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Insight - North Korea leans on China to make economic zones work

By Jeremy Laurence

SEOUL (Reuters) - Hermit North Korea is trying a new pitch to attract foreign investors into one of the world's most closed, and impoverished, economies. This time it might even work.

What makes this attempt a bit more credible is that world no. 2 economy China is scaling up support for its heavily sanctioned ally and neighbor which has long made a point of avoiding contact with the outside world.

Unlike the past when that support came only from the local and regional level, now China's central leadership is backing Pyongyang's latest effort: the construction of two liberalized "special economic zones" in the east and west.

Michael Hay, a British lawyer and business consultant based in Pyongyang, said Asian companies, mostly from China, are showing the most interest in entering the destitute state and forming joint ventures.

There has been a perceptible increase in trademark filings and registrations, indicating "that some countries and major companies are gearing up for a possible improvement in the political climate which has a knock-on effect on the business and legal climate," he told Reuters.

The North's push to make the zones work coincides with an easing in tensions on the divided peninsula and tentative signs of detente between Pyongyang and Washington.

United Nations data shows Chinese investment in North Korea grew from $1.5 million in 2002 to about $42 million in 2008. China's official data from early 2008 show 84 Chinese investment streams in North Korea with a total value of $440 million.

Analysts say the North wants something to show for its self-acclaimed rise as a "strong and powerful nation" to mark the 100th anniversary of founder Kim Il-sung's birth next year.

Experts caution against reading too much into the latest drive to woo foreign capital, saying Pyongyang has embarked on such projects before, including talk back in 1991 of constructing an economic zone in the northeast.

"If the past is an indicator, the chances of success are not high," Andrei Lankov, a North Korea expert at Kookmin University in Seoul, wrote on the East Asia Forum website.

In the past, the door was often quickly shut by an authoritarian leadership fearful that engaging the outside world was anathema to its 'juche' policy of economic self-reliance and a threat to its dynastic rule.

SEZ SOLUTION

The North's 10-year economic plan, announced in January, focuses on developing its poor infrastructure, seen by investors as one of the biggest turn-offs to doing business there.

In June, within days of Kim Jong-il's return from his third trip to China in a year, Beijing and Pyongyang declared they would work together to make the special economic zones work.

There are two SEZs, one at the small port of the Rason on the east coast near China and Russia, and the other in the west at Hwanggumpyong island near the Chinese city of Dandong.

"The North Korean government obviously hopes that small areas of controlled capitalism will generate enough income to make a difference -- or at least to keep afloat the long-decaying economy," said Lankov.

Experts see Rason as the most viable project, mainly because of China's considerable interest in ensuring it is successful. The opening of an SEZ seaport will provide a valuable transport link for Chinese companies in landlocked areas in the northeast.

"Rason has become more important to China because of the Northeast development policy and the need to find alternative access to the sea," says Roger Barrett, head of Beijing-based Korea Business Consultants who takes investors to Pyongyang.

The North has set it sights high, declaring last month the zone could one day become a worldwide trade and investment center linking Northeast Asia with Europe and North America.

Hwanggumpyong's future as a tourism, logistics and production center is less certain, experts agree.

DEJA VU

Investors have heard it all before. Over the past decade, they have had their hopes raised by two summits between the Koreas and Pyongyang's signing of denuclearisation deals.

In that time, investors mostly from South Korea poured hundreds of millions of dollars into building scores of factories and a tourist resort in the North with the backing of the government in Seoul.

But the political mood can change abruptly in the North, and the investment appetite fell off as the North tested nuclear devices and missiles, carried out a series of attacks against its neighbor and abandoned its dabble with marketisation.

"One ignores the political situation at one's peril," said Hay, who has worked out of his office off Kim Il-sung square in central Pyongyang for the past seven years.

The election of a hardline president in Seoul in 2008 all but ended trade between the two Koreas, with the exception of business at the special economic zone in Kaesong.

"This slack appears to have merely left room for a large number of Chinese companies that are now seeing the benefits of, for example, tapping into the DPRK's (North Korea's) rich natural resources while also benefiting from labor costs that are undercutting those prevailing in the arguably overheated Chinese economy," Hay said.

Experts say the North's mineral reserves are estimated to be worth $2 trillion. Beijing is driven by strategic interests to cash in on the North's untapped natural and human resources and resources such as coal, iron ore, limestone and magnesite are the primary targets of major Chinese investments, they say.

South Korea said its neighbor's trade with China last year increased nearly 30 percent from a year earlier to $3.47 billion, compared to inter-Korean trade of $1.91 billion.

With the opening of the two trade zones, Beijing is encouraging companies to go behind the border fence, and get a foothold in the market before other countries.

"Investment in China's northeast and the handful of small-scale Chinese investments in North Korea reveal an array of Chinese actors with a common strategy to position themselves for a future opening of the DPRK," Drew Thompson wrote in a report for the U.S.-Korea Institute at Johns Hopkins University.

China's gravest fear is the scenario in which North Korea collapses, allowing U.S. troops stationed in the South access right up to its border. It thus wants to keep the status quo.

Beijing has encouraged the North to follow its path of "socialism with Chinese characteristics," or controlled capitalism, but analysts say that replicating such reforms would be suicide for North Korea's leadership.

Lankov said that copying China's formula would only result in a relaxation of societal controls. "The net result of these changes would likely be a grave crisis in the regime's legitimacy and, perhaps, its complete collapse."

(Editing by Yoko Nishikawa and Jonathan Thatcher)

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