North Korean Economy Watch

Stephen Haggard and Marcus Noland published a piece focusing on North Korea’s economic integration.  Download it here: petersoninstitute.pdf

Although not the focus of the piece, here is an excerpt:

A first corollary of the injunction to avoid top-down approaches is that any collective development assistance must be extended in support of economic reform. Experience throughout the developing world demonstrates that assistance will have only marginal effects and may even have negative consequences if not coupled with policy changes. It is not simply that aid sustains the regime; since aid is fungible, even purely humanitarian aid will have that effect. The problem is that too much aid can delay or even undermine the reform process. Whatever the multilateral mechanism that ultimately emerges, it should encourage reform and economic opening in the North.

A second corollary of the injunction against top-down approaches is the importance of engaging the private sector: through trade, foreign direct investment, private capital flows (including remittances), and sheer expertise. Economic rehabilitation will require investment in social overhead capital, which will be led primarily by the public sector. But if North Korea is to evolve toward a self-sustaining market-oriented economy, private-sector involvement will be crucial. Participation of foreign firms means that projects are subject to the market test of profitability, and it encourages North Korean authorities to think of economic engagement in terms of joint gain rather than as political tribute.

(and)

North Korea is in need of depoliticized technical assistance for a whole panoply of issues running from the mundane but critical, such as developing meaningful national statistical capabilities, through basic agricultural and health technologies, to social infrastructure of a modern economy. This infrastructure includes policy mechanisms to manage macroeconomic policy, including through reform of the central bank; specify property rights and resolve commercial disputes; regulate markets, including financial markets as they emerge; establish and implement international trade and investment policies; and so on.

Read the full paper here:
A Security and Peace Mechanism for Northeast Asia: The Economic Dimension
Staphen Haggard and Marcus Noland
Peterson Institute Policy Brief
April 2008

This new program, co-sponsored by LiNK and the International Republican Institute (IRI), seeks to invest North Korea’s future by teaching former North Korean citizens  leadership and organizational skills so they may bring benefits to the DPRK when the doors are opened.

Fifteen candidates of different ages, genders, and experiences will be selected on the basis of their potential to benefit from the program.

The three week program will be hosted in Seoul where workshops will be conducted by experts and trainers from various countries and backgrounds.  Topics to be covered include: democracy and governance, rule of law, international human rights, comparative movements, comparative politics, business protocol and etiquette, and leadership development.

All applications must be submitted with all components completed by March 31, 2008. If you feel you, or others you know, would be a good candidate for the Chollima Leadership Program, please contact jane (at) linkglobal.org for more information and an application.

Here is a summary on the IRI web page.

Institute for Far Eastern Studies
NK Brief No. 08-3-7-1
3/7/2008
 
North Korea’s latest demand at the Kaesong Industrial Complex (KIC) is a 100 USD per person registration fee for South Korean workers residing in the complex’s dormitories. The North demanded the fee early in 2007 to cover registration and issuance of registration certificates regarding workers visiting or residing in the complex, and negotiations have been underway the entire year.

An unnamed source close to the South Korean government stated, “At the end of January, the North unilaterally decided on the KIC visiting and residing fees, and when they were not complied with [the North] notified [the South] that they would ban entrance” to the complex, however, “despite this, currently entrance into the complex is freely obtainable.”

The North set a 35 USD fee for registering a short-term stay of up to 90 days, and a 100 USD fee for registering a one-year residency, according to the source. A Unification Ministry official acknowledged, “The fee demanded by the North is not exorbitant, but from the perspective of the businesses in the complex, negotiations on reasonable measures were in progress.”

North Korea is making its demands based on the ‘Kaesong Industrial Zone Entrance, Dwelling and Residence Regulation’ enacted in December 2003. According to this regulation, fees must be paid for issuance and reissuance of registration papers when applying for short term stays up to 90 days, long term visits over 90 days, and residency of one year or more. Currently, there are over 800 South Korean employees who would need to pay fees for visiting or residing at KIC.

Yesterday’s post on accountability and South Korean aid to the North got me thinking about game theory again.

The South Korean Ministry of Unification has a dominant strategy to lend/give/invest in North Korea for ostensibly two reasons: 1. If the MoU does not, their raison d’etre goes away.  2. South Korea will ultimately see a payoff if a development strategy works in the DPRK.

Contracting with North Korea, however, is essentially a prisoner’s dilemma (see chart above), and North Korea has the ability to cooperate or defect.  However, the North Koreans have rational expectations, so they know the Ministry of Unification has a dominant strategy to cooperate.

Therefore the Nash equilibrium is for the South to keep cooperating and for the North to keep defecting.  In a repeated game, cooperation evolves over time as trust develops and defection decreases.  Because of South Korea’s dominant strategy,however, the North never has an incentive to cooperate–so we end up with an “anti-folk theorum” where defection is the only incentive compatible outcome over time.

Addendum: The game could be radically different for private investors, however, who are in a more credible position to say “no”–leading to defect/defect moves (because South Korean investors are not as politically constrained and can recognize sunk costs).  These moves result in neither gains nor losses for either side, however, because both sides have the ability to bargain, cooperation that is mutually beneficial can evolve over time as it should.

On February 8, it was announced that the South Korean Ministry of Unification, the agency responsible for official interactions with the North, would not be merged with the Foreign Ministry (full story)–dealing an early policy blow to the newly elected South Korean President’s efforts to reduce the size of the South Korean government.

However, just three days later, on February 11,  the Chosun Ilbo reported that a South Korean government cash donation to North Korea (cash donations are apparently unlawful) has [surprisingly] gone missing:

In March last year South Korea gave US$3.8 million worth of aid, including $400,000 in cash and building materials, to North Korea to build a center for inter-Korean video-link family reunions in Pyongyang. But North Korea has not even started construction on the site, it was known on Sunday.

The donation violated a ban on cash aid to North Korea, but South Korea’s Ministry of Unification said at the time that there would be no room for suspicious dealings because the North agreed to inform the South where the money was spent and the South agreed to visit the construction site to find out whether the money and materials were used properly.

It has been almost a year since the aid was delivered, but it is not clear what the North has done with the cash and building materials. The South Korean government has demanded that it be allowed to visit the construction site, but the North has brushed off the requests, saying it will show the site “next time” or after the center is dedicated.

[and…] 

On eight occasions from early April to late August last year, South Korea delivered to the North building materials such as cement, iron bars, electric cable, tiles, drills, adhesive glue, interior furnishings, elevators, and air-conditioning and heating equipment. It also sent 10 buses and six Rexton SUVs.

When sending the materials, Seoul demanded five times that the North allow South Korean officials to visit the construction site and provide details on where the materials were used. All such demands were rejected. (Chosun Ilbo)

Today, February 14, South Korean military authorities admitted to knowing (since 2003, when the previous Roh Moo-hyun administration was inaugurated), that North Korea has transported rice supplied by the South for humanitarian purposes to front-line units of the Korean People’s Army.

The South Korean military has admitted it found no fewer than 200 South Korean rice sacks transported to North Korean Army units on about 10 occasions to the demilitarized zone including Gangwon Province between 2003 and recently.

This is the first corroboration by the South Korean military of testimony by North Korean refugees that the food aid provided by South Korea is being diverted for military purposes. But despite their knowledge of this fact, neither the South Korean government nor military authorities protested to North Korea or asked it for an explanation, apparently for fear of provoking Pyongyang. (Chosun Ilbo)

Updated: 2/21/2008: North Korea denies it diverted food aid to military. 

Now, I personally favor some kind of engagement policy with the North, but implementing an effective strategy is difficult.  Strict transparency and accountability are absolutely necessary to avoid mismanagement of public funds.  This is admittedly difficult, even in the OECD, much less in a secretive communist state.  Under the current circumstances, however, the North is treating the South like an unwanted lover, and this is not a healthy outcome. 

Handing out public funds with weak- or no-strings attached (as the South has done for years) creates markets in political corruption in the North.  The North Koreans know that the Ministry of Unification has a bureaucratic incentive to spent the money on aid.  If they don’t, it will not be appropriated in the next fiscal cycle.  This is why government budgets almost never go down, and agency heads go on a spending spree just before the fiscal year ends–use it or lose it.  The North Koreans have simply learned how to say the right things, etc., so the Ministry of Unification can check the box and pay up, because they know there will be no consequences when they fail to deliver.

So what is the solution?  If the South Korean government demonstrated some desire to monitor development aid, and reduce it if necessary (say “no” once in a while), they might encourage the North Koreans to do with the money as they claim (at least more so).

Another option available to the South Korean government is to stop using public funds to develop North Korea and instead free the South Korean business community, and other individuals, to take their chances contracting with North Korean entities themselves.  Putting their own Won on the line will definitely encourage private investors and venders to keep an eye on their balance sheets, and will help depoliticize the development of a country with a poor reputation.  

See the gratuitous game theory here.

You can read the referenced articles below:
S.Korea Knew Its Rice Feeds N.Korean Military
Choson Ilbo
2/14/2008

N.Korea May Have Diverted Cash Aid
Chosun Olbo
2/11/2008

Kang: North Korean Trade Potential
Council on Foreign Relations
12/17/2007

Last December, David C. Kang, a professor of government at Dartmouth College and an adjunct professor at Tuck Business School, discussed the North Korean economy for the Council on Foreign Relations. I have excerpted some of his comments below.

His view on the new North-South cargo train service:

It doesn’t have huge economic significance in the overall GDP of North Korea. But it does have major economic significance in the fact that what North Korea had to do in order to let a train go through was an awful lot of adjustment[…]in terms of linking up the railroad, all the ministries had to prepare.  The old [Korean Energy Development Organization] had this problem as well. [W]hen they wanted Americans and South Koreans working in North Korea to build this light-water reactor, [they] had to set up protocols [Post offices, phone calls, where they were going to stay, etc]. It is pretty significant in terms of how much they had to adjust.

He quoted the following figures on North – South trade:

From $200 million in 1998, to now exceeding $1.7 billion in 2007.   South Korea’s total trade volume is $250 billion.

His opinion on the direction of the North Korean economy:

At this point what we’re seeing is very initial steps on the part of North Korea as they try to open up reform and yet maintain control. At the same time, they are being forced into a number of institutional changes and mind-set changes that are the first step forward in this process.

His view of North Korea’s comparative advantage:

Most of the companies that have gone in—the South Korean companies that have gone in—are assembly and light manufactures, such as or textiles and light consumer goods. This is the sort of obvious point of departure. It’s not hugely capital intensive in terms of building factories, and can take advantage of North Korean cheap labor and South Korean technological advantages.

There are a lot of potential mineral resources in North Korea, which would require a whole infrastructure of legal reforms to happen before anyone would take care of them. But at this point the safest bets are the ones that are on the order of assembly and light manufactures in the North and then exporting them out.

His view of South Korea’s long term goals:

If there’s unification, or even better relations, and South Korean companies can use cheap North Korean labor, instead of having to send those factories to China or Vietnam—not only do they speak Korean, they’re culturally similar, and the labor would be cheaper.

[I]f you could reconnect the railroads, from Japan, through Pusan [South Korea], up through North Korea, then out to China and Russia, you would be linking up all these economies in a much more efficient way than they are now. So everybody wants that. But obviously there’s the political problem. And even on the infrastructure side, the North Korean rail system is so old and so decrepit, that basically it would have to be rebuilt from zero. But the potential upsides are massive, in the long run.

His view of China’s engagement:

China has been essentially as deeply involved in economic engagement with North Korea as has South Korea—and by some measures, actually more so. Whereas South Koreans just do this assembling, some Chinese companies are moving in and building full factories in the North. There’s a lot of interest in Chinese-North Korean economic relations on both sides.

Institute for Far Eastern Studies (IFES)
NK Brief No. 08-2-12-1
2/12/2008

South Korean businesses currently involved in inter-Korean economic cooperation are facing many difficulties, both due to and in spite of the system in place, so that at the moment, investment in North Korea does not look much more appealing than in Vietnam or China.

The Korea Chamber of Commerce carried out a survey, titled “Business Perspective on the Direction of South-North Economic Cooperation Policy”, targeting 300 successful businesses (170 companies responded) and 200 companies currently involved in inter-Korean economic cooperation (132 companies responded). According to the results of the survey, 79.4 percent of companies involved in inter-Korean cooperation responded that they are “currently facing systemic and procedural difficulties.”

More specifically, 44.7 percent pointed to the “3-C” (commute, communication, and customs) issues, 22.4 percent pointed to “claim resolution procedures,” 14.3 percent highlighted “difficulties with financial transactions,” 11.8 percent chose the “ban on the import of strategic materials,” and 5 percent indicated that “limited markets” were the main issue.

In addition, 58 percent of responding companies noted issues not related to the system set up for inter-Korean cooperation. 36.6 percent pointed to difficulties resulting from the “lack of understanding of market economics,” 28.7 percent noted a “lack of supervision by managers,” 24.8 percent chose “uncooperative, highly tense attitudes,” and 8.9 percent pointed out “demands for quick production.”

When asked about the relative attractiveness of investment in North Korea if the current situation were maintained, as compared to Vietnam and China, only 27 percent responded, “more attractive”, while 53.7 percent, or twice as many companies, responded that investment was “impossible.”

However, 58 percent responded that, in the event the North’s nuclear issues were resolved, investment in North Korea would be “more attractive than China and Vietnam”, while only 21.7 percent responded that investment in the North would still be “impossible.”

The overall impression of these companies regarding inter-Korean cooperation is that “improvement of inter-Korean relations offers opportunities for new enterprises and is a positive influence on the South Korean economy” (65.3 percent), and 19 percent felt that cooperation would “in the future, serve as a springboard for the relaunch of the South Korean economy.” 15.7 percent of responding companies felt, however, that “there would be no substantial positive influence on the economy.”

Currently, a resolution to the North Korean nuclear issues is the most important factor, but it is imperative that pledges of the incoming ROK administration such as strengthening investment security, preparing claim resolution measures and other issues to placate business interests, and nurturing North Korean exporters, are institutionalized.

Writing today for the Asia Times, Sunny Lee gives an update on the North Korean-run restaurants in China and South East Asia.  Much has already been published on these restaurants: how they channel money back to North Korea and how the waitresses tend to defect.  (As mentioned in the Kaesong post yesterday, they probably also pay hefty bribes for their overseas posts and have well-connected relatives.)

Sunny Lee points out that these restaurants (see YouTube video here) are now diversifying their product lines to boost profits, and like other successful capitalists across Asia, they are doing it by leveraging their most unique asset–attractive North Korean women.  How?  By transforming into karaoke bars after dinner hours.

North Korea has some 100 restaurants overseas, mostly in China and Southeast Asia, including Laos, Vietnam and Cambodia. These restaurants serve as an important revenue pipeline for earning foreign currencies for Pyongyang. Each overseas North Korean restaurant is said to be allotted a revenue quota to fill, ranging from US$100,000 to $300,000 a year to send to Pyongyang, which makes the total revenue estimation some tens of millions of dollars.

The business formula – restaurant by day and karaoke bar by night – is also seen as an effort for these restaurants to meet the assigned financial quota. Currently, there are scores of North Korean restaurants in China, including in cities such as Beijing, Tianjin, Tsingdao, Dandong and Yanji. Beijing has 11 North Korean restaurants. All of these employ North Koreans whose total employment number in China is estimated to be several hundred. (Asia Times)

Despite the higher cost, business is brisk…

The reason that North Korean restaurants are expensive yet remain popular among customers is their immaculate service from beautiful employees. In China, where service quality at restaurants is often unsatisfactory, North Korean restaurants are becoming a favorite alternative among members of the businesses community. (Asia Times)

However, if you want to enjoy an authentic North Korean dining experience but have moral qualms about supporting the regime, then you can patronize similar resturants managed by North Korean defectors in South Korea–though the experience is quite different.  Whereas the Chinese pay extra for premium restaurant service in Beijing, the South Koreans pay for the genuine socialist restaurant experience.  In other words, they pay to be treated like an annoyance to the staff.

[At the Pyongyang Moran Bar (located in South Korea), the] North Korean waitresses wore traditional dresses in the bright colors that were fashionable in the South some years back. The singer’s interpretation of “Whistle,” a North Korean standard of the 1980’s, was shaky and off-key. Service was bad and included at least one mild threat. Drinks were spilled, beer bottles left unopened and unpoured.

But the South Korean customers could not get enough of the Pyongyang Moran Bar. (New York Times)

So you have your choice of North Korean themed restaurants:  The propaganda ideal or the  socialist reality.

The full articles can be found here:
Chillin’ at a North Korean karaoke bar
Asia Times
Sunny Lee
2/8/2008

In Deep South, North Koreans Find a Hot Market
New York Times
Norimitsu Onishi
5/25/2006

Yesterday the Jong Ang Daily reported that Hyundai Asan hopes to draw more tourists to the DPRK this fall, but their forecasting record is not exactly stellar:

The number of tourists to Mount Kumgang tallied 350,000 last year. The North Korean tour unit of Hyundai Asan hopes to pull the number of visitors up to 430,000 this year, 10,000 of whom would head to Kaesong, which began tours in December, and 15,000 of whom would visit Mount Paektu, with tours slated to start in May.

Hyundai Asan had marked annual losses from 1999 until it made profits in 2005. Its 2007 profits totaled 10 billion won.

Today, Andrei Lankov, writing in the Asia Times, chimes in on his experiences with the new Kaesong Tour and gives a rationale for western participation in such activities:

The Kaesong tour is the first project which gives the average South Korean, Mr Kim or Ms Pak, an opportunity to see a semblance of North Korean life. Hitherto, only a handful of South Koreans, most of them government officials, have been able to visit North Korean cities. Now, for the first time in 60-odd years, a very limited opportunity is open for an anybody who is willing to pay a fee.

Of course, North Korean authorities went to extraordinary lengths to prevent any interaction between locals and visitors. The list of prohibited items is quite impressive. Tourists cannot take any kind of printed material, computers and computer equipment, mobile phones, radios and video cameras, universal serial bus and other memory devices. The old film cameras are banned as well. Only digital cameras are allowed into the North, since at the border check point North Korean police officials check every single picture taken by every single tourist.

Despit the limitations, Lankov still feels that these types of exchanges are ultimately worthwhile…

The extraordinary security measures undertaken by the North Korean authorities ensure that only a very limited number of northerners are allowed to approach the visitors. Nonetheless, the tours are a major event.

Every single day, a small city is invaded by an impressive motorcade: 10 large imposing buses, half a dozen jeeps and other vehicles – incidentally, produced in South Korea. The preparations are thorough and, one might suspect, seriously disrupt the city’s routine. The North Koreans can see, albeit from the distance, the visitors – their dress, their height, their behavior. The South Koreans can immediately see how poor the North is. It seems that North Koreans, being necessarily street-smart, also instantly feel the South Korean prosperity.

The waitresses, girls in small stalls and even a handful of genuine guides (not the plaincloth intelligence operatives) who can see the visitors will also notice a lot. Even the willingness of the guests to spend a dollar on a cup of instant coffee or a few cookies is an important sign to them – after all, the average monthly salary in Kaesong is about $4. Those South Korean guests definitely do not look like impoverished victims of evil US imperialism. For a while it will be possible to explain away their extravagant behavior by insisting that those people come from the exploitive elite. But the longer the tours continue, the more difficult the task will become.

So why did the North decide to open Kaesong in the first place? It seems that the major reason is the easy currency income the project brings to Pyongyang. Every visitor pays 180,000 won ($190) – a hefty sum for a one-day bus trip. Out of this amount, 100,000 won goes to the North Korean authorities. All investment into necessary infrastructure is done by Hyundai Asan, so for the North this is easy money. Since 17,000 visitors joined the tours during the first two months of its operations, annual earnings could be in excess of $10 million.

At the same time, they might believe that the Kaesong area has become ideologically contaminated anyway. The Kaesong industrial park is located just a few kilometers from the city. In this facility, some 15,000 North Korean workers are employed in factories owned and run by South Korean capital, largely small businesses which are in desperate need of “cheap labor”.

These workers interact with South Koreans regularly, and they also see life inside the industrial park, which presents a remarkable contrast with their native towns or villages: well-paved roads, trees planted everywhere, modern buildings and round-the-clock supply of water and electricity. Even traffic lights, famously absent from North Korea, are present in this de-facto South Korean enclave.

So why did the North decide to open Kaesong in the first place? It seems that the major reason is the easy currency income the project brings to Pyongyang. Every visitor pays 180,000 won ($190) – a hefty sum for a one-day bus trip. Out of this amount, 100,000 won goes to the North Korean authorities. All investment into necessary infrastructure is done by Hyundai Asan, so for the North this is easy money. Since 17,000 visitors joined the tours during the first two months of its operations, annual earnings could be in excess of $10 million.

The only way to promote change, evolutionary or revolutionary, is to bring North Koreans into contact with the outside world. The North Korean dictator and his elite might see partial exchanges as an easy way to earn money, which is necessary for them to maintain their caviar and cognac lifestyle. In the short term they are probably right. But in the long term, the exchanges will make breaches in the once monolith wall of information blockade. Sooner or later, those breaches will become decisive.

The full articles can be found here:
Tourism boost to North in works
Joong ang Daily
Moon So-young
2/6/2008

A breach in North Korea’s iron curtain
Asia Times
Andrei Lankov
2/7/2008

Yonhap (Jan 7, 2008) reports that newly elected South Korean president Lee Myung-bak will revisit the agreement struck between former President Roh and Chairman Kim Jong il last fall.

(excerpt) Projects under review will be the construction of a shipyard complex and its infrastructure in [Haeju] North Korea, along with the establishment of a “peace zone” along the disputed [Northern Line Limit] border in the West Sea, the site of deadly naval clashes between the two Koreas in 1999 and 2002.

“Humanitarian projects, such as the reunion of family members living separately in the two Koreas, and rice and fertilizer aid can be continuously pushed for, but economic cooperation projects should be carried out in parallel with the pace of North Korea nuclear talks,” a key member of the team was quoted as saying at the briefing.

——

Projects in the North are not the only things potentially headed for the chopping block–so it seems is the South Korean Ministry of Unification itself, which could potentially be merged with the South Korean Foreign Ministry. 

The incoming president, however, did suggest a carrot to go with his sticks.  Yonhap reported on January 4 that the new administration plans to launch a USD$40 million fund to promote economic growth in North Korea. 

(excerpt from Yonhap) The planned fund is in line with Lee’s ambitious plan to help increase the impoverished North’s per capita income to $3,000 within a decade if it makes the bold decision to abandon its nuclear program and open its market, said the team’s spokesman Lee Dong-gwan. There are no accurate data on the reclusive nation’s economy but some estimates put its per capita income at around $1,300.