North Korea has expelled most of the South Korean managers from a joint industrial park on the border which has been a key symbol of reconciliation.
The Kaesong industrial park employs 23,000 North Koreans
South Korea's unification ministry said 11 of the 13 managers at the Kaesong complex had been pulled out.
Production will go on at the 70-factory zone, just north of the border.
No reason was given for the expulsion, but it came after Seoul said it would link progress at the park with progress on the North's denuclearisation effort.
The US and South Korea earlier warned Pyongyang that time was running out for it to declare the full extent of its nuclear capabilities.
For the past four years, the Kaesong industrial park has been matching cheap North Korean labour with South Korean capital and management expertise.
It was set up under the so-called "sunshine policy", whereby previous South Korean governments tried to win concessions through engagement with the North.
Kaesong, just north of the demilitarised zone between the rival states, employs more than 23,000 North Koreans and hundreds of South Korean managers and technicians.
But now South Korea has a new conservative government, led by President Lee Myung-bak, which has demanded more in return for the aid and assistance provided to its communist neighbour.
The South's unification minister, Kim Ha-joong, said last week that the expansion of the complex was dependent on progress towards North Korea's denuclearisation.
The BBC's John Sudworth, in Seoul, says it would seem to be in reaction to this comment that North Korea has demanded the withdrawal of the government officials from Kaesong.
But despite this latest setback to the spirit of co-operation, production will continue, he adds.
The South Korean unification ministry expressed its "deep regret" at the expulsions and urged Pyongyang to normalise economic exchanges as soon as possible.