A Whiff Of Reform In North Korea

Pyongyang tests free-market moves while trying to keep the lid on

Inside the saunas and soaking tubs of the Rajin International Club on the northern tip of North Korea, you can almost forget that the economy of the world's last Stalinist society is on the edge of collapse. For $30--a price too high for all but ultra-elites in the "workers' paradise"--you can sweat, steam, watch satellite TV, and undergo a pummeling from a masseuse who complains if not given a fat tip. When it's time to leave, a big beige Cadillac Coupe de Ville waits outside. But halfway home, reality bites. The driver stops and tells the passengers to get out. The car is almost out of gas.

Such are the contradictions of North Korea's first efforts to reach out. Unique for being the world's most closed and secretive state, the repressive regime of this Stalinist country is now desperate to lure foreign investors. It has created a secluded trade zone, Rajin-Sonbong, on the far northern tip of the country. From there it hopes to suck in foreign exchange to fund the rest of the country and is strongly encouraging investment from South Korean and U.S. blue-chip companies. It also is allowing a Japanese-South Korean consortium to proceed with construction of light-water nuclear reactors in exchange for halting its own nuclear program. In another tentative foray, Pyongyang has agreed to permit commercial aircraft to fly over its territory (table, page 28).

But these economic openings, by themselves, won't be enough to reverse the downward spiral of North Korea's economy. Worst-case scenario: complete collapse, with streams of starving refugees fleeing to South Korea, China, and Russia, and the devastating prospect of bailing out an economy that has shrunk 30% over the last six years. Military strategists also fear a desperate armed attack against the South.

MIXED MOTIVES. To help prevent an implosion, the Clinton Administration in late September is likely to ease a 46-year-old trade embargo. According to a high-level U.S. source, Washington will permit some U.S. companies to do business with North Korea. In exchange, Pyongyang will agree to attend briefings about four-way peace talks that also involve South Korea, China, and Japan. Even though the North hasn't agreed to actually participate in the talks, the U.S. seems ready to accept their gesture as a means of easing tensions.

South Korea, Japan, and China also are eager to prop up the North, but for different reasons. South Korea, where per capita income is more than 10 times higher than in the North, wants to stave off reunification until the North can advance economically, reducing an eventual cost that could range from $450 billion to $1 trillion. Japan favors propping up the North to prevent a crisis, but also to slow the creation of a more potent Korean competitor. And the last thing China wants is a booming, democratic South Korea to extend to its border. It much prefers a repressive communist state as a buffer. "A strong capitalist system on the border could be seen as a source of spiritual and cultural pollution in China," says researcher Mark J. Valencia of the East-West Center in Honolulu.

The key question is whether trade, aid, and investment can reverse the country's dizzying slide. Its industrial sector, ravaged by shortages of fuel and spare parts, appears close to paralysis. Trade volume has fallen 57% since 1990, and North Korea owes a staggering half its annual gross national product in foreign debt. Severe drought and flooding have forced its hungry population to boil grass and roots for food. According to the U.N., the North will need $43.6 million in rice and other goods to get through the winter. "There is no other alternative for North Korea except to carry out economic reforms," says Kwun Young Hoon, an economics professor at Hanyang University in Seoul.

Can North Korean leaders dance with the capitalist devil without losing their political grip? There's little doubt substantial economic reform would endanger the whole political system. "I think they understand that if they open up, they put their survival at stake," says James J. Przystup, director of the Asian Studies Center at the Heritage Foundation.

So far, the regime of Kim Jong Il has permitted only limited, controlled experiments with Western-style capitalism. The remote, fenced-off Rajin-Sonbong is as far from Pyongyang as possible and off-limits to regular North Koreans. Here, a market-based system based on real prices has begun to operate in a few thriving, Chinese-run shops and restaurants. A handful of the 140,000 North Koreans who live in the area are getting a taste of capitalism.

North Korean reformers hope the free-trade zone will be a prototype for others throughout the country. An unprecedented government-sponsored conference Sept. 13-15 drew 440 participants from China, Japan, Thailand, and the U.S., about a third of them interested investors.

But the regime continues to set prices for labor and land that are higher than in nearby China. It also maintains a foreign exchange rate 25 to 50 times actual value, designed to take advantage of foreign capital. Kim Jong U, the North Korean official spearheading the project and the second cousin of Kim Jong Il, is noncommittal about further liberalization. "If it's good, we can swallow it," he says. "If not, we can spit it out."

While the North Koreans claimed to have nailed down $840 million in foreign-investment contracts in the zone, more than half of it came from unnamed sources. The most significant deal was not in the area of manufacturing, which North Korea would prefer. Rather, the $210 million pledge from the Emperor Group, a Hong Kong company with a less-than-clean reputation, was to build a hotel and casino complex catering to Chinese gamblers.

ON THE EDGE. Even a few hundred million dollars, though, is far from enough to salvage the North Korean economy. Marcus Noland, senior fellow at the Institute for International Economics in Washington, reckons the money would boost GDP by only $100 million, or about $5 per person. "It's a drop in the bucket," he says. According to Noland, North Korea would require a total investment of $500 billion to $750 billion over 20 to 25 years to raise its per capita income to 60% of the South's. Even if the money could be raised, North Korea lacks the infrastructure to absorb such huge amounts of capital.

Despite fresh coats of paint at the conference center and a new fleet of Romanian-built buses sent in from Pyongyang, evidence of decline was impossible to hide. In Sonbong, an oil refinery and other large industrial complexes were shut down. A power plant built in 1974 with Russian technology appeared to be operating close to the edge of breakdown. Unrepaired pipes vented jets of steam, and several appeared to be patched with makeshift materials like cloth and netting. There was no evidence of malnutrition, but conference banquets were long on kimchi and short on rice, meat, and fish.

Scarcity doesn't scare the likes of Loxley Pacific, which sees only opportunity. The Thai company has already invested half of a planned $35 million for a modern telecom system covering the Rajin-Sonbong district, plus the nearby parts of China and Russia. China also has an interest in ports in Rajin and Sonbong, eager for development in Northeast Asia that will even out the disparity with its booming coastal provinces in the south.

But big U.S. companies haven't been able to move in yet. St. Louis-based Monsanto wants to sell herbicides, seeds, and agricultural chemicals. While the North lacks hard currency to pay for the products, it possesses rare minerals Monsanto can use. "There's lots of things I'd like to do here," says Donald H. Abresch, president of Monsanto Korea Inc. in Seoul. "North Korea is ripe."

Other U.S. companies have explored investing but are not keen to go plunging in. General Motors Corp. officials made two trips to North Korea to explore manufacturing last year but now have "absolutely no thoughts" of building a plant there, a spokesman says. "If somebody can make a good business case, we'll consider it," he says. Coca-Cola, however, is interested but must wait for the easing of sanctions, says Robert Harland, vice-president and director of group external affairs in Asia.

South Korea, eager to use investment as a bargaining chip, has also been blocking its companies' access to the North. Only Daewoo Corp. has put $5 million into a joint-venture factory in Nampo to make jackets and shirts for export. Samsung Group, Hyundai, and Daewoo Electronics units are among 10 investors that want to locate in the North. But Seoul forbade business leaders from attending the investment conference in a visa dispute.

Even for those who get in, North Korea's investment climate remains harsh. In addition to relatively high state-set land and labor costs, foreign companies are not free to hire and fire without the state's agreement. "An underdeveloped legal framework and financial network are also causes for concern," says Chun Hong Tack, a research fellow at the Korea Development Institute in Seoul. ING North East Asia Bank, for instance, which set up an office in Pyongyang, sought advice from a North Korean joint-venture partner on how much to pay newly hired local employees. But the partner declined to give a figure. "They said it's a state secret," says General Manager Keith Chiddy.

In another case, Tony Michell, president of Euro-Asian Business Consultancy in Pyongyang, was close to arranging foreign financing for a heliport and helicopter service linking Rajin and two nearby cities. But when the group of potential Western investors applied for visas to inspect the project, they were told to come on different dates. "They're busy people, so they got pissed off and pulled out," Michell says. He's still looking for $1.5 million to launch the joint venture with state-owned Air Koryo.

FACTION FRICTION. Some of the decision-making paralysis can be explained by divisions in the government. Since the death two years ago of Kim Il Sung, the younger Kim has yet to assume the titles of head of state or general secretary of the Korean Workers' Party. No one definitively knows who's in charge.

There are policy divisions in South Korea, too. Some in the government want reunification quickly. Others hope that a North Korean faction impatient with the pace of reform will emerge. A South Korean government official told BUSINESS WEEK that Seoul's best-case scenario would be to encourage the ascendance of North Korean military leaders who would maintain the border while allowing their country to develop economically. Then, eventually, the two countries would merge.

But even under the best circumstances, North Korea faces a long and tortuous path. It has survived this far on its system of juche, or self-reliance, under which schoolchildren learn that hardship is good for the sake of the nation. "North Korea is likely to accept a lot of punishment," says Charles E. Morrison, an Asia strategist at the East-West Center. "Most of the people know no other life." Unless Pyongyang can greatly accelerate its economic opening, the punishment will continue.

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