in question. Those architectures that do exist will vary in terms of quality as well as suitability.

It is also necessary to understand that this case study cannot possibly capture all the architectures being employed. I will be relying primarily on the availability of online resources and thus my goal is to capture the essence of each architecture type while providing concrete examples to illustrate my points. At the end of this attempt, I will summarize the case study by briefly looking at how Enterprise Resilience Management (ERM) might be deployed to better integrate Kaesong-related flow architectures.

Economic Flow Architectures

The economic dream for Kaesong is driven by the optimism of its supporters. This optimism is captured in the promotional videos for Kaesong, which not coincidentally resemble the promotional video for Incheon's Songdo technology park and videos I have seen for special economic zones in China. (Dramatic music and intense voices included)

On June 30, 2003, three years after the Joint Declaration, a joint groundbreaking ceremony was held for Kaesong, it having officially been designated a special economic zone by the North Korean Government (see picture).

Although later than initially inticipated, by December 2004 fifteen South Korean companies moved into the Phase I, 91,840 square meter model complex, illustrated in the picture on the left (Chul, pg 1). One of these companies, a South Korean kitchen utensil company, Living Art, had manufactured and sold all of its 1,000 sets of Kaesong-made stainless steel cooking pots only two days after hitting the South Korean market (Chul, pg 1).

Physical Architecture

Starting with the most basic infrastructure utilized in the supply chains driving economic flows to and from Kaesong, reconnection of the Seoul-Sinuiju railway and roads crossing the DMZ was first agreed upon. Specifically, roads opened up in the first half of 2004. The first-stage infrastructure at Kaesong is to be completed this year--a plot of 3.3 square kilometers. Including the 91,840 square meter pilot complex illustrated above, this will be a small part of the final, 65.7 square kilometer site, of which 60% will be residential housing and services infrastructure (Chul, pg 3-4).

With the following pictures, we can review how Kaesong's geograhical location is appealing. (Graphics are taken from Hyundai Asan's English website. Please reference for a nice outline of Kaesong's basics).

The lead developers are Hyundai Asan and Korea Land Corporation, which together have obtained leasing rights from Korea for 50 years. Handling the above-ground, electricity infrastructure is the Korea Electric Power Corporation, which launched its service of 15,000 kilowatts to Kaesong on March 16, 2005. However, this service is limited to the pilot fifteen South Korean companies (Chul, pg 4-5). The initial companies are low-tech, low-resource firms who don't have the ability to initiate production in China or elsewhere overseas, nor the talent to facilitate such an effort. In this sense, North Korea's proximity, low-cost, and language familiarity are significant deal winners. (Note: English websites tend to be quite outdated, but are helpful for the basics).   

Korea Telecom has a agreed to provide telephone lines, through a service agreement signed on December 30, 2004 and supplemented on March 24, 2005.  However, due to the complexity of deliverying telephone and internet service across the DMZ into Kaesong, several details are still under negotiation. These include such things as: telephone area code, how to physically install the optic cables across the DMZ, call rates, management, income shares and worksheet methods (Chul, pg 6). In other words, no short list! An update from Korea Telecom dated March 29, 2005, however, states that the call rate will be US 40 cents per minute with telephone numbers from South Korea to Kaesong designated by 001-8585-XXXX and from Kaesong to South Korea 089-XXX-XXX. As of February 24, 2006, there is now caller ID service for Kaesong phone calls.

North Korea supplies the human capital. As of March 2005, 1900 North Koreans were working at Kaesong, 730 to 740 were in training, and 950 were working in construction and road paving in building the site infrastructure. Another 220 North Koreans were involved in office work assisting the management committee and Hyundai Asan or are involved in basic services such as cleaning, convenience store sales, and cooking (Chul, pg 6). More  recently, an article in chosun.com from April 9 (in Korean) states that there are currently 6500 North Koreans working at Kaesong, almost double from the same time in 2005. The article also mentions that the plan is to utilize approximately 100,000 North Korean employees when Phase I of Kaesong is in full swing. UPDATE: A new article lists the employee number as 6895, an indication that employment is rising quickly in the complex:

"The number of North Korean workers at a South Korean-run industrial complex in the North Korean border city of Kaesong rose 22 percent every month over the past one and a half years, the South's Unification Ministry said Wednesday.

"Over the same period, production increased 36 percent every month due largely to a rise in the number of South Korean factories operating in the complex, according to the ministry.

"As of Friday, a total of 6,859 North Korean workers, including 1,047 construction workers, were registered at the complex."

It also states:

The North Koreans work with about 300 South Koreans in Kaesong.

From the banking sector, Woori Bank has taken the lead in developing physical architecture for banking services.

As I mentioned in Part IV, my friend indicated Hyundai Oil Bank has established two gas stations at Kaesong. After researching Oil Bank's site, I found an English article from August 2004. It is reprinted here in its entirety because it is a great illustration of the physical architectures in place to deliver fuel to Kaesong:

"Hyundai Oilbank (CEO Youngtae Seo) announced on the 29th that it would deliver fuels to North Korea via land for the first time among the Korean refineries. It is said to send 2 tank lorries bearing the logo of the company for construction to link railway and highway lines of the two Koreas named Kyung-i Line and Tonghae Line.

"Fuels to be delivered by Hyundai Oilbank are said to be used for various equipment and facilities on the site of railway and highway construction. For the first ground transportation of fuels, which is a step forward from previous drum transportation method by ship, Hyundai Oilbank will use tank lorries to deliver fuels directly to construction site.

"Hyundai Oilbank is said to deliver fuels to Kyung-i Line construction site first. Hyundai Oilbank will load a total of 58,000 liters of fuels to two 32 kl-tank lorries at its Incheon storage site. The tank lorries will cross Reunification Bridge and pass through the Military Demarcation Line and then finally arrive at a fuel storage site in Gyesung, North Korea, to unload fuels. After arriving at Gyesung, the tank lorries will be sent to Kyung-i Line and Tonghae Line construction sites to unload fuels at fuel storage facilities and then head back to Incheon Storage on the same day.

"Diesel fuel of 58,000 liters to be delivered by Hyundai Oilbank is the volume of fuel consumed at the construction sites in about a week and the company is said to make about 100 fuel deliveries until the railway and highway constructions are completed.

""We are very pleased that our fuels are to be delivered via land to the construction sites where South Korea and North Korea are working side by side to link their railways and highways, which symbolizes reconciliation and cooperation between the South and the North," said Young-moo Lee, Managing Director of Direct Sales Team of Hyundai Oilbank."

Other details, such as plumbing, drainage and roads will continue to be under construction, including separate infrastructure facilities for industrial water, waste water and factory waste treatment centers (Chul, pg 9). 

Financial Architecture

As cash flow is created at Kaesong, the companies that have incorporated the industrial complex into their supply chains as well as the governmental organizations managing the site must have the right financial architectures in place to facilitate further growth and investment. In terms of Kaesong's cash contribution to inter-Korean trade, an article posted at the Kaesong Community Forum from January states:

Inter-Korean trade volume broke $1 billion for the first time last year since the North began to import South Korean products in 1988, the Korea Investment-Trade Association (KITA) said Sunday.

Trade between South and North Korea brought to a halt with the division of the peninsula 55 years ago reached $100 million in 1991 and again soared 10 times to $1.05 billion in 14 years last year, up 51.5 percent from a year earlier.

"As companies in the North's Kaesong industrial complex are expected to put themselves into a full gear this year, inter-Korean trade will surely surmount last year's trade volume," a KITA official said.

Of the inter-Korean trade, exports bound for the South stood at $340 million while those bound for the North was at a much higher $710 million. Trade regarding the Kaesong industrial area accounted for 6 percent of the total inter-Korean trade in 2004. It rose 10 percentage point to 16.7 percent, or $177 million, last year.

As a result, the non-governmental, commercial trade amounted to 65 percent of the total inter-Korean trade, the highest level since 2000, while the government-led non-commercial trade accounting for 35 percent.

Moreover, more South and North Korean firms are forming a joint venture turning away from a processing-on-commission. But the inter-Korean trade accounted for only 0.19 percent of the nation's overall trade volume for 2005.

Inter-Korean transaction seems to have much room to grow given its tiny proportion in the total trade between the two sides, the KITA official said.

"To promote inter-Korean trade," he noted, "Seoul should allow South Korean businessmen to freely visit the North on their needs, make their communication with their North Korean counterparts easy and establish a quick road transport system across the demarcation line."

UPDATE: A more recent article comments on the financial figures from Kaesong:

"Since the first product was made in December 2004, the total output has amounted to US$27.46 million, which means a monthly average rise of 36 percent. In particular, production exceeded $5 million in March, a 40 percent rise from February," he said.

Once cash flow is generated in Kaesong, it is distributed as follows:

• Workers are paid basic wages of $57.50 per month (about 1/3 of China). This includes social insurance and pension, with an annual maximum pay raise of 5% per year.
• Corporate income is taxed from 10% to 14% based on set criteria regarding industry type

Woori Bank, mentioned above, primarily handles remittances and foreign exchange services for the firms at Kaesong (Chul, pg 8). Foreign currency can be used freely and the architectures exist for the use of credit cards.

Informational Architecture

As the saying goes: "Information is power." Thus, given North Korea's long-time isolation in the face of encroaching globalization and Seoul's densely wired metropolis, it is not unexpected that informational architectures lag those already discussed above. In fact, with almost any supply chain in its rudimentary stages advanced informational architecture is often considered a luxury.

For Kaesong, much of the future informational architecture to be expected will rely on the foundation of telecommunications infrastructure being developed by Korea Telecom and its North Korean counterparts. Negotiations will be key and so will the governing political architectures.

For the time being, the basic architectures exist enabling both cell phones and the internet to be freely used, as mentioned above.

Relational Architecture

Relational architectures are a very significant part in making economic flows into and from Kaesong possible. They elevate links between supply chain entities from a simple transaction involving the exchange of cash for a good or service to the level of collaboration and partnership, creating and driving more value through the supply chain and passed on to customers. As an example, The Center for International Cooperation for North Korean Development plays a role in facilitating Kaesong's progress across participants in its development. Its aim is to:

• Facilitate productive interaction between the international development community
  and North Korea
• Conduct research and evaluate roadmaps for North Korean development
• Work cooperatively with North Korea institutions and potential development partners
  in designing and promoting effective programs and projects
• Create a worldwide network of experts who can contribute toward North Korea's
  development
• Strengthen institutional capacities within North Korea to work productively
  with development partners
• Work to eliminate other barriers impeding cooperation

As can be seen, this organization is all about building relational architectures. They have a list of activities at their site, but like I said before, the English site is less dynamic and outdated compared to the Korean site.

Innovational Architecture

Innovational architectures are often the last to be developed in a supply chain. They represent an evolution of improvements that ends in a firm regularly reinventing itself across and within its supply chains to increase value provided to customers and improve extended enterprise resilience and thus long-term health of the entire organization; not just financially, but in terms of customer success, process strength, and the health of IT, people and leadership foundations (see Balanced Scorecard strategy mapping).

We can safely say that supply chains utilizing Kaesong are not yet to this level. Although this type of outsourcing is intriguing:

"In November 2004, several South Korean companies hired 255 North Korean workers when they moved into the complex at its opening.

"The complex, still in its pilot stage, is now home to 11 South Korean companies that produce garments, kitchenware and shoes.

"Go said four of them, such as apparel maker Shinwon Co. and socks manufacturer Sunghwa, sent a total of 53 North Korean workers to China for technical training."

This utilization of China in the supply chain is a basic form of innovation--and illustrates in one respect China's rise in the food chain. I would bet that the same type of exchange is being initiated by firms operating in Vietnam.

As we will see in the next parts to this case study, the characteristics of the architectures upon which the other flows are built on will affect the supply chain resiliency of economic flows. The flows cannot be divorced from each other, but they can be sequenced and timed according to the development scenario in question.

COMMENTARY: Honestly, collecting and dissecting information on economic flows into and from Kaesong took longer than I anticipated. The economic interaction between North and South Korea has reached a complexity through just this industrial complex above and beyond what I had imagined when I started my research. As we will see, breaking down the architectures for parallel political (Part VI), security (Part VII) and people (Part VIII) flows will add additional, and necessary, complexity--a complexity that I believe can be managed by the ERM (ERM) Solution in development by Enterra Solutions. This component, the third in building my FAR Matrix, ensures the ability to design and describe the appropriate pathways for a DiB solution. I hope this becomes clearer by the end of this case study.

Kaesong Industrial Complex Part IV: Rationale Behind Kaesong Selection

A Case Study on Globalization's Reach into North Korea

The rationale for targeting the Kaesong site for developing an ideal economic zone within North Korea relied on the following factors, some of which were mentioned in Part III:

- increased goodwill due to the June 15 Joint Declaration of 2000
- an assertive investment drive by Hyundai Corporation
- geographic proximity to the Seoul Metropolitan Area (includes Incheon)

Hyundai`s Investment Drive

Hyundai has a well-connected yet suspicious past in regards to North Korean relations. Exchanges of large sums of money as an investment in a set of North Korean mega-projects, including Kaesong, have been questioned in regards to their timing. Whether or not these funds were partially intended to initiate the Joint Summit of June 15 2000, the fact that Hyundai's founder escaped from the North to the South in the 1950's ties Hyundai to the North in blood and spirit. According to a good friend working currently for Hyundai Oil Bank, it is this connection that provides it leverage with and drives it to lead projects with the North. In fact, Hyundai Oil Bank even has a couple gas stations in Kaesong, which I will post more on later.   

On August 10, less than two months after the Joint Declaration, Hyundai finalized an agreement with North Korea choosing Kaesong for development. The business rationale established by Hyundai seems sound on the surface. Examining the key aspects of the Kaesong development, we can see a McDonald's-type strategy is in play--"location, location, location:"

1. It is in the center of the Korean peninsula, and with the Kyongui railway passing through it, it would be a natural transportation hub. Kaesong is a large city, 70km from the Seoul Metropolitan Area (SMA) and 160km from Pyongyang. When Kyongui railway (Seoul-Shinuiju) restored, it will be connected to Sariwon, Pyongyang and to Shinuiju, and even to the Trans-China Railways. If land transportation can be facilitated through the Kaesong district, it would considerably reduce the high logistics costs that have been a heavy burden on inter-Korean economic cooperation (Nam, pg 82).
2. Located near the SMA and other industrial areas, the Kaesong industrial complex will have easy access to raw materials, as well as semi-processed goods, components and information (Nam, pg 82).
3. Kaesong is an ideal city, in terms of location, where the South and the North can link their electricity, railways, roads, and water for use by an industrial park (Nam, pg 82).
4. The population of Kaesong and neighboring areas is around 350,000––a large workforce (Nam, pg 82).
5. Finally, vast plains lie to the west and the south of Kaesong, providing ample sites for establishing an industrial complex (Nam, pg 82-83).

In the PowerPoint file below, I have tried to illustrate the positioning rationale:

Download kaesong_positioning_rationale.ppt

Hyundae's Vision--Pie in the Sky?

Hyundai aimed to develop the Kaesong area and wanted it to be designated as a special economic region for international business, turning it into a North Korean version of the Chinese special economic district of Shenzhen. This would transform Kaesong into an international economic free zone with global competitiveness in manufacturing, finance, commerce, and tourism (Nam, pg 82).

The company expected that its development of Kaesong would have spillover effects: restoration of severed South-North railways and roads, and contribution to the development of neighboring communities, job creation, and promotion of exchanges of technology and foreign currency earnings through export (Nam, pg 82).

The primary details of Hyundai's business plan as of 2001 were as follows (I will provide the current status later) (Nam, pg 79):

• Complex Dimensions: 6.05 million square meters
• Phase I Industry Target: Light industry--textiles, apparel, shoes, leather, bags, toys, socks, food (processed ginseng), beverages, electrical/electronic goods, metals and machinery, etc.
• Phase II/III Industry Target: high-tech industries dealing with industrial equipment, information and communications, computers, and software
• Development Period: 2001-2008
• Lease land rights over 50 year span

As of late November 2000, 450 South Korean companies had expressed their interest in establishing themselves at the Kaesong Industrial Complex (Nam, pg 83). The labor-intensive light industries mentioned above are on the decline in the South due to high labor costs (Nam, pg 83). Ideally, North Korea would become a low cost country (LCC) for South Korea that is closer and more familiar in terms of base culture and language, especially relative to China.

North Korea's Rationale

Like China's "free market with Chinese characteristics" concept, North Korea adopted an earlier China strategy from 1984 in facing encroaching globalization--the "one center and two basic points" strategy. Understanding this strategy clarifies the constraints the Kim regime has placed on itself in its development process. The strategy's general intended effect is to open up to globalization's flows in only limited areas, while blocking any unwanted outside influence on the regime. Basically, North Korea hopes to have its own little zoo of globalization's animals, contained and controlled in cages for everyone to see but which the majority of its own people would never experience. In this way, Pyongyang has set four basic requirements:

1. Developed areas must be far away from Pyongyang and must not be located close to any military bases.
2. Any developed area must be a coastal city with a port nearby which can serve as a gateway for international trade.
3. The developed area must be equipped with industrial infrastructure.
4. The developed area must have an easy access to a labor force.

In the below PowerPoint file, Table 2 describes the five districts that could potentially fit within these criteria, in addition to each district's assessment. Table 1 describes Kaesong benefits and Table 3 illustrates Kaesong's construction costs.

Download Kaesong_Tables.ppt

The division is based on the status of the respective cities’social overhead capital (SOC), access to the outside and the possibility of the North Korean authorities’ support (Nam, pg 80). Other factors may shape some of these results, such as geography, but this provides a sense of investment potential (Nam, pg 80).

Key Questions:

• How does the leading investment firm, Hyundai, reconcile its romantic vision of North Korea's development and the realities of doing business on the ground?
• Can the desired level of economic flows into and from Kaesong survive the isolation from political flows demanded by the North Korean regime?
• Once established inside North Korea, will globalization's animals be too unruly for the North Korean regime to manage? 

Administrative Notes

I have made a few changes in the sidebar:

- Some new blogs have been added under Favorite NEA Blogs: Korea Liberator, Silicon Hutong, Asia Business Intelligence, and China Law Blog. Please take a look at each one--they all offer unique and insightful content.

- I have added a category, "Case Studies," which will provide a more in-depth focus on certain subjects versus the usual article driven posts. The first case study is regarding "Kaesong." Parts I-III are already posted.

- Bill Roggio of The Fourth Rail has moved to the new Counterterrorism Blog. The blog is now posted under General Blog Favorites.

More to come on Kaesong soon!

Kaesong Industrial Complex Part III: Summary of Economic, Political, Security and People Flows at Inception

A Case Study on Globalization's Reach into North Korea

In order to see how the context surrounding Kaesong's development has changed in the wake of world shaping events such as 9/11 in 2001, the subsequent "War on Terror" across the Gap, and North Korea's admitted nuclear programs, it is necessary to first benchmark the regional environment at the time of the industrial complex's inception.

Economic Flows

There were several interesting economic statistics by the end of 2000 regarding flows to and from North Korea via the rest of Northeast Asia. Here are some of the highlights:

• Total volume of inter-Korean trade stood at $425.15 million, an increase of $90 million from 1999
• That volume accounted for 0.6% of South Korea's total trade
• That volume accounted for 22.5% of North Korea's total trade
• Trade surplus for North Korea with South Korea was around $50m in 2000 (excluding aid and development projects)
• Processing-on-commission trade accounted for 53.5% of total trade between North and South
• Processing-on-commission trade involved almost 140 companies
• Interest by South Korean firms centered on Mt. Kumgang tourism and manufacture of textiles, footwear and electronics

Political Flows

The Kim Dae-jung government had adopted the "Sunshine Policy" of engagement toward the North and promoted its vision of building a national economic community through active inter-Korean economic cooperation. This engagement had begun with the June 15 Joint Declaration, which envisioned the balanced development of the North and the South. Shortly thereafter, Kim was graced by the presence of US Secretary of State Madeleine Albright. However, even at the time of this wave of diplomacy, North Korea was sticking to its militant antiforeign, anticapitalist values and ideas, which had guided its external policy since its founding (Eliot Kang, pg 282).

Obviously, at this time, political relations remained strongest with China despite the fact that the strong economic and people flows across China's borders had already started to gradually pull its political positioning further away from the often belligerant and irrational political positions of North Korea. Essentially, North Korea has been in constant conflict with itself in order survive in an ever interdependent world while trying to uphold the juche philosophy espoused by its leadership (Eliot Kang, pg 295).

Security Flows

More than any other Northeast Asian power, North Korea is confronted with the geographical reality of a security complex that defines the region more than does anything else (Eliot Kang, pg 281). Along with South Korea, North Korea occupies a geopolitical space that is the pivot of Northeast Asian security, creating the most important strategic nexus of the Asia-Pacific, where four of the greatest powers in the world system--the United States, Japan, China and Russia--meet and interact (Eliot Kang, pg 283). The fact is that the Korean peninsula is now the most militarized geographical space in the world (Eliot Kang, pg 283).

An in-depth look at the opposing security forces in the region can be found here for the United States and South Korea and here for North Korea. Basically, security flows stop at North Korean borders--with an unknown number of exchanges with perhaps China and Russia. In 2000, North Korea signed with Russia a renegotiated friendship treaty, though without the provisions for ideological solidarity and security guarantees; China had remained a security guarantor of North Korea, but not to the level of the South Korea-US relationship (Eliot Kang, pg 285-286).

Notice the map at the left illustrates the Kaesong region as an avenue for military approaches into South Korea. (In regards to private sector logistics, the best rule-of-thumb in Gap states is to follow local or regional military logistics routes when possible--they usually will have already scouted out the best avenues and areas for building a fledgling supply chain).

People Flows

In early 2001, people flows across North Korea's borders from the rest of Northeast Asia were still insignificant, and mostly limited to Chinese tourists. When these flows did occur, the stories were often of Kim Jong-Il and his train rides to China or North Koreans escaping from its living conditions to find asylum through embassy break-ins. The Aquariums of Pyongyang is a book that illustrates the underground nature and difficulties of this process. Needless to say, there had never been many people who desired to get into North Korea. Around this time however, South Korea had begun to organize tours to Mt. Kumgang with the cooperation of North Korea (as mentioned in economic flows) and allow strictly controlled family meetings.

Kaesong Industrial Complex Part II: The Predecessors

A Case Study on Globalization's Reach into North Korea

It is no secret that China is in many ways the envy of North Korea. China has been able to successfully maintain its communist leadership (so far) while overseeing a burgeoning economy driven by its several, rapidly growing special economic zones. These zones are quite strategically positioned on the east coast, where sea ports have been the mouths of trade for centuries. Combined with the new infrastructure of airports, highways and railways, China has built enough momentum to aggressively cultivate FDI that will further aid in "filling and shrinking the many gaps" that still exist in its heartlands. Its lagging and yet accelerating political reform flows aid this progress. People flows are encouraged in the forms of talent immigration and tourism. Security flows are managed so as to not disrupt the other three flows. In the least, China seems currently satisfied with the status quo on Taiwan (fortunately) and North Korea (unfortunately), if not perhaps illustrating a more diplomatic assertiveness towards a regional security framework through more open cooperative exchanges,in particular with the USA.

Along with the change in China's behavior and fortunes, Kim Jong-Il's trips to China have also changed in terms of itinerary, with the special economic zones becoming priority visits. During a secret visit January 15 of 2001, Kim opted for four days in the Shanghai-Pudong area versus the usually obligatory trip to Beijing. The objects of Kim's attention at this time focused on the symbols of a modernized economy--the Stock Exchange, IT facilities, the Japanese firm NEC, as well as General Motors (Nam, pg 69).

Rajin-Songbong Economic Zone Failures

But the Kim Family's dream of following China's path began much earlier during the 1980's and continued through the 1990's with the Rajin-Songbong Economic Zone projects. These were ultimately failures, but their story provides an indication of how North Korea's thought process has changed since its past mistakes.

Rajin-Songbong was the first location where a specific strategy was applied based on an effort to try and replicate the Chinese model (see map for comparison of location with Kaesong--Rajin is labeled as Najin). The year was 1984, and North Korea initiated the effort by passing joint-venture legislation to attract the necessary FDI in the form of financial capital and advanced technology (Nam, pg 75). To get a sense of the speed of this reform, the Rajin-Songbong area wasn't designated a special economic zone until December 1991. The rational for developing this area was geographically centered, with North Korea marketing the area's natural resources and its logistics potential as a land-sea link bordering Russia, China and Mongolia while facing Japan across the East Sea. On paper this seamed like the ideal location and, at the time, Kim Il-sung invested himself heavily politically by publicly displaying his confidence in exchanges with Cuban and Russian media (Nam, pg 76). His quote at the time reflected this confidence, "The area has already stirred foreign investors’great interest due to its economic potential and favorable location and many countries desire to make investments (Nam, pg 76)."

As the project drove forward, North Korea made an effort to modify the area's business practices so as to mimic a free market system. As such, Rajin-Songbong displayed all the characteristics of the Chinese model in terms of political flows in the form of legislation (Nam, pg 76). However, the desired level of parallel economic flows--FDI--never came to fruition.

Despite foreign companies accepting the extremely high risk of investment, which included that by firms in China, Hong Kong, and Japan, only 10 percent of the $800m in contracts was followed through on--approximately $88m (Nam, 76). What were these firms investing in exactly? The balance of investment was heavily skewed towards infrastructure and service sectors--communications, hotel, transportation, construction and tourism. Investment in actual goods production was limited to a mere 4 percent by 1997 (Nam, pg 77).

Trying to shore up support, North Korea held more than 30 events to lure investors from more than 10 countries, including an investment forum in the Rajin-Songbong Economic Zone itself. As a foundation, the North Korean government sent personnel overseas to be educated on capitalist economic management methods, but these efforts never succeeded in instilling investor confidence as hoped (Nam, pg 77).

Primary Constraints Against Success

North Korea may share in essence China's communist roots, but it is hardly a mini-China and the constraints against success are different, requiring a customized approach. First of all, the legal framework that regulated the flows of FDI capital fell short of expectations held by prospective foreign investors. Perhaps this was caused by North Korea's misguided pride at the highest levels, driving it to be overly optimistic about its attractiveness as an investment location. Combined with an assortment of distracting political obstacles and the passive and rigid attitudes of the North Korean workforce, barriers to entry are significant (Nam, 77). Another layer includes the lack of a consumer market and the poor infrastructure in transportation and communications, ensuring costs will far exceed benefits of any investment. From a supply chain logistics perspective, adding a North Korean hub to any supply chain would throw it out of wack under these conditions, raising the total cost of any goods or services provided to customers.

Key Question: How is a country with a small land area, scarce resources, a 55 year-old autocratic system of government, poor infrastructure, and uncompetitive labor force going to convince supply chain professionals, who would be responsible for the assessment of North Korea as a supply chain hub or node, to include it in a regional or global network of operations?

Kaesong Industrial Complex Part I: Introduction

A Case Study on Globalization's Reach into North Korea

Since the beginning of this year, I have been collecting information on the Kaesong Industrial Complex, which lies just across the North Korean border from South Korea near the city of Panmunjom (see map). The park is an economic experiment between the two Koreas, initiated first as an idea around 2000 during the presidency of Kim Dae-Jung, the founder of the infamous "Sunshine Policy" towards North Korea.

My primary curiosity in Kaesong began when I became interested in the role of supply chain logistics in "shrinking the Gap," a subject I have admittedly been drum-beating on a regular basis but which to me is an exciting area for discussion. In terms of the phenomenon itself, the subject is not new. But the purposeful and conscious application of supply chain logistics in the areas of economic development in post-conflict/post-disaster scenarios, combined with its parallel application in terms of political, security and people flows seems relatively unchartered. I base this on having been educated by three of the top supply chain professors in the United States--Dr. David Closs (Michigan State), Dr. Don Bowersox (Michigan State), and Dr. Joe Cavinato (Thunderbird). If anywhere, this type of conscious application is occuring most inside America's military institutions and in the private sector by the world's top logistics-capable firms.

But these activities are somewhat siloed in the sense that the private sector will do its best covering economic flows and the military its best handling security flows. Coordination arrives ad hoc to cover the delivery of humanitarian aid (where public and private sector seem to be increasingly in convergence), while political flows are seen as a separate responsibility for governments to handle, and people flows managed by a bureacracy of non-standardized, governmental processes.

Thus, especially in today's underdeveloped countries (the "Gap"), there are significant lag times across the four flows depending on their context. Even where sequencing of flows and their stages of progress is necessary, in the above siloed phenomenon, there is no integrating system to manage what sequence is best, at what timing, and in what location. This type of scenario is a set-up for setbacks, repeated mistakes and high probabilities of failure--all in all leading to a prolonged state of underdevelopment. That is of course assuming there are any connectivity flows at all! As we see in the case of North Korea, it is a country seeing very little of the four flows of connectivity (i.e. globalization), and at very low quality levels when it does.

And yet, there is this seeming anamoly of Kaesong.

My purpose for this case study is to deeply explore the Kaesong project utilizing the FAR Matrix. This will involve analyzing Kaesong's current status in terms of economic, political, security and people flows and dissecting each flow by supply chain architecture: physical, financial, informational, relational and innovational. Finally, based on this analysis, I believe we can come to some conclusion on whether the project is currently successful as a "Gap shrinker," and speculate on its future.

This will be a somewhat ambitious and tedious task, but a useful and interesting process nonetheless.

NOTES: All sources, unless linked in text, will be listed at the end of the case study for further reference. 

More on 'Development in a Box' (UPDATED)

The great discussion continues!

Enterra's Steve DeAngelis of the Enterprise Resilience Management Blog responds to my post on applying the FAR matrix I recently created, and its application to 'Development in a Box.' It is a flattering post for me personally, and Steve helps illustrate where my thinking is in alignment with that of his own. I particularly like this statement:

This kind of open, flexible discussion draws on multiple viewpoints and resources -- and in so doing, creates its own form of resilience.

I actually have a series of posts up my sleeve that I will be rolling out this weekend to provide a more thorough application of the FAR matrix than the Japan immigration example. It is a full fledge case study on an 'entity' in Asia that I have seen in only 'under-the-radar' reporting in the Western world, and in some more regular reporting in the Asia press. My goal is to make the concept of 'Development in a Box' more tangible for those curious about its practical applications. I look forward to input from the Enterra team when possible as well as any others with constructive insights.

Since I am going on vacation to Shanghai, Beijing, Nanjing and Jiangyin from April 28 to May 7, I will have the entire case study completed for consumption prior to leaving.

Have a great weekend!

More on China M&A Activity

The China Law Blog has a nice post on a recent OECD report regarding FDI in China. The timing of this post is interesting as I was just chatting with friends over dinner here in Tokyo last night about FDI in China, venture capital markets in Japan and China, and in general the climate for M&A transactions. Here is an excerpt of the post:

The report specifically calls on China to do the following to improve M&A:

• Streamline the approval process for cross-border M&A and make it more transparent;
• Put in place a sound competition framework;
• Further open its capital markets to foreign investors;
• Encourage its firms to increase corporate transparency and provide more up to date and accurate financial information to make it easier to value a potential acquisition, especially regarding a firm’s liabilities;
• Relax foreign ownership restrictions. In particular, revise existing catalogues that list the type of firms that can or cannot be acquired by foreign investors.

The report also recommends China pilot test these recommendations in the North-East of the country before rolling them out nationwide. The report states that this region, China’s historical industrial heartland, has a high concentration of state-owned firms in need of restructuring and technological upgrading, as well as high unemployment and low productivity and cross-border M&A could help rejuvenate the region’s economy.

Read the entire post, and check out the rest of China Law Blog. It provides a lot of insight.

Caterpillar Leadership Comments on US-China Relations

The below letter was in this week's Wall Street Journal. Since I have posted about Caterpillar's strategy in China before, this letter might provide readers some additional insight:

Caterpillar's Position On U.S.-China Relations

On April 17, The Wall Street Journal published an editorial-page commentary under my name entitled "Embrace Globalism." Most of the content was taken from a speech I gave at a National Association of Manufacturers' (NAM) event on March 22 in Chicago. The full text of the speech can be found on NAM's Web site (www.nam.org/owensspeech). While I was pleased to see Caterpillar's endorsement of globalism on your editorial page, I was disappointed in how it was edited by your staff and printed without my review.

On the positive side, the piece did accurately portray my opinions regarding the merits of free trade and the need for U.S. manufacturers and policymakers to reject protectionism in our global economy. However, the tone of this edit came across as self-serving regarding Caterpillar's success. We are encountering many of the same challenges as other U.S. companies and recognize that some industries face difficult transitions as they move toward global competitiveness.

In my March speech I outlined the steps manufacturers could take themselves to enhance competitiveness. I also called on our government to address critical issues that impact U.S. manufacturers' ability to compete globally. These suggestions come from The President's Manufacturing Council on which I serve. This group has identified priorities (in addition to trade) for improving American competitiveness:

• tax reform to level the playing field for U.S. companies;

• an energy policy to assure availability and international price competitiveness;

• tort reform and other initiatives to bring health-care-related costs in-line with competitive international levels;

• aggressive R&D tax credits and additional workforce development initiatives to encourage American innovation.

There is also a need for thoughtful government support when one of our industries is not competitive in the global economy. In these cases we need to do a better job of helping workers and communities retrain and retool for the future.

In the March speech Caterpillar strongly championed the need for U.S. engagement with China. Both countries have much to gain from keeping relations positive and constructive. I suggested engagement is a two-way street and encouraged China to make major changes as it takes its place in the global economy -- including better enforcement of intellectual property protection, continued commitment to fair currency valuation, more transparent institutions and greater reliance on market-based principles. These thoughts, which are at the heart of Caterpillar's position on U.S.-China relations, were not included in the April 17 editorial-page piece.

On behalf of Caterpillar, I was complimented that The Wall Street Journal chose to publish an article reflecting our thoughts on the merits of free trade and globalism. I hope this letter helps to clarify and amplify my -- and Caterpillar's -- position.

Jim Owens
Chairman & CEO
Caterpillar Inc.
Peoria, Ill.