North Korea’s growing economic ties with China

Posted in Koreas | 06-Apr-06 | Author: Erik Mobrand

North Korean refugees try to enter the compound of the Canadian Embassy in Beijing to be transfered to South Korea.
North Korean refugees try to enter the compound of the Canadian Embassy in Beijing to be transfered to South Korea.
North Korea remains one of the stickiest security issues in East Asia. Diplomacy appears to have gone nowhere in resolving questions about North Korea’s nuclear program. The six-party talks on the North Korean nuclear problem have again run into a snag, if they ever were meaningful. The United States continues to refuse to sit down and talk seriously with North Korea.

However, changes are underway in North Korea. In March, foreign journalists were invited to the Kaesong Industrial Park, where South Korean firms have been operating since last year. In January, Kim Jong Il made a trip through China, visiting sites of capitalist success.

Is North Korea reforming? Is the secretive socialist state opening to the world? What would that mean for international security?

One of the few clear trends in North Korea is her rising trade with China. Even though trade is not a traditional security concern, the topic is worthy of consideration because it has received too little attention and because this development could have implications for security in North East Asia. While many observers of North Korea speculate on what Kim Jong Il may be doing, taking a look at some trends beyond the “Dear Leader” can offer a firmer basis for sketching out the direction that country is moving.

North Korea’s foreign trade

The North Korean economy runs at around US $18 billion, with less than $3 billion in foreign trade per year. North Korea’s biggest trading partner is China, with South Korea in a close second. In 2005, trade between North Korea and China surged 14.8% over 2004, reaching $1.58 billion.1 Two-thirds of that volume came from North Korean imports of oil and corn, and the main exports to China were coal and iron ore.

South Korea last year did $1.08 billion in trade with her northern neighbor, up an astonishing 50% over the previous year. North Korea’s trade with most other countries, including the United States, declined. Still, South Korea and China account for the lion’s share of North Korea’s foreign trade.

According to estimates by the South Korean central bank, China has contributed 3.5% of economic growth in North Korea since 2000. This effect has prevented the North Korean economy from shrinking.2

Chinese investment in North Korea

Chinese businesspeople have two major interests in North Korea, access to natural resources and selling daily goods.

Mountainous North Korea is rich in natural resources. Industrializing China is resource-hungry, combing the globe for inputs to keep her factories running. Chinese are particularly interested in North Korean coal, iron, gold, and offshore oil.

North Korea, however, lacks the technology to access big portions of the country’s natural resources. That is where China can be of help, and this potential for cooperation has been recognized by diplomats as well as entrepreneurs. In an October 2005 visit of a Chinese delegation to North Korea, the two parties discussed China’s role in North Korean natural resource exploration.

While North Korea has natural resources to offer China, Chinese entrepreneurs are increasingly seeing opportunities in North Korean consumer markets. Chinese business magazines have recently run articles advising readers of opportunities in the North Korea market.

To speak of the “North Korea market” as a place to consider investing may sound odd to most of us, given the poverty of the country. Why invest in a country where large numbers do not have money for food and basic necessities? How could such ventures possibly be profitable?

North Korean foreign trade and China, 1999-2004. The pink line represents total North Korean foreign trade in millions of US$; the blue line indicates trade with China. Source: Korea Trade Investment Promotion Agency (KOTRA).

Chinese are in a unique position to see opportunities in the poverty-stricken socialist country. Chinese observers repeatedly compare North Korea today to China in the 1960s and 1970s, before reforms.3 Few outsiders would have expected that the country’s economy at the time was on the verge of take-off, but it happened nonetheless. From their own experience, Chinese entrepreneurs may be particularly attuned to the business opportunities in a socialist economy. As one Chinese writer puts it, writing of the North Korean economy, “Lack of business experience does not indicate an absence of business opportunities.”4

Erik Mobrand: "The primary recommendation for concerned parties is to watch and wait."
Erik Mobrand: "The primary recommendation for concerned parties is to watch and wait."
The leaders in Chinese investment in North Korea have been merchants from the coastal province of Zhejiang, particularly the strip of land known as Wenzhou. These are the pioneers who brought private enterprise to China, investing among other things in buttons, which had been left out of state plans early in reforms as Chinese exchanged their Mao suits for other attire. These innovative merchants are also in need of natural resources, which they lack at home, making it appropriate for them to be at the forefront of Chinese business in North Korea.

Since the first half of 2004, 300 Wenzhou merchants have run North Korea’s largest daily goods shopping center. The shopping center, located in Pyongyang was also built by a Chinese firm, from the northeastern city of Shenyang. The Wenzhou entrepreneurs went on to post Pyongyang’s first commercial advertisements.

The trick to earning profits in North Korea, the Wenzhou merchants have discovered, is in undercutting the high prices on daily goods distributed by the state or sold in regulated farmers’ markets. They sell food products, but the biggest profits are in appliances and electronics that have become cheap or obsolete in China, especially color televisions, VCRs, freezers, and even computers. A television that might get only 800 Chinese yuan (about US $100) in China can be sold for 1000 to 1100 yuan in North Korea.5

Another key to investing in the North Korean consumer market has been targeting Pyongyang rather than other locales. The capital city is home to the country’s high-end consumers, who fall under at least three categories. First are officials, who are concentrated in the capital city. Second, a relatively large portion of North Korea’s residents with family overseas, especially in Japan, reside in Pyongyang, and they receive extra funds from their relatives abroad. Third, workers’ wages in Pyongyang are far higher than those of workers in other parts of the country. For those reasons, Chinese entrepreneurs interested in North Korea have been descending upon the capital.

The year 2005 saw a Chinese “investment craze” in North Korea.6 In early 2006, a group of 40 Zhejiang businesspeople visited Pyongyang and signed a letter of intent with a merchant there. They were looking to sell daily goods in return for access to natural resources.7

Involvement of the North Korean government

The political and legal environment in North Korea certainly raises challenges to foreign investment. The country lacks regulations by sector on foreign investment. The ground rules that a complex economy needs simply do not exist. Foreign investors do face taxation, of which there are three types – income tax, business tax, and local tax – as well as personal tax.

The North Korean government has, at times, been uneasy about entrepreneurial Chinese interest in the socialist country, whose leaders extol the virtues of self-reliance. One North Korean official who was interviewed by a Chinese magazine expressed discomfort about foreign interest in investing in North Korea.8

At the same time, North Korea has promoted Chinese investment. North Korean officials have held talks in Beijing to introduce the North Korean economy and offer suggestions of where investment would be most welcomed. In an interview with a Chinese business magazine, a North Korean official responsible for promoting foreign trade reported that North Korea needs investment most urgently first in agriculture, followed by power and mining, then in light industry, and finally in urban construction. In order to attract foreign investment, the government offers tax incentives to those who bring new technology. In late 2004, the wages of workers were even lowered in order to make the investment environment more attractive. In addition, the time needed to get approval was said to have been shortened from 50 days to 10 days.9

These do not sound like the activities of the North Korea we hear of as secretive and closed to the world. And yet the leadership, in fits and starts, has been encouraging Chinese investment.

The transformation of North Korean foreign trade, 1990-2004. The figures indicate trade with the given partner as a percentage of total foreign trade. Source: KOTRA.

Cross-border trade

Another dimension of Chinese business interest in North Korea has been trade across their common border. The two countries share a long border of 1416 kilometers. The principal point of cross-border trade is at Dandong, the largest city on any of China’s borders. From Dandong, merchants need only cross the Yalu River to reach the North Korean town of Sinuiju.

The merchants involved in border trade are not the Wenzhou entrepreneurs who set up shops in Pyongyang but locals with family ties in North Korea. They include ethnic Chinese whose relatives are among the some 8,000 ethnic Chinese who reside in North Korea.10 Also among them are ethnic Koreans who have long lived in China – who number around two million – and who have relatives in North Korea. These groups have created bridges between the Chinese and North Korean economies.

Ethnic Chinese residents of North Korea, who are concentrated in the areas of Sinuiju, Pyongyang, and Ryongch’on, started making trips to relatives in China when economic reforms began in the 1970s. They began by taking daily necessities from China back to North Korea for their own consumption. By the late 1980s, more Chinese in North Korea engaged in these activities and started doing so for trade, selling sewing machines, watches, black and white televisions, clothes, cosmetics. By the 1990s, more successful Chinese in North Korea set up cross-border trading companies in Dandong.11

These activities of North Korea’s Chinese population helped spark cross-border trade through Dandong, which started to pick up in 1991. Dandong is home to an estimated 78,400 people with families in North Korea, as well as 8,600 people who have returned from that country.12 Of all trade between China and North Korea in 2003, one-quarter – or $250 million US – went through Dandong.13

In Dandong an overseas Chinese street has emerged, where commercial activities are geared toward the North Korean market. Hundreds of companies in Dandong are involved in trade with North Korea. Around the merchants, transport and packing industries have developed. They carry goods across the Yalu River by hand, car, and train, often at night to avoid authorities.14

Dandong merchants sell the same daily goods that Zhejiang merchants market in Pyongyang. Some are making tens of thousands of yuan per month in Dandong selling computers. They can make 20% profits on food and textile products. These entrepreneurs advise that the goods must be suited to the particular characteristics of the North Korean market. Men’s clothing, for example, should only come in shades of gray and black.15

South Korean responses

China is not the only country interested in investing in North Korea. The South Korean economic presence in North Korea is also on the rise. The conglomerate Hyundai has invested US $1.4 billion in North Korea, primarily in bringing South Korean tourists to the North’s Mt. Kumgang and in the Kaesong Industrial Park.

At the park in Kaesong foreign firms, particularly South Korean firms, set up factories that employ North Korean workers who produce goods for export. By the end of 2005, the site had 15 South Korean factories, which are manufacturing simple goods like lamps, watches, and shoes. By the end of 2006, 300 more firms are to be set up in Kaesong Industrial Park, and another 2,000 by 2012. Poor infrastructure raises a challenge for foreign firms in North Korea, including those in Kaesong. To address the issue, the South Korean government in February approved US $80 million in loans for projects to improve power and communications at Kaesong.

South Korean business activities in North Korea have not proceeded entirely smoothly. Besides a temporary difficulty with North Korean authorities last October, Hyundai has yet to turn a profit. However, Hyundai – and many other South Koreans – are willing to invest in North Korea, for emotional reasons, even if doing so brings losses. Their partly-nationalist motivation differs greatly from that of Chinese entrepreneurs, but appears to be at least as powerful in generating business interest in the country.

China and South Korea have eyed each others’ activities in North Korea with suspicion. South Korean leaders and media express concern about China playing too large a role in Korean territory. The South Korean press has even voiced fears that North Korea will become northeast China’s “fourth province.”16 Meanwhile, the Chinese worry about losing opportunities in North Korea to the South Koreans. Noting that South Korea has rights to Kaesong and Mt. Kumgang for 50 years, one Chinese journalist urges China to respond before it is too late.17

"The sources for change will not come from the Dear leader."
"The sources for change will not come from the Dear leader."
The security link

What we may be seeing is a competitive opening of the North Korean economy, as Chinese and South Korean entrepreneurs vie to gain a foothold in the country. While each may be wary of the other, the responses of both could have the effect of prying open the economy to the world.

In fact, China and South Korea share an interest in seeing the North Korean economy open more to foreign investment. At the October 2005 Asia-Pacific Economic Conference (APEC) held in Pusan, South Korea, the South Koreans invited investment in the North, where southern technology and capital is becoming wedded to northern labor. Furthermore, Beijing and Seoul have both opposed the financial sanctions that the United States has slapped on North Korea following the emergence of information about North Korean counterfeiting.

Not only do North Korea’s neighbors want to see the country more open to foreign investment, they also would like to see economic growth and stability in the country. Their own security interests are best served by a stable North Korea. Political instability would mean millions of refugees flooding into China. And instability might very well also threaten security outside the region. Fighting between groups within this highly militarized society – that may have nuclear weapons – would be dangerous globally.

Would North Korean economic growth strengthen a regime that at least tries to threaten American security, or would growth temper its hostility? Members of the current US administration have been quick to assume the former without considering the question seriously. It is by no means clear that new wealth would be poured into military expenditures rather than into productive activities that would substitute for nuclear programs in the country’s search for security and progress.

North Korean representatives, at times, have framed the issue in terms of this trade-off between wealth and weapons. One North Korean minder told the International Herald Tribune, “We want to rebuild our economy fast. How good will it be if we can use the money spent for our nuclear weapons to buy rice for our people? But we can't.” He continued, "We saw what the Americans did to Iraq. What option would a small country like us have but to build nuclear weapons when a big bully is determined to strangle us and gang up on us?"18 Economic development, in other words, would turn North Korea away from producing nuclear weapons.

We might guess that Chinese and South Korean investment in North Korea affect this security issue in different ways. South Korean projects to this point have tended to be very large, involving collaboration with high levels of the North Korean government. North Korean workers at Kaesong, for example, are paid indirectly by their South Korean employers, who turn money for wages over to the North Korean government. This arrangement provides an opportunity for North Korean leaders easily to siphon off funds for their own purposes.

Chinese business activities in North Korea tend to be much smaller scale, involving less interaction with high government.19 The North Korean government certainly works to tax and impose regulations on these activities, but doing so requires more effort. As small-scale Chinese activities in North Korea expand, the North Korean government will need to develop administrative tools for governing them. The effort for doing so could shift the orientation of the regime toward extracting and developing economic resources, and away from relying on nuclear threats. Facing the challenges of governing an increasingly-complex economy, the regime may shift gears from brandishing weapons to developing tools to deal with those changes.

The activities of Chinese entrepreneurs, then, may really be working to promote long-term regional, American, and global security interests – despite acting in opposition to US calls for sanctions. South Korean projects in North Korea, while more liable to exploitation by North Korean elites, may also be serving to international security interests by helping open up and jumpstart that country’s economy.

Lessons from China?

There is much speculation as to whether North Korea is on the path to reform. Will reform in North Korea look anything like China’s reforms?

In July of 2002 Pyongyang implemented reforms permitting more marketing activities. The regime’s dedication to those reforms has been up for debate. Ethnic Chinese merchants in North Korea note that their activities became much easier from July 2002. One overseas Chinese says, “The situation now is much better. Overseas Chinese can open shops in Ryongch’on and elsewhere.”20 On the other hand, prices remain obscenely high at farmers markets. And just last fall, Kim Jong Il seemed to be backpedaling on those reforms.

In January 2006 Kim Jong Il made a trip to China. He visited coastal areas in the south where spectacular economic growth has followed reform. There is much suspicion that the North Korean leader was inspired by his visit and hopes to initiate similar reforms at home. The Sinuiju Special Administrative Region, which aims to attract foreign investment, is now back on track.21 The Sinuiju project had come to a halt in October 2002 when, the Chinese-born Dutch entrepreneur, Yang Bin, who the North Koreans appointed to head it was arrested by Chinese authorities for tax fraud.

The notion that North Korea might pursue a reform course along the lines of the Chinese model has been criticized, because of the different conditions in North Korea. When China began reforms in the 1970s, the country was mostly agricultural. North Korea today has a much smaller agricultural sector, so loosening up agricultural production and marketing practices would have smaller effects. With more of the population dependent on industry, economic restructuring would be a painful process that puts many out of work.

Another reason why Chinese-style reforms are said to be unlikely in North Korea is that the leadership in Pyongyang would not turn to embrace market principles, because such a move would threaten the regime’s authority.

However, there is also reason to believe that the Chinese experience has some relevance for North Korea’s future. Kim Jong Il might turn to market mechanisms not out of principle but because they could help him retain power and strengthen his country. He is more likely to initiate reforms out of an instrumental calculation than a change of heart. And that is possible. Observers have pointed to unintended economic and political changes coming out of North Korea.22

As already mentioned, Chinese and possibly South Korean investment in North Korea might also spur a change in the tasks of leadership. Instead of saber-rattling, leaders might instead get involved in making the most of their neighbors’ interest in the country. This would be a looser parallel of Chinese reforms. In China, reforms also saw the rise of leaders who were interested in cultivating resources rather than in extolling ideology. That broader lesson, rather than the particular path of reform, maybe what China’s experience has to offer for North Korea.

"North Korea remains one of the stickiest security issue in East Asia."
"North Korea remains one of the stickiest security issue in East Asia."
Conclusions and recommendations

It is clear that big progress on the North Korean nuclear issue cannot be made until leaders in Washington and Pyongyang sit down and work out a solution. The United States shows no inclination to take the North Koreans seriously, so that scenario should not be expected any time soon.

But the current situation is actually not so bad. Washington is too busy elsewhere to get as tough as it might otherwise be on Pyongyang. Meanwhile, Beijing has taken responsibility by doing very little – simply hosting talks that put off addressing the issue fully. Under the status quo, serious challenges to regional or global security are unlikely to break out.

Cynics say we should expect the worst from North Korea. Pyongyang would never yield control of the economy to market forces. Even if the economy were to pick up, the argument goes, that would only support the regime. The fear that any wealth in North Korea would benefit the leadership has driven US leaders to impose sanctions.

The fact is, though, that no one knows what growing economic ties will lead to. We cannot assume we know more than we do, and we know especially little about North Korea.

A couple of scenarios for the future might be imagined. One possibility is that trade between China and North Korea fizzles, never growing into a source of fundamental change in the North Korean economy. Perhaps Chinese entrepreneurs and media have exaggerated the potential economic value of North Korea. This scenario could mean that North Korea’s economy remains closed and without change, or that South Korean investment in North Korea rises to be the most dynamic factor in the economy.

On the other hand, if the trend of rising Chinese business interest in North Korea continues, we could expect major social and political changes to follow. Trade and foreign investment can provide the regime with a new resource base, which would offer an alternative to developing nuclear weapons and counterfeiting currency. This could make the regime in Pyongyang oriented to extracting and developing resources rather than threatening others. This transformation would be in the long-term security interests of the region and beyond.

The primary recommendation for concerned parties is to watch and wait. Analyzing North Korea has tended to mean endless speculation about Kim Jong Il’s next move, but the sources for change in that country probably will not come from the Dear Leader. Policymakers are advised to look beyond Kim Jong Il to social and economic trends that can be more clearly identified.

Financial sanctions on North Korea, insofar as they slow the economy, do not improve anyone’s security. China and South Korea have resisted US pressure to impose sanctions, and their actions may in fact be in the long-term security interests of the United States and the international community.

1 “Pukhan-Chungguk muyok gyumo sasang ch’oegoch’i kyongsin” (North Korea-China Trade Scale Reaches Historic Peak), E-daily (Seoul), Feb. 5, 2006.

2 Cited in Yonhap (Seoul) report, Feb. 13, 2005.

3 See, for example, “Touzi chaoxian zhengdang shi” (The Right Time to Invest in North Korea), Zhongguo jingmao (China Business), May 1, 2005, pp. 80-82; and “Chaoxian shangji yongdong qiye shenshen taojin” (North Korean Business Opportunities Push Firms to Carefully Pan for Gold), Shijie jidian jingmao xinxi (World Electronics Business Information), 2005 no. 3, pp. 36-38.

4 “Touzi chaoxian zhengdang shi” (The Right Time to Invest in North Korea), Zhongguo jingmao (China Business), May 1, 2005, p. 82.

5 Xiaofei ribao (Consumption Daily) Feb 7, 2006; and “Touzi chaoxian zhengdang shi” (The Right Time to Invest in North Korea), Zhongguo jingmao (China Business), May 1, 2005, pp. 80-82.

6 Zhongguo jingying bao (China Management Report), Jan. 9, 2006.

7 Xiaofei ribao (Consumption Daily) Feb 7, 2006.

8 Zhongguo jingying bao (China Management Report), Jan. 9, 2006.

9 “Chaoxian nengfou chengwei Zhongguo de touzi retu?” (Can North Korea Become a Hotspot for Chinese Investment?), Dangdai jingliren (Contemporary Manager) 2005, no. 5, pp. 91-92.

10 Li Tieli and Jiang Huaiyu, “Lun Zhongguo-Chaoxian jingji hezuo de zhanlue yiyi yu Liaoning sheng de zuoyong” (On the Strategic Merit of China-North Korea Economic Cooperation and the Role of Liaoning Province), in Liaodong xueyuan xuebao (Journal of Liaodong University) vol. 7 (2005, no. 1), pp. 39-41.

11 Jiao Shi, “Zai Chaoxian shenghuo de huaqiao” (Overseas Chinese Living in North Korea), Qiaoyuan (Emigrant Garden), 2004 no. 6, pp. 12-13.

12 Hua Wei, “Chaoxian guiqiao qiaojuan de ‘jia’” (The ‘Home’ of North Korean Returnees and Emigrants’ Families), Qiaoyuan (Emigrant Garden), 2004 no. 4, p. 20.

13 Jiao Shi, “Zai Chaoxian shenghuo de huaqiao” (Overseas Chinese Living in North Korea), Qiaoyuan (Emigrant Garden), 2004 no. 6, pp. 12-13.

14 Ibid., pp. 12-13.

15 “Touzi Chaoxian jihui lai le” (Opportunities for Investing in North Korea Have Arrived) Jinrong jingji (Finance and Economy) 2005 no. 4, pp. 47-48.

16 “Puk-chung kyonghyop simhwa, ‘tongbuk sasonghwa’ anida” (North Korea-China Economic Cooperation Is Not ‘North East Four Provincization’), Pressian, March 31, 2006. North east China is typically called the “north east three provinces” (dongbei sansheng in Chinese, or tongbuk samsong in Korean), made up of the provinces of Liaoning, Jilin, and Heilongjiang.

17 “Chaoxian shangji yongdong qiye shenshen taojin” (North Korean Business Opportunities Push Firms to Carefully Pan for Gold), Shijie jidian jingmao xinxi (World Electronics Business Information), 2005 no. 3, pp. 36-38.

18 Choe Sang-hun, “Often-gloomy North Korea shows a sunnier side,” International Herald Tribune, Oct 10, 2005.

19 The point that small-scale economic activities could have a positive impact, while large-scale ones could fund military programs, is touched on in Andrei Lankov, “The Natural Death of North Korean Stalinism,” Asia Policy, no. 1 (Jan. 2006): 121.

20 Jiao Shi, “Zai Chaoxian shenghuo de huaqiao” (Overseas Chinese Living in North Korea), Qiaoyuan (Emigrant Garden), 2004 no. 6, pp. 12-13.

21 Institue for Far Eastern Studies, Kyungnam University (South Korea), “Interest Revived in the Sinuiju Special Administrative Region,” report reprinted March 14, 2006 on the Nautilus Institute website,

22 Andrei Lankov, “The Natural Death of North Korean Stalinism,” Asia Policy, no. 1 (Jan. 2006); and Christopher H. Dale, “Real Reform in North Korea? The Aftermath of the July 2002 Economic Measures,” Asian Survey vol. 45, issue 6 (2005), esp. p. 842.