Archive for the ‘Daesong Market’ Category

The Political Economy of Chinese Investment in North Korea

Wednesday, November 1st, 2006

Asian Survey
November/December 2006, Vol. 46, No. 6, Pages 898-916
Jae Cheol Kim
Professor of International Studies at the Catholic University of Korea, Seoul.

PDF here: chinainDPRK.pdf

China’s investment efforts suggest that it has begun to engage North Korea economically. By investing, the Chinese leadership has attempted to push the North to embrace economic reforms, which in turn could improve the North Korean economy and reduce the country’s potential for political instability. In order to lead the North to embark on reform policies, Beijing has tried to provide it with seed money and technology by encouraging Chinese companies to invest. This suggests that despite expectations and allegations from the West that China might abandon its long-time ally, China is committed to supporting North Korea.

The Chinese investment, however, has increasingly been influenced by commercial considerations. Officials in Beijing have stressed that economic exchanges with the North must be mutually beneficial. Chinese companies, which have become responsible for the majority of the investment, have paid increasing attention to market share and natural resources. That China has increasingly tried to gain economic advantage in the North suggests that Sino-North Korean relations are being transformed from being ideology-motivated to interestmotivated.

Despite a stiff increase over the past couple of years, it is hard to say that Chinese investment is either full-fledged or irreversible. Because the instability of North Korea prevents Chinese entrepreneurs from fully embracing the country, Chinese investment must be seen as a pilot project, with Chinese companies and entrepreneurs testing the water. Looking to the future, Chinese investment in North Korea is likely to increase. Despite problems, the Chinese leadership will probably continue to encourage further investment in an effort to exploit developmental opportunities while simultaneously curtailing the flow of direct aid to the North. In addition, China’s dynamic economic growth will propel its overseas investment. As China’s capital account is gradually liberalized, cash-rich Chinese companies will look for markets and resources abroad to fuel their development. The potential appreciation of the yuan will further force firms to relocate factories producing low-end products to countries where the labor cost is lower. Seen from this perspective, North Korea is a good candidate for future Chinese investment—if there is no major turbulence in bilateral relations.

North Korea has been reluctant to follow China’s path of reform and opening because it worried that the policy may create political problems. In an apparent response to China’s recommendation in the late 1990s for reform, for instance, Kim asked Beijing to respect “Korean-style socialism.” But China’s support for reform is not unconditional. Although Chinese leaders have repeatedly urged the DPRK to embrace market-driven reforms (even taking Kim Jong Il is on tours to see the results of China’s economic reforms), when North Korea decided to set up a special economic zone in Sinuiju, apparently without prior consultation with Beijing, China aborted the project by arresting Yang Bin, whom North Korea had designated head of the zone, in October 2002.

China, however, does not want to see turbulence on the Korean Peninsula, which could not only lead to the economic and political collapse of a socialist regime on China’s border but could also threaten regional stability. China thus has tried to sustain the Pyongyang regime by providing economic assistance–believing that reform and opening would not only revive the North Korean economy but also reduce the need for regular aid to prop up the regime, Chinese Premier Wen Jiabao said that the Chinese government would encourage more of its companies to invest and establish their businesses in North Korea.

For Chinese firms, the prime minister’s statement amounted to a government directive, with some entrepreneurs understanding that Wen’s statement was a signal for Chinese companies to invest.  Organizations were formed to smooth such investment, including the Shenyang Municipal Association of Entrepreneurs (Shenyangshi Qiyejia Xiehui), Dandong Municipal Economic Consultation Center for the Korean Peninsula (Dandongshi Chaoxianbandao Jingji Zixun Zhongxin), and Beijing Sino-Korea Economic & Cultural Exchange Company (Beijing Chaohua Youlian). They organized explanatory meetings on investment, drawing numerous applicants.

Beijing attempted to boost investors’ confidence by signing an “Investment Encouragement and Protection Agreement” with Pyongyang in March 2005 when Premier Park Bongju visited Beijing. The framework for economic and technological cooperation was made clearer through the signing of an “Agreement on Economic and Technological Cooperation” that October. Chinese officials have given financial incentives and guarantees to firms that invest in North Korea. China’s state-run banks have not only provided companies with investment capital but also have underwritten Chinese investment for joint ventures. Beijing granted preferential treatment to products processed in the North, allowing them better access to the Chinese market. Products that were processed in the Rajin area with Chinese materials and then imported to China, for instance, were labeled domestic trade and were thus exempted from customs inspection.

The deputy CEO of Beijing Sino-Korea Economic & Cultural Exchange Company, a Beijing company that helps Chinese companies invest in the North, has been quoted as saying that whether a company is able to invest in North Korea depended not on the company’s will but on whether the North would accept it or not. Foreign investors, he added, needed to meet the criterion of “political reliability.” In practice, concerns about political contamination limit North Korea’s economic cooperation with South Korea, whose government has eagerly pushed economic integration with the North. North Korea’s opening therefore means an opening toward China, and this in turn gives Chinese companies very rare advantages.

Labor costs in the DPRK are low [compared to China], running only 70–80 yuan (about US$10) per month.  Building a factory is very cheap, up to one million yuan (about $120,000).  Chinese entrepreneurs see that what North Korea needs is largely light industrial products. Because brand consciousness there is weak, these investors believe that many Chinese companies, even small- and medium-sized ones, can compete in the North Korean market.  The scope for making profits is bigger in North Korea than in China because manufacturers can charge more for similar products in the North. For example, the price of a cigarette lighter is three to five yuan ($0.36 to $0.60) in Pyongyang but only 0.5 yuan ($0.06) in Wenzhou, China.

Although big state-owned companies account for the majority of Chinese outward investments, they rarely invest in North Korea, leaving this to small- to medium-sized companies. In the past, most Chinese investors were Korean-Chinese merchants from two areas in China: Liaoning Province and the Yanbian Korean Autonomous Prefecture. They do not expect that they can make profits in the North Korean market right away; rather, they plan to be ready for when the North opens to the world, by moving into the market early.

Chinese investment projects in North Korea are not only small in number but also weak in scale. There are no detailed data available on their average size, but they likely are no exception to the fact that China’s outward investment is generally characterized by its small scale and low level of technology.

Although North Korea wants capital in such sectors as home appliances, construction materials, electronic communications products, and machine building, Chinese investment is heavily concentrated in the sectors where China’s needs lie, such as resource extraction, or where its companies can make a profit, such as service sectors. The official Chinese guideline for outbound investment, noted above, recommended investment only in such manufacturing sectors as textiles, clothing, and food products, leaving aside other sectors for which North Korea wants investment.

The North lacks basic frameworks needed for drawing in foreign investment. Policies, laws, and regulations about tax, for instance, are not in place. There is no well established market mechanism for running the economy. The government is still heavily involved in economic management; therefore, potential investors need to have personal networks to open doors, a point that worries potential Chinese investors.  North Korea lacks a sound political environment for enticing foreign investment. The country’s economic policies, especially those related to reform, shift continuously, raising questions about the official commitment to reform.

Pyongyang Department Store No. 1
Zeng Changbiao, chief executive officer (CEO) of the Zhongxu Group, in a much publicized deal in 2004, signed a contract to run Pyongyang’s Department Store No.1 for 10 years. He said his main motive for investing was to take over the North Korean market. He wants to be dominant in the North Korean retail business by securing and expanding market share. But it is not clear whether the contract was put into practice.  An article in a journal published by the National Development and Reform Commission, a ministry-level organization of the Chinese government, suggested that little had changed at the department store by the middle of 2005. South Korean officials also say that the store is still run by North Korea. Zhongxu Group’s Zeng received the lowest tax rate—5% income and 5% import—in the North Korean tax system.

This is one of three big department stores that were being run either by the Chinese alone or jointly.  Shenyang Municipal Association for Trade Promotion opened Daesong Market in Pyongyang, the first wholly foreign-owned company in a non-science sector.

China has shown an interest in joint resources development projects. The best known case is the project to develop the Musan iron mines. It is not easy to draw an exact picture of Chinese investment in the mines because many press reports suggest different stories. According to a Korean report, a Chinese company from Jilin Province planned to invest about $500 million in the mines. Ta Kung Pao, a Hong Kong newspaper, reported that three companies from Jilin—Tonghua Iron & Steel Group (Tonggang), Yanbian Tianchi Company, and Sinosteel Corporation (Zhonggang)—contracted rights to exploit the Musan iron mines for 50 years. According to the report, the Chinese companies were going to invest 7 billion yuan (about $865 million) and planned to produce 10 million tons of iron ore each year.  In the case of the Musan mines, 2 billion yuan (about $240 million) out of the 7 billion China committed to invest was allocated to building roads and railways from Musan to Tonghua in China. Sizable investment levels might help Jilin secure access to seaports in North Korea.

Similarly, the Chinese press has reported that the Musan iron mines development project was canceled by officials in North Korea, embarrassed by publicity over the deal because it highlighted the degree of foreign investment, a subject that Pyongyang would prefer to handle quietly.

Rason International Logistics Joint Company-Rason International secured the exclusive rights to run the No. 3 and No. 4 piers of Rajin port for 50 years. In order to secure the rights, China committed to investing 30 million euros ($36 million) to build an industrial park, tourism facilities, and a road from the trade district of Rason city to Rajin Port. North Korea in turn committed to providing China with 5 to 10 square kilometers of land to build the industrial park.