North Korean Economic Development

North Korean Economic Development:

Special Economic Zones, Global Value Chains, and New Structural Economics

Jason Ross Mallet

Major in Korea & East Asian Studies

GRADUATE SCHOOL OF INTERNATIONAL STUDIES,

SOGANG UNIVERSITY

August 2015

North Korean Economic Development:

Special Economic Zones, Global Value Chains, and New Structural Economics

Jason Ross Mallet

Advisor: Prof. Dr. Si Joong Kim

A thesis submitted to the faculty of

Sogang University

In fulfillment of the requirements for the degree of

Master of International Studies in East Asian Studies

Major in Korea & East Asian Studies

GRADUATE SCHOOL OF INTERNATIONAL STUDIES,

SOGANG UNIVERSITY, SEOUL, KOREA

August 2015

GRADUATE SCHOOL OF INTERNATIONAL STUDIES

SOGANG UNIVERSITY

COMMITTEE APPROVAL

of a Master’s Thesis submitted by

Jason Ross Mallet

This thesis has been read by each member of the supervisory committee and by majority vote has been found to be satisfactory.

August 2015

Referee Prof. Dr. Yoon Je Cho______(Chairman)

Referee Prof. Dr. Si Joong Kim______

Referee Prof. Dr. Jae Chun Kim______

Acknowledgements

Many people helped me to complete the massive undertaking that was writing this thesis. I would like to thank each of them here.

First, I would like to thank my advisor, Professor Si Joong Kim, who guided me every step of the way, offering advice without which I would not have been able even to properly begin my work.

Next, I would like to thank Professors Yoon Je Cho and Jae Chun Kim, who served on my thesis defense committee and gave both wonderful praise and constructive advice.

To my incredible wife Chohee Kim, who supported me day in and day out, continually giving me encouragement and love without fail, I offer my most heartfelt gratitude.

To Nathalie Iñiguez, Paul Butler, and Gary Robinson, who edited and proofread my thesis out of the kindness of their hearts, thank you for your patience, keen eyes, and suggestions.

I would like to thank my family members, both here in Korea and back home in the United

States: my mother, Peggy Mallet, my sister, Stephanie Davis, my brother, Brian Mallet, my father-in-law,

Byung Gon Kim, my mother-in-law, Soonae Kim, and my brother-in-law, Hyuk Min Kim. Their constant words of encouragement and support have helped sustain me for these six months.

Particularly words of gratitude go to my colleagues in the field of North Korean studies, who helped set me on the path towards writing this thesis and whose goal is the same as mine, the improvement of the lives of ordinary North Korean citizens. Thank you to Inhoe Park, Christopher Green,

Soo Ryun Kim, Gregory Pence, and Nova Mercier.

Finally, I would like to thank my supervisors and coworkers who, knowing that I was undertaking such a massive task, were extremely helpful in making adjustments to my schedule, workload, and responsibilities, especially Dr. Ok Sun Kim, Thomas Nickel, and Emi Chen.

Table of Contents List of Figures ...... iii List of Tables ...... iv Abstract ...... v Introduction ...... 1 Chapter 1 – Relevant Overview of the North Korean Economy ...... 6 1. The Kim Il Sung Era ...... 6 2. The Kim Jong Il Era ...... 15 3. The Kim Jong Un Era ...... 21 Chapter 2 – Obstacles to North Korean Development ...... 27 1. Heavy Industry Focus ...... 28 2. Juche and Xenophobia ...... 34 3. Limited Development Strategy ...... 41 Chapter 3 – New Structural Economics ...... 48 1. Failures of Development ...... 48 2. Successes of Development ...... 53 3. General Outline of Proposed Method...... 60 Chapter 4 – Global Value Chains ...... 65 1. Definition and History ...... 65 2. Benefits to Developing Nations and Impact on East Asia ...... 68 Chapter 5 – The Role of Special Economic Zones ...... 76 1. Significance of SEZs ...... 76 2. Shenzhen SEZ ...... 80 3. Rason SEZ ...... 89 Chapter 6 – A Plan for Economic Growth in North Korea...... 101 1. Targeted Industries ...... 101 Natural Resources ...... 103 Tourism ...... 105 Garments and Textiles ...... 107 2. Removal of Constraints ...... 110 3. Attracting FDI ...... 116

Current Laws ...... 117 Areas for Improvement ...... 119 Types of Firms to Target ...... 122 4. Rewarding Self-Discoveries ...... 123 5. SEZs ...... 124 6. Limited Incentives to Targeted Industries ...... 127 7. Further Suggestions ...... 128 Conclusion ...... 131 Appendix A – Law on Rason ...... 134 Appendix B – Known Companies in North Korea...... 141 Garment/Textile Industry ...... 141 Mining Industry ...... 141 Bibliography ...... 142

List of Figures Figure 1-1: Economic Activity in Kim Il Sung Era ...... 9 Figure 1-2: North Korea-Japan Trade Volume, 2000-2008 (millions of current US$) ...... 18 Figure 1-3: North Korean GDP, 2002-2013 (billions of current US$) ...... 19 Figure 1-4: Inter-Korean Trade (Imports + Exports), 2002-2014 (billions of current US$) ...... 19 Figure 1-5: China-North Korea Trade (Imports + Exports), 2002-2013 (millions of current US$) ...... 20 Figure 1-6: Locations of North Korea’s SEZs ...... 24 Figure 1-7: China's Share of North Korea's Foreign Trade, 2004-2013 ...... 26 Figure 2-1: South Korean Food Imports, 1962-1980 (% of Merchandise Imports) ...... 31 Figure 2-2: Light Industry and Heavy Industry Growth in North Korea, 2000-2013 ...... 32 Figure 2-3: Estimated North Korea Energy Demand by Sector, 2005 ...... 34 Figure 2-4: South Korea Annual Rate of GDP Growth, 1961-1979 (%) ...... 40 Figure 2-5: Number of North Korean Defectors Entering South Korea, 2001-2014 ...... 43 Figure 3-1: Tractors per 100 sq km of arable land in North Kora and South Korea, 1961-1984 ...... 52 Figure 3-2: Cereal Yield, 1961-1984 (kg per hectare) ...... 52 Figure 3-3: South Korea's Annual Inflation Rate, 1967-1990 ...... 55 Figure 3-4: South Korea Gross Domestic Savings Rate, 1960-1997 (% of GDP) ...... 57 Figure 4-1: GDP Growth of current ASEAN countries (except Myanmar), 2001-2013 (Trillions of current US$) ...... 69 Figure 4-2: Leveraging Strategies for Developing Countries in GVCs ...... 72 Figure 4-3: GDP of Vietnam, 2000-2013 (Billions of current US$) ...... 74 Figure 4-4: Vietnam's Annual GDP Growth Rate, 2000-2013 (%) ...... 74 Figure 5-1: Population of Shenzhen SEZ, Registered and Non-Registered, 1979-2013 (millions of persons) ...... 81 Figure 5-2: GDP of Shenzhen SEZ, 1979-2013 (billions of current US$) ...... 81 Figure 5-3: Per Capita GDP of Shenzhen SEZ, 1979-2013 (current US$) ...... 81 Figure 5-4: Overnight Tourism to Shenzhen SEZ, 1992-2013 (International and Domestic) ...... 83 Figure 5-5: Total Foreign Exchange Earnings from Foreign Tourists in Shenzhen SEZ, 1992-2013 (billions of current US$) ...... 84 Figure 5-6: Average Annual Wage in Shenzhen SEZ, 1980-2013 (current US$)...... 85 Figure 5-7: Consumer Price Index in Shenzhen SEZ for Food and Services, 1979-2013 (1979=100)...... 85 Figure 5-8: Total Imports and Exports for Shenzhen SEZ, 1982-2013 (billions of current US$) ...... 86 Figure 5-9: Shenzhen Total Imports and Exports as Percentage of China's Total Imports and Exports, 1982-2013 ...... 86 Figure 5-10: Location of Rason SEZ in North Korea (top right corner) ...... 90 Figure 5-11: The Three Piers of Rajin Port ...... 90 Figure 5-12: Cranes at Rajin Port in Rason SEZ ...... 91 Figure 6-1: North Korean GDP by Economic Activity, 2013 ...... 104 Figure 6-2: Number of tourists entering Ghana and Cambodia, 2000-2013 (millions of persons) ...... 106 Figure 6-3: Tourism Receipts for Ghana and Cambodia, 2005-2013 (% of total exports) ...... 106 Figure 6-4: Cambodian Garment Factory Ownership by Nationality, 2011 ...... 108

iii

Figure 6-5: North Korean Imports and Exports of Textile Inputs, 2010-2013 (millions of current US$) . 108 Figure 6-6: North Korean Imports and Exports of Finished Textile Goods, 2010-2013 (millions of current US$) ...... 109 Figure 6-7: North Korean Imports and Exports of Textile Inputs & Finished Textile Goods, 2010-2013 (millions of current US$) ...... 109 Figure 6-8: North Korean Mining Industry Imports and Exports, 2010-2013 ...... 114

List of Tables Table 1-1: Share of Production on Korean Peninsula Following Liberation ...... 7 Table 1-2: Postwar Allocation of Manpower ...... 8 Table 1-3: Selected Output for Seven-Year Plan, 1961-1970 ...... 12 Table 1-4: Annual Food Aid to North Korea 1995-2002 (in tons of food) ...... 16 Table 1-5: Kaesong Industrial Complex Number of Companies and Production Volume, 2005-2014 (millions of current US$) ...... 18 Table 1-6: North Korean Milled Rice Production, 2009-2014 ...... 22 Table 1-7: North Korean Corn Production, 2008-2014 ...... 22 Table 1-8: North Korean New SEZ Types ...... 23 Table 1-9: Kaesong Industrial Complex's share of total Inter-Korean Trade, 2009-2013 ...... 25 Table 2-1: Factor Productivities in North Korea, 1954-1989 (growth rates per annum, %) ...... 30 Table 2-2: Forested Area in North Korea (% of land area) ...... 39 Table 3-1: 13 Success Stories of Sustained, High Growth ...... 54 Table 3-2: Sample Price Changes as a Result of 7.1 Reforms in North Korea (2002) ...... 58 Table 5-1: Summary of Types of Zones ...... 77 Table 6-1: Ten fast-growing countries with double GDP of North Korea, along with their comparative factor endowments ...... 102 Table 6-2: Categorical Breakdown of the DPRK's Planned Special Economic Zones ...... 125

Abstract

The aim of this research is to establish a plan of development for the North Korean economy by first examing the state of the economy and its obstacles to development. This is followed by an examination of a theoretical model of development known as “new structural economics,” which is augmented with a focus on special economic zones (SEZs) and global value chains (GVCs). The hope is that by identifying those areas in which the North Korean economy is deficient, those in which it has strength, and those areas in which it can readily improve, a path can be laid out that has a foundation in previous economic research, theoretical models, and the practical experience of other developing countries. This paper highlights the deficiencies of the North Korean economy as an over-emphasis on heavy industry, Juche and xenophobia, and a limited economic development strategy. An analysis of new structural economics, North Korea’s potential in tapping into GVCs, and an examination o f the role of Rason SEZ provide the information necessary to give the path that I suggest in the final chapter. The contributions of this research are in its novelty: there has not been any work in English since the end of the Cold War that has given such an in-depth analysis of the obstacles to development in the North

Korean economy or given such a lengthy path to development. This paper further contributes to research on developmental economics by implementing the method of new structural economics using a practical example.

Introduction

The Democratic People’s Republic of Korea (hereafter North Korea) has been experiencing economic stagnation for more than twenty years.1 A combination of failures due to the inefficiencies of central planning, extreme fragmentation of the economy, poor business practices, natural disasters, a xenophobic mistrust of the outside world, a series of confrontations with the international community, and an obsession with concentrating all governing power in one person have kept the North Korean state from beginning the process of economic development which would allow it to catch up with the rest of the world. Despite these setbacks, the North Korean leadership has chosen to follow what former Unification Minister Lee Jong-seok calls a “limited economic development strategy,” which

“combines China’s open market policy with South Korea’s experience from the era of the late President

Park Chung Hee.”2 At first glance, it appears that this assessment is correct, and the path is beneficial.

However, this is not quite as constructive as it seems.

In 2013 and 2014, the North Korean government announced the creation of twenty-one new special economic zones (SEZs), covering export processing, as well as the development of industry, agriculture, tourism, and green and high-tech ventures, in addition to the already existing Kaesong

Industrial Complex, Hwanggumpyeong and Wihwa Islands Economic Zones, Mt. Kumgang Tourist Zone, and the Rason Special Economic Zone.3 However, since that time there has been very little word from within or outside of North Korea on what is happening in those zones, and very little information about the zones themselves. In addition, the leadership of North Korea seems still to be somewhat hanging

1 This paper will use the following standards: all Korean words will be Romanized using the Revised Romanization method, except where other conventions are more common (e.g., “kimchi” rather than “gimchi”). Japanese Romanization will use the Revised Hepburn method. Chinese Romanization will follow standard pinyin. South Korean names will be written with a dash (e.g. Park Chung-hee), while North Korean names will not (e.g., Kim Il Sung), following the preferred standards for either country. Standard naming conventions will be used (such as “North Korea,” “South Korea,” “China,” “Taiwan”) for ease of understanding, and is not intended to be understood as any type of political statement or opinion on the legal status of certain territories. 2 Jong Seok Lee, “ The Next Kim: Prospects for Peace in Korea,” Global Asia Vol. 5, No. 4 (Winter 2010): 80. 3 Andray Abrahamian, The ABCs of North Korea’s SEZs (Washington DC: US Korea Institute at SAIS, 2014), 7, 35-36.

1 onto the failed concept of import-substitution industrialization (ISI), which noted economist Professor

Justin Lin claims to have led to the failure of many newly-independent states to rapidly develop in the

1950s and 1960s, and moreover contributed to their economic decline.4 Further complicating matters, the leadership seems fixated on the idea that the only way to develop rapidly is to jump straight into heavy industry manufacturing, without having a light industry base or even agricultural security. The basis for this thought-process comes from the guiding principles of Juche as formulated by former North

Korean leader Kim Jong Il, in which he states that “heavy industry with the machine-building industry as its backbone is the pillar of an independent national economy.”5 However, this attempt to take a shortcut from an underdeveloped economy to a heavy-industry based economy has proven disastrous before for North Korea, as well as for a great number of other countries, including China.

The greatest issue is the concept of the “limited economic development strategy.” Within this strategy, the leadership still wants to be able to assert complete control over the economy and adhere to the principles of Juche by making it completely self-sufficient without any need for outside help or interference. While this is at best a highly difficult task to accomplish, it is at least still possible to develop the economy while maintaining political control. It is also possible to limit the sectors and geographic areas of economic development while still ensuring that all people have a relatively comfortable life and food security. Utilizing the development methods of Lin’s “new structural economics,” we can make a roadmap for the North Korean government to follow when planning their development. However, this is not enough. North Korea must also allow itself to join global value chains (GVCs), which have been shown to accelerate growth in developing and underdeveloped countries, giving rates of growth far higher than those experienced by South Korea, Taiwan or Japan in

4 Justin Yifu Lin, The Quest for Prosperity: How Developing Economies Can Take Off (Princeton: Princeton University Press, 2012), 45. 5 Kim Jong Il, “On the Juche Idea” (Treatise presented at the National Seminar on the Juche Idea, Pyongyang, 1982), 52. I will further expound on the definition of Juche and what it means to the North Korean economy in Chapter 3.

2 their development phases.6 The best method to maintain control over the planning process and the level of development is to restrict international interactions to SEZs, and only allow domestic firms to develop outside of the SEZs through backward linkages and spillovers from multinational corporations operating within the zones.

The research objectives are as follows. I wish to suggest a method of economic growth and development for the North Korean state and people that allows for economic decentralization (but still allows for economic guidance by the State) but in which the North Korean leadership maintains political control. By examining the history of the North Korean economy since the end of the Korean War and its current status under Kim Jong Un, I hope to understand what problems have consistently hindered development over the last six decades. I will then investigate the growth of GVCs, North Korea’s use of

SEZs (as well as how they were used in China) and Justin Lin’s proposed theory of new structural economics. By understanding the problems that face development, I will use information from these three areas to formulate a detailed model of development that North Korea can follow which will allow for them to retain economic guidance (while decentralizing most aspects of the economy) and full political control. Since the collapse of communism in the late 1980s and early 1990s, no research has been written as extensively as this in the English language on this particular topic for this particular country.

Whenever researching North Korea, there are bound to be severe limitations. Even China is far more open with economic statistics, news reports, and access to the situation on the ground. With

North Korea, economic statistics were no longer released on a regular basis after the mid-1960s, and even census records were only released once in the early 1990s and in 2008. For most figures, we must rely on mirror statistics. Fortunately, several economists and statisticians have been able to formulate

6 Fukunari Kimura, “How Have Production Networks Changed Development Strategies in East Asia?” in Global Value Chains in a Changing World, ed. Deborah K. Elms and Patrick Low (Geneva: World Trade Organization, 2013), 362.

“as close as possible” figures. Unfortunately, these figures do not cover the breadth that would most benefit the research for this paper. In addition, statistics can be interpreted in several ways. I have done my best in this paper to remain objective and not force the numbers to fit my narrative while still extrapolating as much information as possible from given statistics.

The scope of this paper is North Korea from 1953-present. This covers the North Korean economy, especially methods of development, special economic zones, economic relations with other countries and economic structure. Political decisions and decision-making are outside of the scope of this paper, including the North Korean nuclear issue. Only its economic effects are discussed herein.

Human rights, though an important issue that holds just as high a priority as the economy (if not more so), will remain outside the scope of this paper and therefore not be discussed. That is a separate issue that deserves far more attention than I can give.

As for special economic zones, this paper will focus primarily on Rason SEZ, though I will discuss all zones in general as well. Kaesong, however, is outside the scope of this paper, as it does not operate in the same way as the other zones were designed, being a joint project between the North and South

Korean governments. Though Rason is jointly managed with Chinese officials, it is the oldest SEZ and will become the model of all new zones as it stands to gain the most from its location and attention.

The layout of this paper is as follows. Chapter 1 gives an overview of the North Korean economy from the end of the Korean War until present. Here I discuss the characteristics that the economy has developed, including its centralized planning structure, emphasis on heavy industry, and fragmentation beginning with Kim Jong Il. I also explain recent attempts at reform in the context of change over time.

It is divided in three sections, each covering the eras of the three leaders, as each era has its own distinct characteristics. Chapter 2 discusses inherent obstacles to economic reform within the system, these three being the emphasis on heavy industry, Juche and xenophobia, and the limited economic development strategy. Chapter 3 moves on to the theory of new structural economics as espoused by

4 economist Justin Lin and explained in his book The Quest for Prosperity. In this chapter I detail lessons from successes and failures (highlighting the two Koreas), as well as a brief overview of the six-step process to development that Lin suggests. Chapter 4 moves into the realm of Global Value Chains

(GVCs). In this chapter I discuss the benefits of linking into these GVCs as part of a development strategy for poorer nations with abundant labor. Chapter 5 discusses special economic zones (SEZs) and the benefits that they provide developing countries. I provide a case study of Shenzhen SEZ in China, followed by details on Rason SEZ in North Korea. The final chapter gives my recommended path of development for North Korea, based primarily on Justin Lin’s work, but with my own augmentation.

This is followed by a conclusion.

Chapter 1 – Relevant Overview of the North Korean Economy

The North Korean economy can be best described as a failed attempt at autarky. The leadership of the Workers’ Party and the State, concentrated in Kim Il Sung, Kim Jong Il, and now Kim Jong Un, have attempted to create conditions in which North Korea can maintain complete economic self-sufficiency in agriculture, manufacturing, services, and energy. These attempts have often led to disastrous results, on par with the failures of the Great Leap Forward in China. Here I will give an overview of the North

Korean economy, separated into three parts: the Kim Il Sung Era (1953 to 1994), the Kim Jong Il Era

(1994 to 2011), and the Kim Jong Un Era (2012 to 2015).7 The focus of this section will be on the structure of the North Korean economy during these times, the priority sectors of development, the failures of development, and the changes that the economy has undergone.

1. The Kim Il Sung Era

The infrastructure and economy of North Korea were devastated by the Korean War, to the point that it was essentially destroyed as an industrial society.8 The production of agricultural and consumer goods, electricity, chemicals, fuel, and metallurgical products had all decreased significantly, while most homes, farmland and transportation infrastructure was completely destroyed. This devastation, however, provided Kim Il Sung with a clean slate to rebuild the North Korean state in his image.

Prior to the Korean War, North Korea, home to the vast majority of natural resources on the

Korean Peninsula, was the center of Korean heavy industry while the South was the center of agriculture and light industry, as can be seen in Table 1-1. Kim Il Sung’s vision involved rehabilitation of heavy

7 I begin the Kim Il Sung Era from the end of the Korean War, as Kim Il Sung had a tighter grip on power from this point on, and economic planning truly began from this point. 8 Charles K. Armstrong, Tyranny of the Weak: North Korea and the World, 1950-1992 (Ithaca: Cornell University Press, 2013), 54.

Table 1-1: Share of Production on Korean Peninsula Following Liberation Production North South Food 35% 65% Consumer Goods 20% 80% Steel 95% 5% Chemicals 85% 15% Coal 80% 20% Hydroelectric Energy 90% 10% Source: Daniel Schwekendiek, Socioeconomic History, 116-117. industry as the focal point of economic recovery. So much effort was put into heavy industry development that it took up 80% of industrial investment (40% of total investment) during the first two years of the Three Year Plan for Postwar Reconstruction, (1954-56) with self-sufficiency in light industry and agriculture being given secondary status (though still emphasized).9 The goal during this initial three-year plan was to bring North Korea back to prewar industrial levels. The government built new machine-building factories, coal and iron mines, steel products, chemical fertilizer plants, rubber plants, brickyards and textile plants during the years 1954-56. All these efforts paid off, as North Korea reached, and in some cases exceeded by a high margin, prewar or near-prewar levels by the end of 1956.10 Farms were collectivized during this period under the central planning system that would define the entirety of the North Korean economy for the next twenty years. By 1957, only 3% of North Korean farmers were private.11

Given the strategic importance of North Korea, the Soviet Union and China both deemed it essential that North Korea develop quickly and be prepared to act as a counter to the American military presence in South Korea and Japan. For the three-year plan, the Soviet Union gave 1 billion rubles while

Eastern European socialist countries gave a combined 1.13 billion rubles.12 In addition, a significant

9 Armstrong, Tyranny, 60; Joungwon Alexander Kim, “The ‘Peak of Socialism’ in North Korea: The Five and Seven Year Plans,” Asian Survey Vol. 5, No. 5 (May 1965): 256. 10 Yoon T. Kuark, “North Korea’s Industrial Development during the Post-War Period,” The China Quarterly No. 14 (April/June 1963), 56-58. 11 Schwekendiek, A Socioeconomic History of North Korea (Jefferson: McFarland & Company, 2011), 123. 12 The exchange rate for rubles during this time was 4 rubles to 1 USD.

Table 1-2: Postwar Allocation of Manpower Type of Worker Jan 1, 1953 Sept 1, 1956 Dec 1, 1959 End of 1960 Labor (Industrial workers) 21.2% 27.3% 37.2% 38.3% Office workers 8.5% 13.6% 13.4% 13.7% Cooperative members 0% 40% 45.7% 44.4% Private farmers 66.4% 16.6% 0% 0% Miscellaneous 3.9% 2.5% 3.7% 3.3% Total 100% 100% 100% 100% Source: Kim, “Peak of Socialism,” 259. amount of raw materials and food was freely offered by fellow socialist countries in the name of solidarity, with China’s combined contribution of cash and materials totaling 8 trillion Yuan (including debt forgiveness). Massive amounts of technological know-how were also provided.13

Following the three-year plan, Kim Il Sung initiated the Five Year Plan in 1957 (1957-1961). As the country was now at or above prewar levels in all areas, the goal was to create a true socialist economy in which “all means of production were to come under the direct control and operation of the state.”14 Once again, heavy industry received the lion’s share of investment (85%).15 It was during this time that the inefficiencies of centralized planning came to light. The entire industrialization and expansion process depended on massive production of steel, but by 1960 steel production was lagging behind the rest of the economy, as it could not keep up with the capacity of the other heavy industries.

The amount of raw material was insufficient for what needed to be produced. In addition, there was pressure within all levels of the production chain to over-produce and meet quotas early in order to impress superiors and advance the North Korean state. This led to disproportions in production at various levels, giving rise to rivalries between different ministries. Thus, in order to increase the amount of raw materials, focus was shifted somewhat away from heavy industry and into the mining sector in

13 Kuark, “Industrial Development,” 61; Piao Jianyi, “China-North Korea Economic Relations,” in Outside Looking In: A View into the North Korean Economy, ed. J. James Kim and Han Minjeong (Seoul: Asan Institute, 2014), 78. 14 Kim, “Peak of Socialism,” 256. 15 Schwekendiek, Socioeconomic History, 125.

Figure 1-1: Economic Activity in Kim Il Sung Era

Source: Schwekendiek, Socioeconomic History, 119. Reconstructed by author.

1960.16

Despite this setback, the originally planned goals were achieved by 1961 (and mostly surpassed), though this would set the tone for future inefficiencies in the planned economy.17 Farms were fully collectivized and extra laborers were moved from farms to factories, as shown in Table 1-2. The financing again came from North Korea’s socialist allies, though the amount was not the same as it had been for the three-year plan. The Soviet Union contributed 300 million rubles (though possibly as much as 2.8 billion rubles, depending on the source), while other Eastern Bloc countries combined gave 62.5 million rubles. Other allies gave various raw materials and food aid as well.18 China contributed 5 trillion Yuan in combined cash and raw materials.19 Aid from the Soviet Union itself accounted for

16 Kim, “Peak of Socialism,” 258. 17 Schwekendiek, Socioeconomic History, 122. 18 Kuark, “Industrial Development,” 61; Armstrong, Tyranny, 63. 19 Piao, “China-North Korea,” 80.

9 roughly half of the financing of North Korea’s entire heavy industry sector.20

While the average rate of growth per annum during the three-year plan had been 26%, it declined to 21% during the five-year plan and would further decline to 8.9% during the first Seven-Year

Plan, when there were even further aid cuts from North Korea’s allies.21 Though some historians focus on the fact that North Korea had higher rates of growth in the 1950s than South Korea, few take into account the fact that such growth was entirely dependent on foreign aid and had very little to do with superior economic planning. The inefficiencies of North Korean central planning and import substitution industrialization did not allow for inputs to be reinvested into the economy.

It was during the 1950s that Juche began to appear as a guiding principle of North Korean life, especially for the economy. In a 1955 speech to the Workers’ Party Central Committee entitled “On

Eliminating Dogmatism and Formalism and Establishing Juche in Ideological Work,” Kim Il Sung set the tone for the next sixty years of North Korean thought.22 The central theme of Juche, according to Kim’s son Kim Jong Il, is to maintain independence and develop one’s own country before all else. One can get a sense of just what Juche’s focus is by counting the extensive number of times Kim Jong Il says “one’s country” in his treatise “On the Juche Idea.”23

To accomplish the complete independence of the North Korean people and State, Kim Il Sung and the Workers’ Party elected to industrialize using the method of import-substitution industrialization

(ISI) that was lauded during the 1950s as the best way for newly-independent nations to catch up with the developed world. This was an attempt to produce everything the people and State needed – from food and consumer goods to military supplies and heavy industry products – within the borders of the

State, swearing off all outside assistance. Very little was expected to be exported to the outside world

20 Armstrong, Tyranny, 63. 21 Joseph Sang-Hoon Chung, “North Korea’s ‘Seven-Year Plan’ (1961-70): Economic Performance and Reforms,” Asian Survey Vol. 12, No. 6 (June 1972), 528. 22 Armstrong, Tyranny, 89. 23 Kim Jong Il, “On the Juche Idea,” (treatise at National Seminar on the Juche Idea, Pyongyang, March 31, 1982).

10 except as a way of raising foreign currency, as Kim Il Sung was afraid that North Korea might become nothing more than a supply base for wealthier socialist nations (though over time, North Korea’s greatest exports would indeed be natural resources).24 While in the 1960s South Korea began focusing on export-oriented industrialization (EOI), a method of development that depended entirely on foreign nations as new markets, North Korea stuck with inward-looking ISI, as did many other States from Africa,

Latin America and Southeast Asia at the time. The ISI approach would dominate North Korean economic planning up until the present day.

The three- and five-year plans were successful and showed strong growth for the North Korean economy, spurring the implementation of the seven-year plan, which though originally slated to run from 1961-67, ended up becoming a “ten-year plan,” running from 1961-70. The emphasis on heavy industry remained the same, but during this plan there were two stark contrasts to previous economic plans: higher priority given to military spending, and a lack of foreign aid. Kim Il Sung became concerned for North Korea’s security situation in the early 1960s for three reasons: the expansion of the war in Vietnam (given the USA’s willingness to fight against communism in Asia), the Cuban Missile

Crisis, and Park Chung-hee’s military coup in South Korea.25 These events, coupled with the falling out that North Korea had at this time with the Soviet Union, must have had a very strong insecurity effect on

Kim, as defense spending rose from 4.3% of the government’s budget during the five-year plan to 31.2% during 1967-69 (with a jump from 10% to 30.4% in 1967 alone).26 As for foreign aid, North Korea and the Soviet Union’s “falling out” meant that North Korea no longer received massive amounts of aid from either the superpower or its Eastern European allies. Ties with China were also somewhat weakened during this period, meaning North Korea could not rely on Chinese aid as much as before. While money and resources were used for building bomb shelters and bunkers all over the country, very little was

24 Schwekendiek, Socioeconomic History, 117-118. 25 Ibid, 126. 26 Chung, “Seven-Year Plan,” 538.

Table 1-3: Selected Output for Seven-Year Plan, 1961-1970 Output Target Result Steel (million tons) 2.3 2.2 Electricity (billion kwh) 17.0 16.5 Grains (million tons) 6.6 5.0 Textiles (million meters) 500 400 Source: Schwekendiek, Socioeconomic History, 122. spent in ways that would allow for future inputs for the economy.27 Further inefficiencies inherent in the planned economy system led to targets not being met, as Table 1-3 shows.

There were, however, some successes. The government managed to provide electricity to every home by 1970; irrigation was improved, raising crop yields; mechanization of agriculture was improved as the number of tractors increased (though the target amount was never met, as the needs of both heavy industry and the military took priority in mechanical parts). Fertilizer production was more than sufficient for agriculture, though it began to decline as resources were diverted from fertilizer factories to military-industrial factories.28 The Party instituted a few small reforms to try to fix the inefficiencies that arose from the centrally-planned system (without actually abandoning it), including incentives for farmers, limited decentralization of decision-making in industrial matters, and a slight expansion of peasant markets in the provinces, which provided a “stop-gap device to provide consumers with much needed relief in daily necessities” in short supply.29

The following Six-Year Plan (which became an eight-year plan, spanning 1971-78) and the

Second Seven-Year Plan (which became a nine-year plan, from 1978-86) focused on heavy industry, modernization and scientific progress. It was during these plans that North Korea began to finance its economic ventures through foreign borrowing. External debt rose from US$3 million in 1970 to US$1.2 billion in 1975.30 As time went by, North Korea borrowed not only from the Soviet Union and its socialist

27 Armstrong, Tyranny, 132. During this period the Workers’ Party adopted the slogan “arming the whole people” in order to turn North Korea into a fortress, reinforcing the ideology of Juche. 28 Schwekendiek, Socioeconomic History, 127. 29 Chung, “Seven-Year Plan,” 540-543. 30 Schwekendiek, Socioeconomic History, 128.

12 allies, but from Western countries and Japan as well.31 The country came to be well-known for not repaying its debts and having very little to show for its investments. By the end of the second seven- year plan, external debt stood at US$4 billion, and in 1989 “North Korea’s debts to the Soviet Union amounted to nearly a year’s worth of exports.”32

It was during this time that Kim Jong Il began to rise within the Party, and with him the Suryong

(“Leader”) economy. In 1974, Kim Jong Il was internally designated as Kim Il Sung’s successor. His status as successor was not assured, however, so he needed a source of funds to win over possible detractors to his side and therefore create a base. In order to do this, he created a new part of the economy called

“Office 39.” Office 39 slowly took control of all enterprises and firms that were involved in foreign- currency earning projects. All currency earned under this new branch of the economy was used for giving gifts to party elites and building monuments to Kim Il Sung.33

The currency was typically earned in the following way: First, Office 39 sent out an order for various items through the Number 5 Management Division, which then handed down the order to various party provincial committees. These committees then instructed residents in their areas on which items and how many of each item to collect. Residents then went into the mountains to pick pine mushrooms, gather copper, scrape for gold, catch fish, or find other items that Office 39 deemed necessary. During this time, these residents did not attend their normal duties, and thus the planned economy suffered for the benefit of the Suryong economy. The residents, upon returning to the party committees with the goods, received scrip that could be redeemed at a State store for sugar, rice or other goods.34 Thus was born a nascent market economy.

In the 1980s, it was clear that the North Korean economy was on the decline. Debts were

31 Library of Congress – Federal Research Division, “Country Profile: North Korea,” July 2007, http://memory.loc.gov/frd/cs/profiles/North_Korea.pdf (accessed March 30, 2015). 32 Schwekendiek, Socioeconomic History, 128; Armstrong, Tyranny, 64. 33 Park Hyeong Jung and Choi Sahyun, Fiscal Segmentation and Economic Changes in North Korea (Seoul: Korea Institute for National Unification, 2014), 18. 34 Ibid, 19-21.

13 climbing higher and higher, aid from China and the Soviet Union was almost completely cut, and the planned economy was being gutted by the Suryong economy.35 Though the government tried to introduce small market reforms through the August Third Consumer Good Movement, it was not enough to make up for the fact that the Suryong economy was utilizing raw materials and facilities needed by the planned economy for earning foreign currency. As other government ministries and party committees saw how lucrative the profits were for Office 39, they asked permission from Kim Jong

Il to create their own foreign-currency earning enterprises (FCEs) so as to raise funds for projects not usually covered by the national budget. Kim was more than happy to grant waks (trading licenses) to those whom he deemed to be most loyal. These waks also gave permission to the ministry or party organ to utilize elements of the planned economy for their FCEs, further degrading it. As the 1980s wore on, other socialist countries began turning more and more to marketization, reducing even more the aid that North Korea had been receiving. Thus, by the end of the 1980s, it became the rule that all ministries and party organs were to finance themselves, and they did so through FCEs.36

By the beginning of the 1990s, the planned economy was in shambles. Food production was down, as evidenced by the failure of the government to meet rationing quotas in most parts of the country. The central bank was bankrupt.37 The Soviet Union was collapsing and nearly all of North

Korea’s socialist allies had embraced capitalism. Kim Il Sung had earlier established a Joint Venture Law in 1984 and attempted to push now for pro-North Korean residents in Japan to establish joint ventures between Japan and North Korea, but it was too little, too late. The poor reputation for paying back debts had caught up with the State, as had its neglect of infrastructure through the financing of the

Suryong economy. The Chinese leadership tried to sway the North into creating special economic zones to experiment with their style of reforms. Kim Il Sung reluctantly established the Rajin-Sonbon SEZ (or

35 Schwekendiek, Socioeconomic History, 129. 36 Park and Choi, Fiscal Segmentation, 24-37. 37 Ibid, 35.

Rason SEZ) in the extreme northeast of the country, but from 1991 to 1997, only US$1.4 million was invested.38 Rason would be neglected throughout the Kim Jong Il era almost until his death.

2. The Kim Jong Il Era

Kim Il Sung died on 8 July 1994, ushering in the Kim Jong Il era of the North Korean economy.

The planned economy itself was virtually gone and the government was only able to survive through foreign currency it could earn through FCEs as well as international aid, primarily from the United States,

China and South Korea, with a great deal of this aid coming through the World Food Programme (WFP).

A great deal of aid came in the form of food, as North Korea was experiencing the worst famine in its history during a period dubbed by the Workers’ Party as the Arduous March. The final economic “years plan” ended in 1995, and no true economic plan in the sense that Kim Il Sung had created has been implemented since.39 Though the government still called for a return to heavy industry growth during this time, there was no food to feed the workers, no raw materials to supply the factories, and nobody willing to extend a line of credit to the suffering nation. Even were all of these things present, the power shortages that plagued the country during the latter half of the 1990s kept any factory from operating at capacity.40 The government was unable to collect much revenue due to the increasing amount of black market traders that surfaced during the famine. Sanctions from the first North Korean nuclear crisis in the early 1990s and the test-firing of the Rodong Missile in the late 1990s also contributed to a further decline in the North Korean economy.

Making matters worse, in 1994 Kim Jong Il announced the beginning of the Songun, or Military

First, policy. Money that was desperately needed for the ailing economy went instead to the military,

38 Schwekendiek, Socioeconomic History, 151-152. 39 Ibid, 130. 40 Daniel Goodkind and Loraine West, “The North Korean Famine and Its Demographic Impact,” Population and Development Review, Vol. 27, No. 2 (June 2001), 223.

Table 1-4: Annual Food Aid to North Korea 1995-2002 (in tons of food) Aid donor 1995 1996 1997 1998 1999 2000 2001 2002 USA 0 22,196 192,614 231,361 589,053 351,253 318,729 222,153 China 0 100,000 150,000 151,105 200,638 280,026 419,834 329,606 S. Korea 150,000 2,754 60,035 48,455 12,204 351,703 198,000 457,800 Other 394,492 380,249 500,932 359,641 198,161 248,452 571,395 168,552 TOTAL 544,492 505,199 903,581 790,562 1,000,056 1,231,434 1,507,958 1,178,111 Source: World Food Programme with military expenditures rising to 15% of GDP in the late 1990s.41 Aid received through the WFP was not monitored, allowing up to 10% to be allocated to the military.42 However, the greatest sources of income at the time for the military were the waks granted by Kim Jong Il. The military gained monopolies on several areas of foreign trade as well as control over factories that had formerly produced goods for civilian use.43 The purpose of the Military First policy was to ensure Kim Jong Il’s succession without any opposition, thus requiring a great deal of gifts and allowances to ensure loyalty.

During the famine, those innovative enough survived. They began to sell personal goods in makeshift markets so as to have money for food. These markets (jangmadang) began increasing in number all over the country, and became even more important as sources of food, as only up to 10% of international food aid was given to the populace, yet up to 80% was given to government officials, a great deal of which was sold by private merchants in these marketplaces.44 This allowed the North

Korean government to remove from itself all responsibility for feeding the people. While the legal status of the markets was never quite made clear in the 1990s, in 2002 Kim Jong Il had the Supreme

People’s Assembly legalize them in order to maintain stability of food flows to the population.45

Though many of these markets started out with vendors selling personal possessions and international food aid, they eventually became a new source of consumer goods. During the famine,

41 Schwekendiek, Socioeconomic History, 139. 42 Goodkind and West, “Demographic Impact,” 225. 43 Park and Choi, Fiscal Segmentation, 44. 44 Goodkind and West, “Demographic Impact,” 225. 45 Andrei Lankov, “It’s not all doom and gloom in Pyongyang,” Asia Times, September 23, 2011, accessed March 31, 2015, http://www.atimes.com/atimes/Korea/MI23Dg02.html.

16 enterprising North Koreans would cross the border into China, purchase goods, then bring them back into North Korea in order to sell at the markets. Coupled with the improving bilateral relations between

North Korea and China (which had deteriorated during the first nuclear crisis), this growth in cross- border trade raised Chinese exports to North Korea by 30% and North Korean exports to China by 400% in the early 2000s (mostly consisting of minerals and other natural resources).46

Beginning in 2001 and continuing into 2002, Kim Jong Il began to show signs of implementing market reforms within North Korea. In addition to legalizing the marketplaces, he also allowed some pricing and wage structures to be determined by the market rather than the state.47 Most of these reforms would be scrapped in 2005 in an effort to “revive the socialist sector, limit the sphere of private activity, and control inflation,” but their effects lingered.48 Three SEZs were also founded in 2002: the

Kaesong Industrial Complex, the Mt. Kumgang Tourist Zone and the Sinuiju Special Administrative

Region (Sinuiju International Economic Zone as of 2014).49 Sinuiju was a failure almost from the beginning due to economic mismanagement and the arrest of the Chinese-Dutch governor of the SEZ

Yang Bin by Chinese authorities for tax evasion. It was also to be yet another attempt at rapid development through heavy industry, but by experimenting with market forces rather than central planning.50

With the failed attempt at Sinuiju, the North Korean government focused its efforts on the

Kaesong Industrial Complex (KIC) and the Mt. Kumgang Tourist Zone (Kumgang). While Kumgang was concerned primarily with tourism, the KIC’s focus was to be on light rather than heavy industry. To date, this has been North Korea’s most successful SEZ, even though it is still kept afloat by South Korean

46 Scott Snyder, China’s Rise and the Two Koreas: Politics, Economics, Security (Boulder: Lynne Rienner, 2009), 115. 47 Ibid, 123. 48 Stephen Haggard and Marcus Noland, “The Winter of Their Discontent: Pyongyang Attacks the Market,” Peterson Institute for International Economics Policy Brief (January 2010), 3. 49 Andray Abrahamian, The ABCs of North Korea’s SEZs, US-Korea Institute at SAIS (2014), 10. 50 Ibid; Schwekendiek, Socioeconomic History, 153-154.

Table 1-5: Kaesong Industrial Complex Number of Companies and Production Volume, 2005-2014 (millions of current US$) Year 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Number of 18 30 65 93 117 121 123 123 123 125 Companies Production 15.91 73.73 184.78 251.42 256.48 323.32 401.85 469.5 223.79 469.97 Volume Source: Ministry of Unification

Figure 1-2: North Korea-Japan Trade Volume, 2000-2008 (millions of current US$)

500 400

Millions 300 200 100 0 2000 2001 2002 2003 2004 2005 2006 2007 2008

Source: Japanese Ministry of Finance subsidies.51 Despite a change in ruling parties in 2007, the KIC has managed to maintain the support of the South Korean government as the last true vestige of successful Inter-Korean diplomacy.

It was in 2002, however, that North Korea began to lose one of its greatest trading partners.

Kim Jong Il admitted to Japanese Prime Minister Junichiro Koizumi that North Korea had kidnapped thirteen Japanese citizens in the past and issued an apology in order to help speed along normalization of relations. However, the Japanese public believed there to be far more kidnapping victims, with North

Korea continuing to deny these accusations.52 The Japanese people and government, angered over the abduction issue even more than the second nuclear crisis (also happening at this time), called for sanctions against the North Korean regime. During the period 2002-2006, the government passed laws banning all North Korean ships from entering Japanese harbors, disallowing remittances to North Korea, and severely restricting trade.53 As shown in Figure 1-2, trade flows between the two countries diminished after 2002, most significantly in 2006 when Japan began eagerly enforcing the sanctions

51 Schwekendiek, Socioeconomic History, 154. 52 Kyuryoon Kim, ed., North Korea’s External Economic Relations (Seoul: Korea Institute for National Unification, 2008), 123. 53 Ibid, 130-133.

Figure 1-3: North Korean GDP, 2002-2013 (billions of current US$)

15 Billions

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: United Nations, Bank of Korea

Figure 1-4: Inter-Korean Trade (Imports + Exports), 2002-2014 (billions of current US$)

2.5

2 Billions 1.5

0.5

0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Source: Ministry of Unification called for under UN Security Council Resolution 1718. In March 2015, Japan once again extended its sanctions against North Korea over the kidnapping issue.54

During the final ten years of Kim Jong Il’s rule, the economy continued to stagnate. It could not grow at a rapid pace due to Japanese sanctions, extreme fragmentation of the economy, a lack of raw materials and necessary infrastructure, and very little investment. The main sources of trade were

China and South Korea. Most trade with South Korea was done through the KIC (Table 1-5 and Figure 1-

4). During the Kim Jong Il era, trade rose steadily, only falling in 2004, 2009 and 2011 (2009 was probably due to both the 2008 Global Financial Crisis and 2009 currency reform, while 2011 was

54 “Japan extends North Korea sanctions amid stalled abduction probe,” BBC News, March 31, 2015, accessed March 31, 2015, http://www.bbc.com/news/world-asia-32126588.

Figure 1-5: China-North Korea Trade (Imports + Exports), 2002-2013 (millions of current US$)

7 6

Billions 5 4 3 2 1 0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Peterson Institute for International Economics probably due to South Korea’s response to the attacks on Yeonpyeong Island and the ROKS Cheonan).

Trade with China (Figure 1-5) during the Kim Jong Il era constantly rose, with the exception of

2009 (again probably due to the 2008 Crisis and the 2009 currency reform). Beginning in 2005, China and North Korea agreed on a path forward for trade and economic relations in which all matters would be “state-led, enterprise- based, and market-driven.”55 Under this agreement, China would begin investing heavily in North Korea, while North Korea agreed to allow more mines to be leased and operated by Chinese firms. North Korean imports from China during this time consisted primarily of rice, corn, minerals, fuel, heaters, machinery, electronic goods, audio and visual equipment, automobiles and automobile parts, iron, steel, plastic, rayon, and chemical fertilizer. North Korean exports to China consisted primarily of coal, seafood, iron ore, textiles, iron, and steel.56 From this list we can surmise that North Koreans during this period were purchasing ever more consumer goods from

China, while still relying on them to deliver fertilizer for agriculture and machine parts for factories.

However, North Korea actually lost money on its exports, as Chinese firms were paying below-market prices for many minerals and resources, while charging North Koreans above-market prices on oil

55 Piao, “China-North Korea,” 90. 56 Ibid, 91.

20 products.57 During the period 2002-2010, North Korea ran a constant trade deficit with China.58

The last great economic endeavor which occurred during the Kim Jong Il era was the failed

November 2009 currency reform. This measure came about due to the ever-growing marketplaces and the threat that Kim Jong Il felt this “independence from state power” posed to his authority.59 The end goal was to wipe out the massive savings that North Korean citizens had accrued through trading over the previous ten years. Because of the lack of a proper banking and credit system at the time, most

North Koreans who engaged in trade simply kept large amounts of cash in their homes rather than in accounts that could be monitored. Therefore, the currency was revalued so that 1,000 old North Korean won (OKPW) would be equal to 10 new North Korean won (KPW), with a limit of 100,000 OKPW that households would be allowed to convert to the new currency.60 Thus, several years’ worth of savings for many households was wiped out overnight.

3. The Kim Jong Un Era

The Kim Jong Un era began with the death of Kim Jong Il on December 17, 2011. Little changed until June 28 of the following year, with the introduction of the so-called 6.28 Measures. The measures were primarily focused on agriculture, and were a sharp turn from previous attempts at socialist planning. Summing up the measures, Randall Ireson explains:

Key provisions of the 6.28 measures were that SWTs [sub-work teams] should be kept small (10-12 persons), that they would be responsible for their own production decisions, and that they would keep 30 percent of their production quota plus any

57 Balázs Szalontai and Changyong Choi, “China’s Controversial Role in North Korea’s Economic Transformation: The Dilemmas of Dependency,” Asian Survey, Vol. 53, No. 2 (March/April 2013), 281. This is mostly due to the lack of knowledge on the part of North Koreans as to how the market works. Recent accounts have shown that this practice is coming to an end as North Korean traders and businessmen are better able to respond with market prices. 58 Marcus Noland, “Hugely important: North Korea running a current account surplus?” North Korea: Witness to Transformation, March 18, 2013, accessed April 1, 2015, http://blogs.piie.com/nk/?p=9647. 59 Haggard and Noland, “Discontent,” 1. 60 Ibid, 6-7. The limit was raised several times with confusing requirements included every time, each with the purpose of finding out those who engaged in a great deal of market activity (such as allowing one to convert 1 million KPW “if the sources of the funding could be explained.”).

Table 1-6: North Korean Milled Rice Production, 2009-2014 Attribute 2009 2010 2011 2012 2013 2014 Area Harvested (1000 HA) 585 580 570 580 570 565 Milled Production (1000 MT) 1,520 1,600 1,600 1,740 1,880 1,700 Total Supply (1000 MT) 1,609 1,708 1,661 1,790 1,950 1,760 Consumption and Residual (1000 MT) 1,609 1,708 1,661 1,790 1,950 1,760 Source: USDA Foreign Agricultural Service

Table 1-7: North Korean Corn Production, 2008-2014 Attribute 2008 2009 2010 2011 2012 2013 2014 Production (1000 MT) 1,540 1,600 1,600 1,700 2,000 1,950 1,930 Total Supply (1000 MT) 1,740 1,700 1,700 1,875 2,100 2,025 2,030 Source: USDA Foreign Agricultural Service

excess over the quota (meaning that 70 percent of the quota would be delivered to the state). Whether the retained grain surplus could be sold in the open market, or must be 61 sold to the state was not entirely clear.

While the 30% allowance is highly significant (as roughly one third of the North Korean labor force is still in the agricultural sector), even more so is the fact that farmers can now make their own production decisions. This is very important, as in the past, “over-centralized management of agricultural organization and production…ha[d] reduced adaptation to local conditions, prevented adjustments to changing circumstances, and distorted incentives.”62 Additionally, with the smaller SWTs (eventually reduced to five or six people), one could simply register one’s household as a “collective farm,” further decentralizing agricultural production. Though there were some areas of the country that did not fully implement the reforms (due to either the timing of the measures or to interest groups not wanting to change the status quo), in February 2014 Kim Jong Un reaffirmed his commitment to the reforms by issuing a letter to a convention of roughly 8,000 SWT leaders “calling for specific technical and organizational innovations in farming.”63 Throughout 2014, these reforms were implemented countrywide, including other reforms in the 6.28 measures such as market pricing of goods and the allowance of

61 Randall Ireson, “DPRK Agricultural Policy: Chinese-Style Reform or Muddling Towards Autonomy?” 38 North January 27, 2015, accessed April 1, 2015, http://38north.org/2015/01/rireson012715/. 62 Edward P. Reed, “Agricultural Development in Two Koreas: Common Challenges, Different Outcomes,” in Outside Looking In: A View into the North Korean Economy, ed. J. James Kim and Han Minjeong (Seoul: Asan Institute, 2014), 38. 63 Ireson, “Agricultural Policy.”

Table 1-8: North Korean New SEZ Types SEZ Light Heavy Information Export Agriculture Tourism Trade Other Type Industry Industry Technology Processing Number 7 8 3 3 6 2 3 2 of SEZs Source: Andray Abrahamian, The ABCs of North Korea’s SEZs Note: Some SEZs serve more than one purpose. These represent only the most promising of the new SEZs, not all. private investment.

The 6.28 Measures were strengthened even further in May 2014 with the so-called 5.30

Measures, to be implemented beginning in early 2015 (these have been completely implemented as of

April 2015).64 These measures allow SWTs (essentially households) to keep 60% of their harvest rather than just 30. In addition, households are to be given private plots ranging all the way up to 3,300 m2

(the limit prior to this was 100 m2).65 However, the measures go beyond the agricultural sector and into the industrial sector. With the new “director responsibility system” in place, state factory directors “will have the freedom to decide how, when and where they purchase technologies, raw materials and spare parts,” as well as making decisions on customers and the hiring, firing, and wages of employees.66 These changes have given some economists hope that North Korea may soon experience high levels of growth, unseen since the first decade of the Cold War. Hyundai Research Institute made a 2014 prediction that in 2015 North Korea could experience up to 7.5% growth.67

Along with these measures, in 2013-14 the North Korean government announced the creation of twenty-one new SEZs of varying size and function all around the country (Figure 1-6). These SEZs range in type from new export processing zones down to agricultural development and tourism development. There is even a “Green Demonstration Zone,” which will have a focus on organic agriculture. Overall, the new SEZs seem to have a rough balance in different sectors, with some of them

64 “N. Korea Gives Up on Big Collective Farms,” Chosun Ilbo, April 28, 2015, accessed May 11, 2015, http://english.chosun.com/site/data/html_dir/2015/04/28/2015042801736.html. 65 Andrei Lankov, “Reforming North Korea,” Al Jazeera November 30, 2014, accessed April 1, 2015, http://www.aljazeera.com/indepth/opinion/2014/11/reforming-north-korea-20141117121917871925.html. 66 Ibid. 67 “현안과 과제: 북한 농업개혁이 북한 GDP 에 미치는 영향,” 현대경제연구원, 14-36 호 (September 24, 2014), 4 (Korean).

Figure 1-6: Locations of North Korea’s SEZs

Source: Andray Abrahamian, The ABCs of North Korea’s SEZs Note: Reconstructed by author 13 – Mt. Kumgang Special Tourist Zone 1 – Amrok River Economic Development Zone 14 – Onsong Island Tourist Development Zone 2 – Chongjin Economic Development Zone 15 – Orang Agricultural Development Zone 3 – Chongnam Tourist Development Zone 16 – Pukchong Agricultural Development Zone 4 – Chongsu Tourist Development Zone 17 – Rason Special Economic Zone 5 – Hungam Industrial Development Zone 18 – Sinphyong Tourist Development Zone 6 – Hwanggumpyong and Wihwa Islands Economic Zones 19 – Sinuiju International Economic Zone 7 – Hyesan Economic Development Zone 20 – Songrim Export Processing Zone 8 – Hyondong Industrial Development Zone 21 – Sukchon Agricultural Development Zone 9 – Jindo Export Processing Zone 22 – Unjung Hi-Tech Development Zone 10 – Kaesong Industrial Complex 23 – Waudo Export Processing Zone 11 – Kangryong International Green Model Zone 24 – Wiwon Industrial Development Zone 12 – Manpo Economic Development Zone 25 – Wonsan-Mt. Kumgang Special Tourist Zone

overlapping in different areas, though agriculture, tourism and heavy industry seem to be dominant

(Table 1-8).68 The North Korean government still believes that heavy industry is the best way to catch up with the rest of the world.

In 2013, the KIC saw a slowdown in production, as it was closed for almost half of the year (166 days) due to the 2013 nuclear crisis and the standoff between North and South Korea. However, in 2014

68 Abrahamian, ABCs, 14-17.

Table 1-9: Kaesong Industrial Complex's share of total Inter-Korean Trade, 2009-2013 Year 2009 2010 2011 2012 2013 % of Inter- 56% 75.5% 99.1% 99.5% 99.7% Korean Trade Source: Lee Jong-kyu and Nam Jin-wook, “North Korea’s External Trade Relations,” in Outside Looking In: A View into the North Korean Economy, ed. J. James Kim and Han Minjeong (Seoul: Asan Institute, 2014), 106. it returned to 2012 levels of production (Table 1-5). The KIC now represents more than 99% of Inter-

Korean trade (Table 1-9). As for Kumgang, the South Korean government still prohibits its citizens from visiting the resort after the 2008 fatal shooting of a South Korean tourist by a North Korean soldier. This has severely reduced the amount of cash earned through operation of the resort.

With regard to trade, China has maintained its preeminence by holding more than 50% of North

Korea’s total foreign trade since 2005, and in 2013 holding almost 90% (Figure 1-7). Though every year of the Kim Jong Un era there have been trade deficits that favor China, these deficits suggest improved purchasing power in North Korea.69 Citizens and firms continue to import consumer and machine goods, the latter of which are used to develop North Korea’s export sector.

In addition to development through imports, North Korea also receives a great deal of direct investment from Chinese firms, mostly in the mining sector and for transportation infrastructure. China is attempting to develop its three northeastern provinces of Liaoning, Jilin and Heilongjiang. As part of this process, it began the “Changjitu Project” in 2010, operating within Jilin province. The provincial government began improving infrastructure almost immediately, including a high-speed train between

Jilin and Changchun.70 However, in order to fully develop the region, China needs access to a warm- water port. The existence of the Rajin Port in Rason SEZ serves China’s interests very well. When China ships goods to South Korea or Japan from Jilin, it usually takes up to twelve days. However, shipping the

69 Lee and Nam, “External Trade Relations,” 91. 70 Li Fusheng, “Changjitu zone powered by NE Asian trade,” China Daily, September 25, 2013, accessed April 2, 2015, http://www.chinadaily.com.cn/kindle/2013-09/25/content_16993363.htm.

Figure 1-7: China's Share of North Korea's Foreign Trade, 2004-2013 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: Ministry of Unification goods straight from Rason will only take one day, a highly significant gain.71 China foresees Rason as being part of a greater hub of Northeast Asian goods transportation with Jilin as the center. This will be part of a larger transport route connecting “Northeastern Asia, Europe and America.”72 For that reason,

China has begun pouring investment into the North Korean border area to fully develop its transportation and support infrastructure. For example, by 2013 the road connecting Hunchun in Jilin province and Rason SEZ was renovated (including the Quanhe-Wonjong Bridge), and there are plans to completely replace the Quanhe-Wonjong Bridge over the Tumen River as a joint effort.73

71 Yeon Ho Lee and Jeong Shim Kang, “The Changjitu Project and China-North Korea Economic Cooperation: Beijing’s and Pyongyang’s intentions” (paper presented at the BISA Annual Conference, Manchester, April 27, 2011), 9. 72 Ibid. 73 Li, “Changjitu”; “China, DPRK agree to build new border bridge,” Xinhua June 28, 2014, accessed April 2, 2015, http://en.people.cn/n/2014/0628/c90883-8747988.html.

Chapter 2 – Obstacles to North Korean Development

Having explained the current condition of the North Korean economy and how it arrived to where it is today, I now turn to the obstacles to development. I argue that while there are many hindrances to economic improvement, the three that are truly holding back the North Korean state are

1) the focus on heavy industry as a means of catching up, 2) the inherent contradiction in adhering to

Juche in a globalized world (coupled with the xenophobia that it brings), and 3) the limited development strategy that many in North Korea wish to pursue.

There is a rationale for why these three reasons were chosen among others. As for the focus on heavy industry, this above all has drained valuable resources from the North Korean economy, resources which would have otherwise been used to ensure agricultural security and a strong light industry base.

Heavy industry is extremely capital intensive, which does not bode well for a country that has no capital.

Since 1953, no other part of the North Korean economy has been as big a drain on funds and produced so little in return as the heavy industry sector. Abandoning heavy industry alone would help the economy by a tremendous factor. As for Juche and xenophobia, this was chosen as it remains a cultural trait that cannot apply in the globalized economy of the 21st century. This trait is so pervasive that it guides all of the leadership’s thinking when making economic choices. The goal of complete autarky is so counter to the concept of economic efficiency that it will only cause economic stagnation and decline.

Even the nuclear issue and North Korea’s outward bellicosity fall under the purview of Juche and xenophobia. As for the limited economic development strategy, this was chosen as it represents more than anything else the last vestiges of Kim Jong Il’s rule, in which the desire for full economic control was held by the leadership. Full economic control was what North Korea experienced up until 2002, and all that they were rewarded with was crumbling infrastructure, a lack of capital, no real industry to speak of, a famine that killed hundreds of thousands if not millions and thousands of people escaping the country

27 every year. Giving up some measure of economic control in 2002 allowed for the people to have a somewhat steadier source of food and for the economy to actually slightly rebound. A return to the days of full economic control by the leadership would simply take away what little gains have been made. Any other obstacle to growth either falls under the purview of these three obstacles, or pales in comparison to how they are holding the country back.

1. Heavy Industry Focus

North Korea has believed in heavy industry as a miracle-maker since its inception as a State.

After the Korean War, with the economy and infrastructure in ruins, the three-year recovery plan focused most intensively on heavy industry (40% of total investment).74 Following that, during the first five-year plan, emphasis was yet again placed on heavy industry as a means of rapid development (85% of total investment).75 New factories were built, electricity was supplied to more homes through a rapid expansion of power plants, and high quotas were met on heavy industrial goods. Indeed, the rate of growth was very high, averaging 26% per annum during the three-year plan (1954-1956) and 21% per annum during the five-year plan (1957-1961).76 As a comparison, during the same period South Korea only experienced an average growth rate of 3.4% per annum.77 However, one must keep in mind that a great deal of the financing behind the growth during that time came from the Soviet Union, other members of the Eastern Bloc, and China.

The priority put on heavy industry should not come as much of a surprise, for two reasons. First, the northern half of the Korean Peninsula has always been endowed with a great abundance of natural resources, which led the Japanese to instinctively make the region (including Manchuria) an industrial

74 Philip Rudolph, “North Korea and the Path to Socialism,” Pacific Affairs, Vol. 32, No. 2 (June 1959), 133; Armstrong, Tyranny, 60. 75 Rudolph, “Path to Socialism,” 136; Schwekendiek, Socioeconomic History, 125. 76 Chung, “Seven-Year Plan,” 528. 77 Ann Sasa List-Jensen, “Economic Development and Authoritarianism: A Case Study on the Korean Developmental State,” Diiper Research Series, Working Paper No. 5 (2008), 8.

28 base for supporting their imperialist expansion. Thus the area was built up to suit Japan’s needs; for example, most large factories were built on the coast so as to make shipments to Japan more efficient.

Though many of these factories were destroyed during the Korean War, the North Koreans had a great deal of knowledge on how and where to rebuild them (such as in more productive areas closer to mines), as well as help from friendly socialist countries.78 Indeed, historically the southern half of the peninsula was considered Korea’s breadbasket, with only the southern provinces of North Korea being arable enough to produce massive quantities of food (only 16% of North Korea’s land is arable).79

The second reason is that at the time, the championed model of economic development for poorer countries was import substitution industrialization (ISI). This model promoted developing one’s domestic economy through large projects and distortions favoring domestic industries and firms in order to limit imports, and so to “avoid being exploited by developed countries.”80 This method of industrialization highlighted the need to develop heavy industry in order to quickly catch up with developed nations. The North Korean leadership took this to heart by attempting to ensure that it alone could produce all of the resources, machine tools, chemicals, steel and other heavy industry goods with as little outside assistance as possible so as not to be dependent on the Soviet Union or China. For the most part, only natural resources and a few consumer goods were exported, and this was essentially to obtain foreign currency rather than to establish North Korea as part of a trade network.81

However, this approach of catch-up-through-heavy-industry did not work out as well as the

North Korean leadership had planned. During the five-year plan (1957-1961), steel production was not able to keep up with the demands of the rest of the economy.82 Steel was perhaps the most important component, as all parts of the heavy industrial sector required steel. Each subsequent economic plan

78 Armstrong, Tyranny, 60. 79 Goodkind and West, “Demographic Impact,” 222; Schwekendiek, Socioeconomic History, 116-117. 80 Justin Yifu Lin, The Quest for Prosperity: How Developing Economies Can Take Off (Princeton: Princeton University Press, 2012), 37. 81 Schwekendiek, Socioeconomic History, 117. 82 Kim, “Peak of Socialism,” 256-258.

Table 2-1: Factor Productivities in North Korea, 1954-1989 (growth rates per annum, %) Labor Capital Period Labor Force Capital Stock Productivity Productivity Growth Growth 1954-1960 5.7 13.0 3.5 -3.2 1960-1965 5.2 6.9 -1.8 -3.4 1965-1970 3.8 4.1 -0.5 -0.8 1970-1975 4.0 7.3 0.5 -2.5 1975-1980 4.5 6.6 -1.3 -4.2 1980-1985 3.0 8.6 0.9 -4.2 1985-1989 2.6 7.5 0.1 -4.5 Source: Kim, Kim and Lee, “Assessing the economic performance,” 574. focused primarily on heavy industry, and yet each time labor and capital productivity remained low, keeping heavy industry from developing to a high level (Table 2-1).83

Why did this happen? To begin with, North Korea never had a strong supply of capital stock. Its pursuit of ISI as a means of development while avoiding foreign trade (except as a means of earning foreign currency for the state) meant that investment capital for heavy industry planning had to constantly be provided by outside sources, mostly the Soviet Union and China. This was a problem, as, beginning in the 1960s, foreign aid was reduced, and most financing came through Soviet loans.84 The government could never finance all of its ambitious plans while still trying to maintain other parts of the economy.

In addition, food security was never assured. As only 16% of North Korean land was fit for farming (20% in 2015 due to land reclamation projects), a great deal of food had to be imported, often as a gift or a loan from a friendly socialist country.85 Even in 2004, when North Korea had “its best harvest in ten years,” it was only enough to feed 75% of its people.86 South Korea was able to switch its focus to light (and eventually heavy) industry by, among other things, allowing food importation during

83 Byung-Yeon Kim, Suk Jin Kim and Keun Lee, “Assessing the economic performance of North Korea, 1954-1989: Estimates and growth accounting analysis,” Journal of Comparative Economics, No. 35 (2007), 574. 84 Armstrong, Tyranny, 64. 85 Schwekendiek, Socioeconomic History, 117; World Bank figures for North Korea, 2005-2013. 86 “North Korea has bigger harvest,” FAO Newsroom, November 23, 2004, accessed April 3, 2015, http://www.fao.org/newsroom/en/news/2004/51607/index.html.

Figure 2-1: South Korean Food Imports, 1962-1980 (% of Merchandise Imports) 25 20 15 10 5 0

Source: World Bank. Equivalent data for North Korea not available. the 1960s, which accounted for more than ten percent of merchandise imports at the time (Figure 2-1).

Throughout the 1980s, the Public Distribution System (PDS), the government organ responsible for dispensing rations to the people, began to break down due to a lack of food as a combination of a) low productivity in the agricultural sector due to inefficient central planning and b) a lack of aid in the form of food and cash from socialist allies. Without a steady supply of food for its people, North Korea could not hope to support a foundation for heavy industry.

In addition to agriculture, light industry was never fully given the attention it deserved, as the government placed far more emphasis on heavy industry. During the 1950s, Kim Il Sung argued against his political opponents, wanting further investment in heavy industry as opposed to light industry, for he foresaw that North Korea would not be able to rapidly catch up and isolate itself if it slowly went through the motions of developing by first using light industry.87 This would continue into the 1960s and1970s. While light industry was still pursued, it was never put on the same level of priority as heavy industry. Thus, consumer goods that were produced were of low quality, and very little was earned through exports.

More recently, the North Korean leadership continues to believe that heavy industry is still the best means of catching up economically to the rest of the world. Heavy and light industry combined make up 39% of the national economy, but heavy industry, for the most part, has had higher rates of

87 Armstrong, Tyranny, 64.

Figure 2-2: Light Industry and Heavy Industry Growth in North Korea, 2000-2013 14 12 10 8 6 4 2 0 -2 -4 -6 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Light Industry Heavy Industry

Source: Bank of Korea Note: (2003 statistics unavailable) growth than light industry (Figure 2-2).88 Further proof that the government still favors heavy industry can be seen in North Korea’s foreign investment laws, particularly Article 7 of the Law on Foreign

Investment, which states “The State particularly encourages investments that are conducive to the introduction of high technologies and other state-of-the-art technology, manufacturing of internationally competitive goods, construction of infrastructure facilities, scientific research and development of technology.”89 Furthermore, in Article 8, the Law states: “A foreign-invested enterprise that invests in the priority sector shall enjoy such benefits as reduction and exemption of income tax and other taxes, favourable conditions of land use and preferential bank loans.”90 As can be seen from

Article 7, part of this current strategy includes an emphasis on “developing scientific technology” as a precursor to “establishing scientific economic planning” and upgrading technological efficiency. This was partially carried out by the Workers’ Party through the creation of a computer science college at the prestigious Kim Il Sung University as well as an information technology school at the Chosun Academy of

88 “GTI Economic Outlook of the Northeast Asia Region,” United Nations Development Program (October 2010), 27. 89 Article 7, Law of the Democratic People’s Republic of Korea on Foreign Investment (2011). 90 Article 8, Law of the Democratic People’s Republic of Korea on Foreign Investment (2011).

Science, both in Pyongyang, in addition to creating computer science schools in every province.91

However, now the government is looking beyond domestic sources and attempting to find foreign investors.

How is this focus an obstacle to development? There are two main reasons. The first is that the inefficiencies of central planning and the lack of trade revenue from pursuing ISI do not allow for much capital to be reinvested into the economy. This was apparent in the 1950s and 1960s when all the investment capital for heavy industry development came from foreign sources, and once the foreign sources stopped supplying cash, development essentially slowed to a halt. Heavy industry development is not cheap. Additionally, it requires an economy that already has strong foundations with a secure agricultural sector and a continually operating light industry sector in order to continue functioning, not to mention a constant supply of electricity and energy, both of which North Korea has been severely lacking since the beginning of the Kim Jong Il era. As can be seen in Figure 2-3, the industrial sector took up 32% of North Korea’s energy demands in 2005; most of which has been focused on trying to keep heavy industry alive.

The second reason concerns the theory of comparative advantage. David Ricardo believed that a nation could make gains from trade if it focused on the area in which it was most efficient; that is, at a lower relative marginal cost than another country. Economist Justin Lin builds on this idea by claiming that the best way for an underdeveloped or developing country to advance is to focus on its comparative advantage. For a country such as North Korea, which is endowed with natural resources and cheap unskilled labor, the best use of its comparative advantage is to focus on building light industry. North Korea’s mistake—pushing for heavy industry—was the same as many others during the

1950s and 1960s, which showed “a lack of understanding of the relationship between the economic structure and the development levels of their countries,” and that “few developing countries’ leaders

91 Young Chul Chung, “North Korean Reform and Opening: Dual Strategy and ‘Silli (Practical) Socialism,’” Pacific Affairs Vol. 77, No. 2 (Summer, 2004), 290.

Figure 2-3: Estimated North Korea Energy Demand by Sector, 2005

Transport, 3

Industrial, 32 Residential, 40

Nonenergy, 2 Nonspecified, 0 Public/Commercial, 4 Agricultural, 10 Military, 9 Fisheries, 0

Source: David von Hippel and Peter Hayes, “Energy Security for North Korea,” Science Vol. 316, No. 5829 (June 1, 2007), 1289. Reconstructed by author. realized that their vision for their nations could be achieved only step by step, not by leap-frogging development strategies.”92

It is clear that North Korea has desired to pursue heavy industry above all else since its inception and that this pursuit has held it back from developing at a sustainable pace. Should North Korea’s current quest for foreign investment in the heavy industry sector prove successful, it may continue to drive misallocation of funds from the light industry sector to the heavy industry sector, to the detriment of the sustainability of growth.

2. Juche and Xenophobia

The roots of North Korea’s isolationist tendencies can be stretched further back in time than

1948. Indeed, they go all the way to the Joseon Dynasty period that ended in the late nineteenth century. Nicknamed the “Hermit Kingdom,” Korea tried to keep all vestiges of foreign culture away from its shores. This attitude was justified when, in 1910, the Empire of Japan made Korea its second major colony, after the island of Taiwan.

In the 1930s, Kim Il Sung, leading a band of communist guerrillas, fought against the Japanese in

92 Lin, Quest for Prosperity, 61-63. I discuss this issue in greater detail in Chapter 3.

Manchuria alongside Chinese communists, all supplied by the Red Army. The Soviets and the Chinese would again assist Kim Il Sung in the Korean War. Following the war, these two nations, along with several Eastern Bloc countries, gave massive amounts of aid to North Korea to rebuild its economy and society, with very few strings attached. However, even after all this foreign help, Kim Il Sung and the rest of the North Korean leadership hardly ever gave credit to their communist allies for either helping fight the Japanese and Americans, or for financing the record amounts of growth seen in the latter half of the 1950s.93 Because of this nationalistic narcissism, Eastern Bloc countries found it very difficult to continue cooperating with North Korea diplomatically, economically and politically. North Korea’s disdain for foreign aid in the late 1950s, and the perceived slights given to the Eastern Bloc countries, helped bring an end to foreign aid by 1960, when it accounted for only 2.6% of North Korea’s revenue.94

This sentiment would be further fleshed out by Kim Jong Il in his works codifying the ideology of

Juche, which became the xenophobic and inward-looking foundation of North Korean daily life. Straying from the socialist ideals of internationalism, Kim explains that “[t]o establish Juche in ideology means…centring [sic] on the revolution in one’s own country, and acquiring the viewpoint and attitude of solving all questions by one’s own talents and initiative.”95 This attitude is further explored later in the text:

Without the sense of national pride that one’s nation is inferior to none, without the pride and honour of the revolutionary people, it would be impossible to live up to one’s convictions in an independent manner, uphold national independence and dignity and emerge victorious in the difficult revolutionary struggle. A nation with a strong sense of national dignity and revolutionary pride is unconquerable, but a nation without this attribute is powerless. The people of small countries who have long suffered oppression by foreign forces need so much the more the sense of national dignity and revolutionary pride. In the small countries where nihilism and flunkeyism towards big powers are nationally deep-rooted as a result of the imperialist policy of assimilating colonies and obliterating their national culture, they must give special attention to the struggle to increase the sense of national dignity and revolutionary pride.96

93 Armstrong, Tyranny, 107; B.R. Myers, The Cleanest Race (Brooklyn: Melville House, 2011), 96-98. 94 Armstrong, Tyranny, 58. 95 Kim Jong Il, “Juche,” 42. 96 Ibid, 44-45.

“Flunkeyism towards big powers” almost certainly refers to both the Soviet Union and China in North

Korea’s case, and is most likely referring to the USA in South Korea’s case. As this treatise was written in

1982, immediately following China’s “reform and opening,” and the beginning of the USSR’s defensive posture towards the West (and just before perestroika and glasnost), North Korea was feeling somewhat betrayed by its socialist big brothers, while at the same time “trying to deepen its ties to

China and the Soviet Union.”97 This is the massive irony of Juche in North Korea: it consistently emphasizes independence and self-sufficiency, yet the North Korean state is—and has always been— reliant upon external help, whether it be in the form of monetary and technological aid in the 1950s, loans in the 1960s-1980s, food aid in the 1990s-2000s, or foreign direct investment in the 2010s.

Without external assistance, the North Korean state would have ceased to exist long ago. Juche is, as

B.R. Myers calls it, a “sham doctrine.”98

It is the insistence on economic nationalism (as expressed in Juche economics), moreover, that convinced Kim Il Sung to embrace ISI as a method of development. During the 1950s and 1960s, ISI was presented as a way to “avoid being exploited by developed countries,” which would have fit North

Korea’s desires well.99 However, it was not just developed countries that Kim was worried about, but the socialist COMECON nations as well, for which Kim Il Sung did not want to be “merely considered the water boy.”100 Rather than export all of North Korea’s minerals to COMECON nations, the North Korean leadership devised that they would be mined, processed and used to produce native North Korean goods for both domestic consumption and export. The best example of a native North Korean good in this regard is Vinalon (or Vinylon), which is produced and consumed only in North Korea. It is somewhat easy for North Korea to produce, as its main ingredients are limestone and anthracite, both of which are readily available within its borders. However, it was never accepted internationally as an alternative to

97 Armstrong, Tyranny, 209. 98 Myers, The Cleanest Race, 6. 99 Lin, Quest for Prosperity, 37. 100 Schwekendiek, Socioeconomic History, 117-118.

36 nylon, because even though it is durable and has a much higher tolerance to heat and chemicals, it is difficult to dye, stiff, shrinks easily and has a high production cost.101 Vinalon is considered the epitome of Juche and ISI in practice, as it is made entirely from materials found and processed in North Korea and completely replaces all foreign fibers. However, the Vinalon plant in Hamhung ceased operations in

1994 due to a lack of materials and electricity. It was reopened in 2010, but due to the inefficiencies of central planning and ISI (i.e., necessary materials are needed by higher-priority industries, particularly heavy industries), it has been unable to run at full capacity.102

Xenophobia is present as well in North Korea’s actions, and goes hand-in-hand with Juche.

When foreign aid is received, even from friendly socialist countries, it is almost always referred to as tribute, which helps explain why it is okay to use sacks of rice with the United States flag emblazoned on them.103 This attitude also applies when it comes to cooperation with foreign countries, specifically with regard to the nuclear issue. North Korea entered into the Nuclear Non-Proliferation Treaty in 1985

“only to ‘use’ it for the country’s own ends, whereupon it ‘ignored’ or ‘scorned’ the treaty’s stipulations.”104 This would be painfully obvious when it was discovered in 1989 that North Korea was manufacturing a nuclear bomb, and then in 2003 when it unilaterally withdrew from the treaty, the only country ever to do so. Aid received as part of the negotiation process for dismantling the nuclear program in both the 1990s and 2000s was always propagandized domestically as North Korea having vanquished its enemies.105

Why is this attitude such an obstacle to economic development? The combination of Juche’s aspects—insistence on self-reliance, import substitution industrialization, and a xenophobic disrespect

101 Ibid, 146; “’Vinalon,’ the North’s proud invention,” Federation of American Scientists, April 18, 2008, accessed April 5, 2015, http://fas.org/nuke/guide/dprk/facility/industry38.htm. 102 “Can North Korea sustain industrial growth?” Korea Herald, August 18, 2010, accessed April 5, 2015, http://www.koreaherald.com/view.php?ud=20100818000677. 103 Myers, The Cleanest Race, 131, 148. 104 Ibid, 141. 105 Ibid, 144-145.

37 for foreigners—provides a massive wall to the global economy, in which North Korea refuses to fully participate. This wall is both directly and indirectly built. Through ISI, North Korea is not merely placing very high tariffs on imported goods, as many African, Latin American and Southeast Asian nations did in the 1950s and 1960s. Instead, it is outright forbidding such goods (though this has been relaxed somewhat over the last fifteen years).

This is hurtful to the masses of people who could easily pay lower prices for imported agricultural goods were there an easier way to import them at world market prices. The North Korean government’s insistence that the country be agriculturally self-sufficient was one of the leading factors in the famine of the 1990s. Had the country simply allowed imports of food on the scale that most countries do, thousands of lives could have been saved. The human cost of this is tragic, the economic cost mind-boggling. The pursuit of self-sufficiency is extremely inefficient. Roughly one-third of the population works in the agricultural sector, yet this sector contributes roughly one-quarter of annual

GDP. The corresponding rates for South Korea are six percent and less than three percent, respectively.106 As very little land in North Korea is arable, it must constantly clear-cut forests to make room for more agriculture (Table 2-2). In addition, the World Food Programme reports that “frequent droughts and floods have led to significant drops in agricultural production generating shocks to the overall economy.”107 Though the country does import some food (a great deal of which is through aid), the vast majority is produced domestically, is never enough for the people, and is prioritized for consumption by the military and Pyongyang elites. According to the World Food Programme, commercial cereal imports from China and Russia (the main food import partners) have been steadily increasing as the economy slightly improves. However, the main hindrances to further imports are legal obstacles, a lack of hard currency, and the poor state of the overall economy.

106 Reed, “Agricultural Development,” 35. 107 “FAO/WFP Crop and Food Security Assessment Mission to the Democratic People’s Republic of Korea,” World Food Programme, November 28, 2013, 7.

Table 2-2: Forested Area in North Korea (% of land area) Year 2005 2006 2007 2008 2009 2010 2011 2012 Forest 52% 51% 50% 49% 48% 47% 46% 45% Area Source: World Bank

Allowing for food security through greater food imports would enable the government to switch a great deal of investment and attention to the development of the light industry sector, which needs a greater focus than the heavy industry sector. Due to the ISI method, the North tries to sustain both sectors of the economy simultaneously, a largely inefficient task given that it does not yet have a light industry base. The innate fear of dependency on outside powers for heavy industry products is what drives this relentless pursuit. The misallocation of resources to the heavy industry sector, a sector whose goods could be provided temporarily through imports, means that the light industry sector does not get the resources it requires to run at full capacity, as illustrated by the case of the Vinalon factory. South Korea focused on fully developing its light industry sector in the 1960s. Once it had a firm base, it then switched to the heavy industry sector in the 1970s. Both decades saw high rates of economic growth

(Figure 2-4).

North Korea’s attitudes of disrespect towards the international community spurred by Juche and xenophobia have caused it to behave poorly in international financial transactions and contracts with foreign firms and governments. In the 1960s, North Korea began borrowing to finance its economic projects. Because it could not receive a large amount of capital from other socialist countries, it turned to Japan and Western capitalist countries. By 1975, it had an estimated bill of somewhere between

US$700 million and US$1.7 billion (in 1975 US$). This had been used to pay for smelting and mining equipment from Sweden, a clock factory from Switzerland, textile factories and steel-making equipment from Japan, a petrochemical complex from France, a cement plant, a fertilizer plant, and a host of other

Figure 2-4: South Korea Annual Rate of GDP Growth, 1961-1979 (%) 16 14 12 10 8 6 4 2 0

Source: World Bank heavy industry plants.108 Unable to repay these massive debts, they were rescheduled several times.

With Japan alone they were rescheduled three times between 1975 and 1983, with North Korea finally refusing to repay the US$600 million debt owed.109 This gave North Korea the reputation of being an international pariah that felt no shame in defaulting on loans.

More recently, North Koreans have made a reputation for themselves of cheating investors out of money and thus making investment in North Korea an even riskier venture. If a firm makes a major investment within North Korea, they have to have permission to remit the profits back to their home country. According to economist and North Korea expert Curtis Melvin, “[t]he only firm…that has been able to repatriate significant sums of hard currency is Pyeonghwa Motors.”110 There have been examples of joint ventures between Chinese businessmen and North Koreans in which the North Korean partner will simply take the money and run or not return profits to the Chinese investor as they “see transactions only as opportunities to earn cash” and do not think long-term.111 Despite massive amounts of Chinese investment helping to keep the North Korean economy alive, many North Koreans

108 Donald S. Zagoria and Young Kun Kim, “North Korea and the Major Powers,” Asian Survey Vol. 15, No. 12 (Dec 1975), 1028. 109 Armstrong, Tyranny, 177-178. 110 Curtis Melvin, “Orascom seeks repatriation of profits – or new opportunities?” North Korean Economy Watch, December 6, 2013, accessed April 5, 2015, http://www.nkeconwatch.com/2013/12/06/orascom-seeks- repatriation-of-profits. 111 Drew Thompson, “Silent Partners: Chinese Joint Ventures in North Korea,” US-Korea Institute at SAIS, February 2011, 64.

40 still “look down their noses” at the Chinese as inferior.112 It has become such an issue in Chinese business circles that even the Chinese government-run Global Times reported on it, saying, “[t]hey don’t keep to the letter of the contract,” and that there are at any given moment between eighty and one hundred Chinese businessmen waiting in Pyongyang to try to collect from the government on money owed to them by North Korean firms.113 This continues to happen on a higher level, with the 2014 example of the unfinished Dandong-Sinuiju Bridge being unfinished on the North Korean side.

According to a news report on the bridge, the North decided not to begin work as they “demanded more investment from China for the connecting roads” and have not even begun construction.114

Attitudes like these build barriers to trade and investment that North Korea desperately needs, both in the minds of foreign investors and lending institutions as well as internally in the minds and actions of North Koreans themselves. Believing that countries must all be completely self-sufficient simply cannot work in the globalized economy of the twenty-first century, just as it could not work even in the twentieth century.

3. Limited Development Strategy

Former South Korean Unification Minister Lee Jong-seok coined the phrase “limited economic development strategy” with regard to North Korea’s strategy under Kim Jong Il in the last ten years of his life. He has defined this as combining “China’s open market policy with South Korea’s experience from the era of the late President Park Chung Hee.”115 More specifically, this means using the 1980s

Chinese method of gradual marketization in strictly defined areas and sectors of the economy and

112 Anna Fifield, “Talking kimchi and capitalism with a North Korean businessman,” The Washington Post, March 16, 2015, accessed April 5, 2015, http://www.washingtonpost.com/world/asia_pacific/talking-kimchi-and- capitalism-with-a-north-korean-businessman/2015/03/15/5599ff26-be0a-11e4-9dfb-03366e719af8_story.html. 113 Liang Chen, “Chinese traders resort to desperate measures to get money owed to them,” Global Times, June 4, 2013, accessed April 5, 2015, http://www.globaltimes.cn/content/786669.shtml. 114 Lee Sang Yong, “Opening of New NK-China Bridge Delayed Indefinitely,” Daily NK, October 31, 2014, accessed April 5, 2015, http://www.dailynk.com/english/read.php?cataId=nk00100&num=12499. 115 Jong Seok Lee, “The Next Kim: Prospects for Peace in Korea,” Global Asia, Vol. 5, No. 4 (Winter 2010), 80.

41 national territory, while using the South Korean method of industrialization in which the government took a direct role in allocating funding and directing industries, while letting firms in these industries still have control over their day-to-day affairs. The purpose of this strategy is to “achieve economic development just to the point that does not threaten the existence of the regime, as well as to cut off any negative effects it may have on the regime by limiting areas of development, and labeling these as

SEZ.”116 The North Korean government does not necessarily want to come out of this experiment looking like China, and most certainly does not want to look like South Korea. They still desire control over the lives and political will of the populace, but are ready to give up some economic control as long as they do not feel threatened.

What constitutes a threat to the existence of the regime? Actual threats can be boiled down to two areas: foreign infiltration and bottom-up marketization. The North Korean government has always been concerned about foreign culture, foreign ideas, foreign entertainment and foreign goods entering the state and corrupting the people. Even the thought of foreigners freely intermingling with Koreans and intermarrying with them goes against official Korean nationalist ideology.117 The government and security forces actively try to keep foreign goods out of markets (except for Chinese goods), especially

“items manufactured in South Korea,” for fear of the people realizing how much better life is in other countries.118 Though the crackdowns on foreign goods have eased somewhat, as there is the “possibility of resistance if they [security forces] don’t allow other foreign items to be brought in,” the government is “reacting sensitively to the ‘Korean Wave’” as it influences people from all walks of life, even soldiers

116 Lee and Kang, “Changjitu Project,” 17-18 (emphasis mine). This last part is crucial, as while SEZs are most definitely crucial to the development of the North Korean economy and should be heavily emphasized in all economic matters, they are merely the first step towards building a strong economy (covered in Chapter 5). 117 Christopher Hitchens, “A Nation of Racist Dwarfs,” Slate, February 1, 2010, accessed April 6, 2015, http://www.slate.com/articles/news_and_politics/fighting_words/2010/02/a_nation_of_racist_dwarfs.html; Myers, The Cleanest Race, 73-74. 118 Lee Sang Yong, “No Entry to SK Goods, Chinese Agents Warned,” Daily NK, May 12, 2014, accessed April 6, 2015, http://www.dailynk.com/english/read.php?cataId=nk00100&num=11858.

Figure 2-5: Number of North Korean Defectors Entering South Korea, 2001-2014 3000 2500 2000 1500 1000 500 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Male Female

Source: Ministry of Unification who have begun learning the South Korean song “Letter from a Private.”119 Trends in foreign fashion are even permeating North Korean society all the way down to bras, which until the 1990s were considered a “delinquent capitalist trend,” but have now caught on to women of all ages.120 The rapid changes that the country’s domestic culture has undergone in just the last fifteen years scare the leadership. Part of this anxiety comes from the number of defectors that leave North Korea, experience life outside of the state, and then return, often with foreign items and knowledge of foreign life that is substantially better than life inside the country. While it is very difficult to measure the exact number of defectors leaving the country every year, we can gauge the annual proportions by looking at the number coming into

South Korea every year. As shown in Figure 2-5, since Kim Jong Un came to power the number of defectors has decreased significantly from the peak of the previous six years. This is a direct result of the massive crackdown that Kim Jong Un has made on those defecting and assisting defectors.121

It is not just the infiltration of foreign culture through the markets, however. When the Chinese decided to experiment with marketization in the late 1970s, there was a strong fear of repeating the

119 Ibid; Seol Song Ah, “N. Korean Draftees Take to S. Korean Song,” Daily NK, March 19, 2015, accessed April 6, 2015, http://www.dailynk.com/english/read.php?cataId=nk01500&num=13007. 120 Seol Song Ah, “Bras No Longer ‘Youth Only’ Garments,” Daily NK, November 11, 2014, accessed April 6, 2015, http://www.dailynk.com/english/read.php?cataId=nk01500&num=12540. 121 Chico Harlan, “North Korea puts a hold on defectors,” The Washington Post, July 20, 2012, accessed April 6, 2015, http://www.washingtonpost.com/world/asia_pacific/north-korea-puts-a-hold-on- defectors/2012/07/20/gJQAPgMEyW_story.html.

“century of shame” all over again, in which foreign forces and foreign capital would control the destiny of the Chinese state and people. This was the reason that reforms were instituted in limited areas, specifically SEZs, and with limited rules on the amount of capital that could be brought in and on whether or not firms could be fully foreign-owned or merely parts of joint ventures. This is a very real concern for the North Korean leadership, and one that they, or any developing country, should consider.

To develop, one needs access to capital, which means playing by the rules of international lending institutions and international financing regimes. This means allowing others into your country and telling you what laws to pass and what to allow (or not allow). The leadership—specifically, Kim Jong

Un—would be right to feel somewhat threatened by this possibility, as economic infiltration could lead to political infiltration.

The other major threat to the regime that they wish to combat with the “limited development strategy” is that of bottom-up marketization. The Kim Jong Il leadership legalized the markets in 2002, but then reversed several concessions in 2005, as Kim Jong Il was able to see how much power he had lost over the day-to-day economic lives of the ordinary people through these markets. Several measures have been taken over the years in an attempt to restrict the activities of the markets. Those who attempt to sell goods without buying a costly market permit (called “grasshoppers”) have their goods and money confiscated, and at times can be arrested.122 Those who are able to buy permits are typically women older than fifty years old, as that has been the minimum age allowed for market vendors (though this age restriction has been lifted as of March 2015).123 Because women are the primary market traders, the North Korean government attempted to limit their abilities by banning

122 Park Jun Hyeong, “Grasshoppers Keep Hopping,” Daily NK, October 9, 2011, accessed April 6, 2015, http://www.dailynk.com/english/read.php?cataId=nk01500&num=8260. 123 Kang Mi Jin, “NK Lifts Market Age Restrictions,” Daily NK, March 23, 2015, accessed April 6, 2015, http://www.dailynk.com/english/read.php?cataId=nk01500&num=13022.

44 them from riding bicycles under the pretense that it is “unladylike behavior.”124 As motorcycles and motorbikes became increasingly used by market traders to move items and conduct business more speedily, the government decided to crackdown on their use as well in 2014. Citizens are only allowed to use their motorbikes during the morning commute and from 8:00 PM to 10:00 PM.125 Beginning in late 2014, the North Korean government began curbing the use of foreign currency, especially Chinese yuan, among market traders. Those caught using any currency other than North Korean won (KPW) have their money and goods confiscated.126 However, by far the biggest attempt at wiping out the markets was the 2009 currency reform. As explained in the previous chapter, the move was an attempt to control the markets by virtually eliminating all savings that North Korean market traders had put away over the years. This was done “because the regime’s power ultimately rests on its ability to make

North Koreans believe that it controls their economic well-being.”127

The North Korean government most likely seeks to lessen the market’s grasp by developing to the point that it can fully re-implement the Public Distribution System and thus provide the people with food without them having to resort to private means.128 It will also most certainly limit foreign manufacturing firms to SEZs only in order to control which workers go in and out of the factories and what they see and hear. The government will most likely pick and choose which industries are best to grow based on the needs of maintaining a closed society, which in all likelihood means continuing with a bias toward heavy industry.

124 Daniel DeFraia, “North Korea bans women from riding bicycles… again,” Global Post, January 16, 2013, accessed April 6, 2015, http://www.globalpost.com/dispatch/news/regions/asia-pacific/130116/north-korea-bans-women- riding-bicycles. 125 Choe Sang-hun, “Motorbikers in North Korea Are Told to Park to Save Fuel,” The New York Times, August 8, 2014, accessed April 6, 2015, http://www.nytimes.com/2014/08/09/world/asia/motorbikers-in-north-korea-are- told-to-park-to-save-fuel.html. 126 Kang Mi Jin, “Facing Crackdown, Vendors Use KPW,” Daily NK, January 16, 2015, accessed April 6, 2015, http://www.dailynk.com/english/read.php?cataId=nk01500&num=12800. 127 Evan Ramstad, “North Korean Money Shift Sparks Violence,” The Wall Street Journal, December 9, 2009, accessed April 6, 2015, http://www.wsj.com/articles/SB126029137357982133. 128 Benjamin Katzeff Silberstein, “Food markets still vital in North Korea,” Asia Times, January 10, 2014, accessed April 6, 2015, http://www.atimes.com/atimes/Korea/KOR-01-100114.html.

Why is this strategy an impediment to growth? “Limited development” is still development, but it is not sustainable or even desirable development. Should the sources of finance be limited only to domestic or specially-chosen foreign sources, the costs of loans could be higher as there is less competition, and the funding pool smaller for future borrowing opportunities. Attempting to limit foreign firms involved in manufacturing to SEZs is a smart move for the initial stages of development, but eventually firms should be allowed to move into the domestic economy in order to provide a more stable macroeconomic environment with greater employment that is not entirely dependent on special economic zones. Limiting development also limits the amount of technology that could possibly be brought in through backward linkages into the domestic economy. Should North Korea attempt a more appropriate method of initiation by inviting light industry firms in the beginning, they will not be able to move very far up the value chain and thus will receive very little in technological knowledge from foreign firms.

Limiting the marketization from below also eliminates what has been a stable source of food and consumer goods for many citizens for the last fifteen years, something which the North Korean government has not been able to provide since the 1980s. As mentioned previously in this chapter, food security is absolutely essential for economic development to any higher standard. The markets help provide food security, as they make up for the gap in production and official imports by providing private imports from China.129 North Korea also needs a stable consumer market for when the factories begin producing domestic consumer goods again. The private marketplaces are the perfect location to distribute these goods to the populace at market prices, allowing the government to earn revenue.

The focus on heavy industry, adherence to Juche and the unsustainable idea of the “limited development strategy” are all obstacles to development in North Korea. Each of these must be systematically examined by the leadership when making their policies as they will have profound effects

129 Ibid.

46 on the prospects of future growth. These obstacles should be replaced with ideas that can facilitate growth; that is, a focus on North Korea’s comparative advantage (covered in Chapter 3), connecting the

North Korean economy to the global economy through Global Value Chains (covered in Chapter 4), and focusing development safely and steadily through SEZs for the initial stages in order to maintain political control (covered in Chapter 5).

Chapter 3 – New Structural Economics

In his book The Quest for Prosperity, World Bank economist Justin Lin introduces a new method of economic development which he calls new structural economics. This method combines characteristics of structural economics, state-led development, and Washington Consensus models of growth and development while relying on classical economics as a foundation. In this chapter, I will summarize the work as it relates to my thesis by focusing first on the failures of development in certain countries, the successes of others, and the general outline of Lin’s proposed method. Full applications of this method will be explored in Chapter 6.

New structural economics, as a published path for economic development, is relatively new.

Thus, it has yet to be fully tested in the field. Why is this then a better path for North Korea to follow than, say, continued ISI or complete liberalization? The answer lies in the experience of developing countries on which the methodology is based. Lin did not make a theory and try to find countries that fit the narrative well. He found countries that were poor in the past but developed rapidly. Examining their experiences, he found the common traits that they all shared and from that developed a conceptual framework that all developing countries should be able to follow. As explained below, developing countries that chose to follow ISI failed miserably. When they then decided to embrace the

Washington Consensus model, they again failed. These two models did not take into account how specifically a developing country’s economy should grow—something that Lin’s model does.

1. Failures of Development

Throughout the 1950s and 1960s, many new countries were created (or re-created) out of the colonies of more well-established nations who were either well past their prime (Britain, France) or suffered major losses in World War II (Japan). Extending into the 1970s, the entire continent of Africa

48 and the region of Southeast Asia became free from external control. New nations appeared and were led by native citizens who desired to accelerate the economic growth of their homelands and so be able to catch up with the powers that had once powerfully dominated them. With economic prosperity would come security, and an assurance that never again would a foreign power control the destinies of these countries. Though the initial situation on the Korean Peninsula was slightly different to that of the new nations in Africa and Southeast Asia, the results were largely the same.

Many of these countries chose the import-substitution industrialization (ISI) method of development, as previously discussed in Chapter 2. In an attempt to make their countries self-sufficient and thus not reliant on imports from more industrialized nations, leaders would invest massively in heavy industry projects, agricultural modernization programs and efforts to quickly increase productivity. In order to bankroll such efforts, they were forced to borrow from foreign financial markets as they had no access to domestic investment capital, having been colonies just a few years prior (in many instances, they ended up borrowing from their former colonial masters). Rapid growth rates were experienced in the first few years, along with massive increases in production, but the heavy industry goods produced in these countries were inferior to those already produced in advanced nations and thus not competitive internationally; moreover, the domestic market was not yet able to afford such goods. 130 These failing industries required constant government subsidies to stay afloat. The governments went further than mere subsidies in many situations, “granting market monopolies to firms in the priority sectors, suppressing interest rates, overvaluing domestic currencies, and controlling the prices of raw materials,” which “led to the suppression of incentives, the misallocation of resources, and economic inefficiencies.”131

North Korea’s situation in the 1950s and 1960s fits this narrative almost exactly. Kim Il Sung was worried about exploitation from more advanced economies—even from his socialist ally, the Soviet

130 Lin, Quest, 52-53. 131 Ibid, 69.

Union—and so opted to pursue ISI as a way to protect the North Korean state and people from the ravages of colonialism, whether it be political or economic. In both the three-year and five-year plans, modernization of agriculture through improved scientific techniques, partial mechanization, and collectivization was pursued (and largely achieved). Emphasis was placed over and over again on heavy industry, having been given the highest priority. Steel especially was targeted as a vital industry. In contrast to North Korea’s decision to pursue steel-making so early, in South Korea steel would not be seriously pursued until the late 1960s and early 1970s.132 Productivity increases in the North were sought with massive shifts in labor away from farms and into factories, with a rise in the industrial workforce from 21% in 1953 to 38% in 1960, coming almost completely from former private farmers

(Table 1-2). Financing was provided by the Soviet Union, other Eastern Bloc countries, and China for the first two economic plans, and though the leadership believed it could finance the seven-year plan (1961-

70) on its own, it ended up relying on foreign loans from socialist and capitalist countries alike. During the first two plans, growth rates were high (26% and 21% for the three- and five-year plans, respectively). However, the consumer goods (and even heavy industry goods) produced for both domestic consumption and export to foreign markets were considered “shoddy.” 133 This was the result of the Chollima Movement, in which proper economic management and material incentives were replaced with Kim Il Sung’s on-site guidance and “ideological incentives to work harder” in an effort to rapidly modernize the economy as a smaller-scale version of the Great Leap Forward.134 As demand for higher and higher targets grew, workers sacrificed quality for quantity and thus created goods that nobody, Korean or foreign, wanted to buy, especially when there were plenty of goods of much higher quality for the same price on the international market (though North Koreans were forced to buy these

132 “The role of ODA loans in the rapid economic growth of South Korea,” Japan Bank for International Cooperation (July 2004), 72. 133 Chung, “Seven-Year Plan,” 528, 537. 134 Ian Jeffries, North Korea: A Guide to Economic and Political Developments (New York: Routledge, 2006), 66. Chollima means “winged horse” or “Pegasus,” which in Korean mythology was able to travel long distances in a single day.

50 domestically-produced products). However, the government continued to subsidize the heavy industry sector while attempting to pursue rapid growth through Chollima-style on-site guidance tours and ideological seminars. Inefficiencies crowded upon one another, heavy distortions racked the entire economy (especially after the introduction of the Suryong economy in the 1970s), and material incentives remained non-existent. The economy continued to stagnate from the 1960s to the present.

What specifically brought about this situation? Lin argues throughout his work that the key to economic development is focusing on one’s comparative advantage, which is determined by one’s factor endowments.135 Developing nations do not have massive amounts of capital in the form of foreign reserves saved up, and so should not begin with capital-intensive projects such as heavy-industry development, which cannot provide much in returns. Given that the knowledge and experience of a developing country is very limited compared to advanced nations—the chief competitors in heavy industry—one should not expect that the quality of heavy industry products will be of the same caliber as that produced by a nation with the requisite knowledge and experience. What is needed prior to heavy industry investment and development is for light industry to develop so that there can be enough capital accumulation to eventually provide for a stable transition to a heavy industry base.

North Korea attempted to rapidly industrialize by focusing too much on heavy industry, a sector which would provide very few returns and thus allow for almost no capital accumulation. Though there was a strong commitment during the 1950s to modernize agriculture, it received less and less emphasis over time, especially once the Suryong economy took hold in the 1970s. Though many tractors were manufactured during the 1950s and early 1960s, beginning in the 1970s they were not readily replaced and many fell into disrepair. In addition, these tractors were designed for large collective fields, while

South Korea used the more efficient private farmer method, in which harvesters, planters and

135 Lin, Quest, 10.

Figure 3-1: Tractors per 100 sq km of arable land in North Kora and South Korea, 1961-1984 300 250 200 150 100 50 0

North Korea South Korea

Source: World Bank

Figure 3-2: Cereal Yield, 1961-1984 (kg per hectare) 7000 6000 5000 4000 3000 2000 1000 0

North Korea South Korea

Source: World Bank cultivators were used on small farms (Figure 3-1).136 Thus, over time, South Korea managed to produce far more food in its fields than North Korea (Figure 3-2), and was able to afford food imports due to its commitment to light industry throughout the 1960s. Even though North Korea began producing more tractors in the early 1980s, the amount of food produced was on the decline. Due to these inefficiencies, North Korea never truly achieved food security and thus could not even move onto creating an industrial base.

After the failures of ISI were evident, many of these developing countries decided to take a

136 Reed, “Agricultural Development,” 50.

52 completely different route, that espoused by the “Washington Consensus.” This method proscribes ten policy recommendations, with the most relevant being trade liberalization, privatization, deregulation, security for property rights, liberalization of FDI, market-determined interest rates and competitive exchange rates. However, once these developing countries embraced the principles of the Washington

Consensus, many of them only achieved very slow growth, generated low levels of employment, and in many cases (especially for former communist countries), made the situation worse than before. The neoliberalism of the Washington Consensus turned out to be a failure for many of these countries.137

2. Successes of Development

Drawing information from the 2008 Growth Report by the World Bank, Lin discusses thirteen successful countries that managed to choose tracks of development in the postwar era that led to high, sustainable rates of growth while maintaining stable macroeconomic environments (Table 3-1).138 The

Growth Commission was able to narrow down the reasons for success to five stylized facts:

1. They exploited the world economy by importing knowledge and exporting goods; or rather

“imported what the rest of the world knew and exported what it wanted.”

2. They maintained stable macroeconomic environments, with only moderately high inflation

during defined periods yet maintaining fiscal responsibility.

3. They were “future-oriented” in that they maintained high savings and investment rates,

especially investment in infrastructure.

4. They relied on the market to provide price signals, decentralize decision making, and allocate

resources.

137 Lin, Quest, 73-74. 138 Michael Spence, et. al., “The Growth Report: Strategies for Sustained Growth and Inclusive Development,” Commission on Growth and Development (Washington DC: International Bank for Reconstruction and Development, 2008). The thirteen successful countries are: Botswana, Brazil, China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, Malta, Oman, Singapore, Taiwan and Thailand.

Table 3-1: 13 Success Stories of Sustained, High Growth Period of high growth Per capita income at the beginning and in 2005 Economy (GDP growth 7% or more) (in year 2000 $US) Botswana 1960-2005 210 3,800 Brazil 1950-1980 960 4,000 China 1961-2005 105 1,400 Hong Kong 1960-1997 3,100 29,900 Indonesia 1966-1997 200 900 Japan 1950-1983 3,500 39,600 S. Korea 1960-2001 1,100 13,200 Malaysia 1967-1997 790 4,400 Malta 1963-1994 1,100 9,600 Oman 1960-1999 950 9,000 Singapore 1967-2002 2,200 25,400 Taiwan 1965-2002 1,500 16,400 Thailand 1960-1997 330 2,400 Source: “Growth Report,” 20.

5. They had “committed, credible, and capable governments.”139

These characteristics seem somewhat self-evident. If a developing country does not have specific industrial knowledge or technology but more advanced countries do, it is far easier and far more economical to try to import this knowledge or technology than re-create it yourself. In order to accumulate capital and foreign reserves, it is important to export to foreign markets. Doing this requires relying on one’s comparative advantage, so choosing the correct industry to develop is important. In addition, if a country’s domestic market is quite small (as North Korea’s was and still is), large foreign markets are even more of a necessity. South Korea’s first five-year plan prioritized light industry, especially in textiles, garments, wigs, plywood and simple consumer electronics, as it had a skilledworkforce with high levels of education, but very few natural resources on which to rely.140 It then began exporting these goods to countries whose economies had already moved beyond light

139 “Growth Report,” 21-26. 140 Sudip Chaudhuri, “Government and Economic Development in South Korea, 1961-79,” Social Scientist, Vol. 24, No. 11/12 (Nov/Dec 1996), 23.

Figure 3-3: South Korea's Annual Inflation Rate, 1967-1990 35 30 25 20 15 10 5 0

Source: World Bank industry, especially the United States.141 The focus on the United States as an export market was another way that South Korea exploited the world economy. The United States was attempting to boost

South Korea so that it would be a strong buffer against communism in East Asia and would not continue to rely on foreign aid.142 North Korea, on the other hand, has chosen again and again to go against this wisdom. Despite having very little knowledge of proper heavy industry techniques and technology (not to mention proper management knowledge, having relied on Chollima-style on-site guidance tours instead of allowing managers to guide workers), the North Korean government blindly pushed ahead with massive projects over the years, believing nothing more than a “can-do attitude” would propel them ahead of other countries who had decades of experience under their belts. They chose not to follow their comparative advantage, and not to export what the world wanted.

Avoiding risky actions in policy-making is paramount for stability of the economy, especially when one relies heavily on foreign investment, as investors can easily be scared off. South Korea chose during its first twenty years of development to maintain peace on the peninsula, invest only in areas in which it was sure it would have a strong comparative advantage, and establish firm rules on foreign ownership of Korean firms. However, this does not mean there were periods of instability. As shown in

141 Ibid, 20. 142 Ibid, 29.

Figure 3-3, during the 1970s inflation levels were quite high, reaching 25% in 1975 and 28% in 1980.

Inflation was not battled seriously by contracting investment, as “[l]ong term growth was preferred to short term stability.”143 North Korea, on the other hand, is no stranger to radically unstable macroeconomic environments. Inflation has always been an issue, but after the 7.1 measures in 2002, inflation skyrocketed to triple-digits.144 This became even worse after the 2009 currency reform, in which it rose to quadruple-digits, leading to the execution of Pak Nam Gi, who supposedly “spearheaded the currency reform.”145 In addition, one of the North’s biggest sources of foreign currency revenue is the Kaesong Industrial Complex (KIC), whose profitability is subject to inter-Korean relations, which are usually soured by North Korea itself.146 In 2013, North Korea unilaterally closed the KIC for half of the year, costing itself millions of dollars in lost revenue, especially as it allowed the businesses to forgo paying taxes for that year to make up for lost profits.147 However, nothing has caused more instability than the rocket launches and nuclear tests that even cause investors in South Korea to worry. These tests have brought sanctions upon the regime that give investors pause when they look at North Korea, as they know there will be a mountain of paperwork to prove that manufactured goods comply with UN

Security Council Resolutions 1718 (2006) and 1874 (2009), which prohibit trade in any good that could also be used in a weapon of mass destruction.

South Korea managed to raise savings in the 1960s and 1970s to levels much higher than they had been in the 1950s (Figure 3-4). This was mostly accomplished by controlling consumption expenditure and raising taxes to increase revenue, allowing it to accumulate massive capital to be used

143 Ibid, 32. 144 “North Korea Inside Out: The Case for Economic Engagement,” Asia Society Center on US-China Relations (Dec 2009), 10. 145 Choe Sang-hun, “N. Korea Is Said to Execute Finance Chief,” The New York Times, March 18, 2010, accessed April 9, 2015, http://www.nytimes.com/2010/03/19/world/asia/19korea.html?_r=0; Peter M. Beck, “North Korea in 2010,” Asian Survey, Vol. 51, No. 1 (Jan/Feb 2011), 38. 146 Consider the 2010 sinking of the ROKS Cheonan and bombardment of Yeonpyeong Island. 147 Choe Sang-hun, “Jointly Run Factory Park in North Korea Resumes Production,” The New York Times, September 16, 2013, accessed April 9, 2015, http://www.nytimes.com/2013/09/17/world/asia/jointly-run-factory-park-in- north-korea-resumes-production.html.

Figure 3-4: South Korea Gross Domestic Savings Rate, 1960-1997 (% of GDP) 40 35 30 25 20 15 10 5 0

Source: World Bank for domestic infrastructure.148 This infrastructure included both the “hard” and “soft” varieties. Roads, bridges, railroads, communications, electricity, ports, and airports were all either constructed or improved upon in this period.149 Soft infrastructure likewise was expanded, with heavy investments in education (already having been improved in the 1950s and early 1960s due to aid from the US) and healthcare (the National Health Insurance Service was created in 1977).150 North Korea, on the other hand, has never been able to maintain high savings rates, as it has historically relied on aid, grants, and loans, while the population most likely feared saving due to high inflation. From 2002 until 2009, there were higher rates of household savings due to market activities, but the 2009 currency reform nearly wiped out all household savings. Moreover, as there is a defined lack of banking institutions for personal saving in North Korea, the government would have had limited abilities in collecting tax revenue from these household savings in the first place. Investments in infrastructure have therefore always been lacking. In the 1960s, Kim Il Sung was able to ensure that all households had electricity, access to health services and a stable supply of food, in addition to having built roads, ports, airports, bridges, railroads and other infrastructure, but as the economy dwindled and there was no capital

148 Chaudhuri, “Government and Economic Development,” 22. 149 Kae H. Chung, “Industrial Progress in South Korea,” Asian Survey, Vol. 14, No. 5 (May 1974), 440-442. 150 Chaudhuri, “Government and Economic Development,” 33; Sungnam Cho, “The Emergence of a Health Insurance System in a Developing Country: The Case of South Korea,” Journal of Health and Social Behavior, Vol. 30, No. 4 (Dec 1989), 468.

Table 3-2: Sample Price Changes as a Result of 7.1 Reforms in North Korea (2002) Commodity Price before reform Price after reform Rice (1 kg) 0.08 KPW 44.0 KPW Electricity (1 kWh) 0.035 KPW 2.1 KPW Pyongyang Subway Fare 0.1 KPW 2.0 KPW Basic Monthly Worker Wage 110.0 KPW 2000.0 KPW Source: Christopher D. Hale, “Real Reform in North Korea? The Aftermath of the July 2002 Economic Measures,” Asian Survey, Vol. 45, No. 6 (Nov/Dec 2005), 825. accumulation, all of these services either disappeared or were in very poor condition by the end of the

1990s.151

Allocation of resources through centrally-planned economic systems is efficient only at the beginning of a development push when there is no credible market or industrial base yet established.

This allows for the government of a nation to choose how best to pursue industries that follow the nation’s comparative advantage. However, after an adequate amount of growth has been achieved, it is best for the market to begin dictating prices and supply schedules and for decision-making to be decentralized to the firm level. South Korea controlled these areas during the presidency of Park Chung- hee during the 1960s and 1970s through the Economic Planning Board (EPB), but beginning in the 1980s, control was given up in favor of market allocation of resources.152 North Korea did not begin experimenting with market allocation of resources until the 7.1 measures in 2002. Though allowing the market to determine price levels was a step in the right direction, this move was not fully carried out in a responsible manner, resulting in high levels of inflation following the reforms (Table 3-2). Even to this day, the official exchange rate and black market exchange rate are vastly different. However, it seems that now Kim Jong Un is taking steps to allow for the market to determine what goods should be prioritized for consumption in the markets, perhaps in an effort to lower prices.153

One of South Korea’s greatest advantages during its development period was the fact that

151 Schwekendiek, Socioeconomic History, 66, 127. 152 Chaudhuri, “Government and Economic Development,” 23-26. 153 “North Korea Increases Production of Consumer Goods According to Consumer Demands and Preferences,” The Institute for Far Eastern Studies, NK Brief, August 25, 2014.

President Park Chung-hee was actually committed to developing the economy of South Korea, and knew how to implement changes properly. This was evident in the power given to, and people chosen for, the

Economic Planning Board (EPB), which oversaw the development of the South Korean economy in the

1960s and 1970s. The EPB was staffed with “talented and zealous personnel” who were just as eager as

Park to see their homeland become strong. He was also seen as incorruptible, with an ability to limit the amount of corruption happening under his regime.154 His commitment was obvious. His credibility was somewhat shakier as he took power in a coup, which gave extra impetus to ensure economic development so that his rule would appear more legitimate in the eyes of his countrymen.155 His capabilities were defined by the success of his endeavors and the stability of his rule, backed by the military (being a military man himself) and the intelligence service. Additionally, his abilities to choose the right people, the right industries and the right firms showed his talents.156 As for North Korea, one could say that its leadership completely lacks commitment, credibility or capabilities when it comes to the economy or the lives of its citizens. The existence of the Suryong economy and its exploitation of the planned economy—on which most people previously relied for their well-being—show that the leadership (under Kim Jong Il) cared nothing for the people, but only for its own continued existence.

Under Kim Il Sung, there was a strong commitment, but the credibility and capability were lacking. The creation of the Songbun system of socio-political classification in the 1950s (still in existence today), in which people were grouped into three categories—core, wavering or hostile—is a poor tool for control, as it leads to economic inefficiencies due to unequal development of human capital.157 Under Kim Jong

Un, it does appear that there are some commitments to improving the economy, as the reforms

154 Ronald J. Gilson and Curtis J. Milhaupt, “Economically Benevolent Dictators: Lessons for Developing Democracies,” The American Journal of Comparative Law, Vol. 59, No. 1 (Winter 2011), 246-247; Chaudhuri, “Government and Economic Development,” 23. 155 Gilson and Milhaupt, “Benevolent Dictators,” 245. 156 Ibid, 247-248. 157 Robert Collins, Marked for Life: Songbun North Korea’s Social Classification System (Washington, DC: Committee for Human Rights in North Korea, 2012), 1.

59 announced in 2013 and 2014 show, but other activities in his life show that he seems more committed to enjoying his time in power, such as the creation of a “pleasure squad” of beautiful young women, or spending US$600 million a year on luxury goods, despite sanctions on their importation into North

Korea.158

The five characteristics of the thirteen successful countries were what sustained development over long periods, rather than having short bursts, as North Korea did in the 1950s. North Korea has exhibited none of these traits in a sustained manner. Adhering to these qualities is the first step in starting a development program. In the next section, I will give a general outline of Lin’s proposed method, which I will then incorporate into my own suggested path for growth in the final chapter.

3. General Outline of Proposed Method

Lin’s essential argument is that countries that wish to develop must do so according to their comparative advantage. Their comparative advantage is determined by their structure of factor endowments (relative abundance of production factors, such as physical and human capital, labor and natural resources). These endowments determine not only comparative advantage, but also the budget and relative factor prices. Additionally, they evolve over time as countries reach higher levels of development and thus must shift into new industries that reflect the new comparative advantages they hold. In order to follow this method, Lin proscribes “two tracks and six steps.”159

The two tracks are growth identification and growth facilitation. One must look at the resources available to a country and decide what industry best matches those resources. The best way to do this is to look at what countries which have similar endowment structures but with higher income did in the

158 Julian Ryall, “Kim Jong-un brings back ‘pleasure troupe’ entertainers,” The Telegraph, April 2, 2015, accessed April 10, 2015, http://www.telegraph.co.uk/news/worldnews/asia/northkorea/11510664/Kim-Jong-un-brings- back-pleasure-troupe-entertainers.html; “Kim Jong-un Spends $600 Million on Luxury Goods a Year,” Chosun Ilbo, February 19, 2014, accessed April 10, 2015, http://english.chosun.com/site/data/html_dir/2014/02/19/2014021900954.html. 159 All information for this explanation comes from: Lin, Quest, 149-177, unless otherwise noted.

60 past. As a country’s economy grows, it may lose its comparative advantage in a labor-intensive sector as wages rise. However, it will have also accumulated massive amounts of capital and be able to invest in infrastructure that supports higher levels of industry. This allows the industry that the richer country had previously targeted to become open and ready for a new developing country to enter. By exploiting the advantage of backwardness, developing countries can more quickly move up the industrial ladder than the richer country had when it first entered said industry.160 If the developing country is resource- intensive (as North Korea is), it is best to look at richer countries that are endowed with similar resources, or at least were during their initial development stage. Once one identifies the appropriate industry, one must focus on infrastructure that would best be of assistance to growing said industry. For example, if your country is naturally abundant in marine animal life, fishing would be the industry to develop. To grow this industry, the government would construct ports for fishermen, facilitate financial institutions that could lend to fishermen at affordable rates, build communications and weather- measuring infrastructure so that fishermen could find the best times to go out and find the best markets for selling their goods, roads and railroads for transporting food inland, educational facilities to train future fishermen and their support staff, and healthcare facilities to take care of fishermen when they become sick. Once this industry becomes obsolete, much of this infrastructure could be useful for the next level of industrialization and will not have to be built from the ground-up, which would be costly and time-consuming for a higher level of development.

In addition to these two tracks, there are six steps involved in Lin’s method. The first step is related to growth identification in that one must choose the right target. This can be done by identifying a “list of dynamically growing tradable goods and services that have been produced for about 20 years

160 Erich Weede, “Economic Freedom and the Advantages of Backwardness,” CATO Institute Economic Development Bulletin No. 9, January 31, 2007, accessed April 10, 2015, http://www.cato.org/publications/economic-development-bulletin/economic-freedom-advantages-backwardness. “Backwardness” means being able to “borrow technologies, business models and marketing procedures from more advanced economies.”

61 in fast-growing countries with similar endowment structures and a per capita income that is about 100 percent higher than its own.” Here per capita income is measured in purchasing power parity. It would be best to find “simple labor-intensive manufacturing goods that have limited economies of scale and require only small investments” in order to minimize the amount of initial investment capital. Until a country’s income reaches roughly US$20,000 (in current dollars), it can continue to rely on the work of those who came before it. However, from this point on it has reached the “global frontier” and must rely on domestic innovations.

The second step is removing binding constraints. Firms themselves take the risk of entering an industry that may or may not be profitable for them. If this is an industry that the government has targeted (complying with the method from the first step), the government should then help the firms that have entered this industry by removing obstacles to growth. This involves allowing access to adequate investment capital, building proper infrastructure, enforcing laws against corruption and rent- seeking, providing skilled labor, creating appropriate labor regulations, and growing human capital.

Working together with firms to identify obstacles through public-private partnerships will allow firms to scale up quickly and become net exporters.

The third step is to attract global investors. For a developing country, domestic funding for investment is extremely limited. The best way to overcome this problem is to allow for foreign firms to open factories in the developing country in order to utilize cheap sources of labor. However, as information about the “feasibility of a new industry” can make firms (both foreign and domestic) uneasy at bearing the risk of investment, the government should do all that it can to encourage these firms to invest. Methods to attract foreign firms include tax exemptions, low cost structures, low levels of corruption, a stable political system, a committed government, and an educated pool of labor. The benefits of foreign firms investing in a developing country include technological spillovers in the domestic economy, which can help domestic firms to catch up more quickly with the rest of the world.

New market channels open up as introduced by foreign firms. Extremely important too are the managerial skills that foreign firms can teach to citizens of a developing country. These skills will allow managers to more efficiently and effectively run new domestic firms once development truly kicks in.

The fourth step in Lin’s proposed method is to scale up self-discoveries. Suppose a domestic firm decides to enter an industry that, while exploiting the comparative advantage of the developing country, was not previously considered a targeted industry by the government. This firm then becomes successful, showing that this is a viable industry that the country can take advantage of and grow. The firm should be rewarded for making this discovery and being the first to enter (and therefore shouldering a great deal of risk). The government should immediately step in and remove barriers to growth in accordance with the second step. However, as an extra incentive, the government should award patents and trademarks, tax exemptions, short-term subsidies and discounted loans to scale up the firm and, therefore, the industry much more quickly.

The fifth step that Lin recommends is utilization of special economic zones (SEZs). SEZs can be a miracle cure for developing countries that do not have sufficient infrastructure covering the entire country or do not wish to rapidly change their economies for fear of unstable macroeconomic environments. Creating an area in which special economic laws apply can attract foreign firms who would otherwise choose not to invest in the regular domestic economy. In addition, external economies of scale among firms can easily be created by prioritizing hard infrastructure in SEZs so that firms do not have to wait on the entire country to be upgraded. This induces industrial clustering, in which firms from the same industry will operate in the same business park, allowing supporting businesses to operate in the same area and serve a greater number of firms, thus increasing efficiency and adding to national income. Building SEZs with access to warm-water ports, airports, rail transport and roads is essential. This reduces costs of trade tremendously, allowing firms to reach a greater number of markets and reinvest in the local economy. Citing World Bank estimates, Lin posits that a “10 percent

63 increase in infrastructure assets directly increases GDP per capita by 0.7 to 1.0 percent.” I will cover the benefits of SEZs further in Chapter 5.

The final step is to provide limited incentives to the right industries. Lin is very careful in this regard, as his entire thesis rests on how the government should support and direct industry, but not to the point that it creates distortions through incentives as ISI-pursuing nations did in the 1950s and

1960s. For this reason, pioneering firms in the industries that the government has targeted should be given incentives, similar to those firms who make discoveries as shown in the fourth step. Subsidies, income tax holidays, directed credits to assist with investments, or foreign reserves access for importing essential equipment are some of the incentives that Lin suggests. Doing this for a limited amount of time will reward pioneer industries for taking the risk to start a new industry. This will allow the firm to grow and provide incentives for newcomers to quickly join the industry, thus growing the economy.

New structural economics is a pathway to development for underdeveloped countries that are looking at how to raise their economies to a higher level. However, I argue that while the strategy is a great one, it is somewhat incomplete. It should be augmented with a focus on global value chains

(GVCs) and with a stronger emphasis on the use of economic zones in order to more fully control the process, as the North Korean leadership desires. In the following chapter, I explore GVCs, their impact on East Asia, and the potential they offer to North Korea.

Chapter 4 – Global Value Chains

Global value chains (GVCs) have become the de facto method of production in East Asia since the 1990s, and are growing to encompass world production and trade. Numerous studies have been done on the benefits of participating in GVCs for both firms and countries. For developing countries,

GVCs provide a way to accelerate growth faster than what the East Asian development model provided in the 1960s and 1970s. In this chapter, I will first give a definition of GVCs along with a brief history

(focused primarily on East Asia), and then explain how they are beneficial for developing nations and the impact they have made in East Asia.

1. Definition and History

Global value chains are defined by “fragmented supply chains, with internationally dispersed tasks and activities coordinated by a lead firm.”161 The key words are highlighted within the UNCTAD report from which this definition comes: fragmented and coordinated. GVCs are chains because they break up the production process of a good in a way that allows firms to take advantage of economies of scale and comparative advantages in different countries. Much like Adam Smith’s pin factory, in which the manufacture of a pin was broken up between several workers—rather than each worker making an entire pin—to increase production, more and more firms nowadays are breaking up the manufacture of various parts of their products all over the world. The value chain is not just the production of a good, however, but rather “the entire sequence of productive (i.e. value-added) activities, from the conception of a product to its manufacturing and commercialization.”162 This involves planning, pre- production, parts production, assembly, marketing, sales and after sales service, among others.

161 “World Investment Report 2013,” United Nations Conference on Trade and Development, (Geneva, 2013), 125 (emphasis original). 162 Hubert Escaith and Satoshi Inomata, ed., Trade Patterns and Global Value Chains in East Asia: From Trade in Goods to Trade in Tasks (Geneva: World Trade Organization, 2011), 10.

Originally, parts production and assembly were the links in the chain that were offshored to foreign countries, but now nearly all links in the chain are being done abroad in countries that specialize in those specific areas.

This is the core of GVCs. Countries no longer design, manufacture, assemble, sell and support a product in one country. Now, different countries will specialize in certain areas, certain industries and perhaps only export certain parts. This allows for maximum efficiency in that a single country can sell similar parts to different firms for a wide variety of products, and firms can shop around in different countries for the lowest price at the best quality.163 In probably the most commonly cited example, a

2009 paper entitled “Innovation and Job Creation in a Global Economy: The Case of Apple’s iPod” showed the path that is taken to manufacture an iPod. Inputs for the hard disk drive (HDD) are manufactured in China, the Philippines, Japan, Thailand and Singapore, the HDD is then fully manufactured in China and the Philippines, the memory chip in South Korea and China, other chips in

Taiwan and various countries, the printed circuit board assembled and tested in China, the display panel in Japan, and the final assembly done in China and Taiwan. Meanwhile the engineers, designers and managers are located in the US and Singapore, while distribution, freight, retailing and after sales services are performed in various countries around the globe.164 Each country is able to concentrate only in the area in which it holds a comparative advantage, lowering production costs overall.

How did this begin? International economist Richard Baldwin calls the period beginning in the

1950s the “second unbundling,” in which trade costs began dropping and trade flows began rising, due primarily to tariff liberalization and more efficient and well organized global transportation methods

(such as containerization.) As communications technology improved and the wage differentials

163 For example, semiconductors, which are used in a very wide range of electronics and are manufactured primarily by the United States, South Korea, Japan, Taiwan, Singapore and the European Union, with China and Malaysia gaining a foothold. 164 Greg Linden, Jason Dedrick and Kenneth L. Kraemer, “Innovation and Job Creation in a Global Economy: The Case of Apple’s iPod,” UC Irvine Personal Computing Industry Center (2009), 228.

66 between developed and developing nations were realized, leading industrial nations began to offshore production to the less developed nations.165 In Asia, Japanese firms took the lead through vertical integration of the production process in various Asian countries: the most complex components would be manufactured and assembled in Japan, with lower-value components to be manufactured and assembled in less developed countries in which wages were much lower. By the mid-1980s, Japan had created a system in which they had components manufactured and assembled primarily in resource-rich

Malaysia and Indonesia. After the Plaza Accords, Japan had to find cheaper ways to manufacture their goods and bigger markets than just the US and EU. They began accelerating the movement of entire production facilities into other East Asian countries, as well as selling more goods to the Newly

Industrialized Economies (NIEs).166

By 1995, the United States entered the production networks initially set up by Japan, taking advantage of contacts between supplier firms in Malaysia and Singapore. It later added the Philippines to its chains. By 2000, China had begun establishing new chains and networks and taking over ones previously dominated by Japan. By 2005, China had completely pushed Japan and the United States to the side and came to dominate the entire production process, in which parts and components were manufactured in (primarily) Southeast Asian countries with final assembly and export performed in

China itself.167

The vast acceleration in this process was made possible by the revolution in communications made in the late 1980s and early 1990s with the rise in telephones, fax machines and the Internet in

East Asia, along with the switch from import-substitution industrialization (ISI) methods of development to export-oriented industrialization (EOI) methods among developing East Asian nations. Liberalization

165 Richard Baldwin, “Global supply chains: why they emerged, why they matter, and where they are going,” in Global Value Chains in a Changing World, ed. Deborah K. Elms and Patrick Low (Geneva: World Trade Organization, 2013), 15-16. 166 Escaith and Inomata, “Geometry,” 140-142. 167 Ibid, 142.

67 of trade barriers has made a huge impact as well, allowing timely flow of goods from country to country.

2. Benefits to Developing Nations and Impact on East Asia

Baldwin states that “[t]he offshoring of labour-intensive manufacturing stages and the attendant international mobility of technology launched era-defining growth in emerging markets.”168

Wealth from exports has been shifting increasingly from mature economies, such as the US, Canada and the European Union, to the developing countries of East Asia. East Asia managed to surpass these North

Atlantic economies in the late 1990s in terms of GVC participation and breadth.169 This has caused a

“de-industrialization” of the global North while the global South industrializes and takes over export markets, in both production and consumption. Firms have been flocking in droves to East Asia as a result in order to take advantage of the low wages, skilled workers and efficient production created due to external economies of scale.

This has caused a major change in the composition of exports. Exports are now made up of more than 50% intermediate goods, primarily in Asia, Europe and North America, but with growth happening fastest in Asia (7.2% between 1995 and 2009).170 This shows more than simply a decline in the North Atlantic economies in GVC; it also shows that GVCs are truly regional in nature. A growth in trade in intermediate goods reflects regional integration. Parts and components are imported in East

Asian countries, and then re-exported to other East Asian countries for further value-adding or assembly. 64% of Asia’s 2008 intra-region imports were intermediate goods.171

Throughout this same period, we have seen tremendous economic growth in ASEAN countries.

From 2001-2013, there was 4.04% growth in all current ASEAN countries (without Myanmar), as shown in Figure 4-1. Growth particularly took off after the 2008-2009 Global Financial Crisis, especially in

168 Baldwin, “Global supply chains,” 13. 169 Ibid, 18. 170 Escaith and Inomata, Trade Patterns, 82. 171 Ibid, 84.

Figure 4-1: GDP Growth of current ASEAN countries (except Myanmar), 2001-2013 (Trillions of current US$)

14 12

10 Trillions 8 6 4 2 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: World Bank Note: Data for Myanmar not available

Thailand, Indonesia and Laos. If we include China, the growth rate becomes 6.1%. This reflects China’s role as the lead organizer of these regional chains.

What causes this growth? In the past, countries like Germany, Japan and the United States would have to invest for decades in building up their infrastructure and creating entire industries before becoming competitive. For those who chose the ISI method, this was met with disaster as the governments of these countries inevitably chose to target heavy industry and other capital-intensive sectors without having adequate capital or a strong economic base from which to work. For those who chose the EOI model, it was a more sound process but still took a great deal of time, as the production facilities for the entire production process would have to be built, maintained and upgraded. An entire good would be produced completely within the borders of a country, sometimes in one factory, an extremely inefficient use of resources, time and money. This led to growth, but not as fast as was possible. With GVCs, “now they [developing nations] can join supply chains rather than having to invest decades in building their own,” a method that is “drastically faster and surer than the old import- substitution route.”172 Now developing nations simply invest in particular industries in which they can have a comparative advantage and manufacture parts and components (or do assembly) for groups of multinational firms (MNFs).

172 Baldwin, “Global supply chains,” 13 & 24.

This also introduced a new method of attracting FDI and jobs: unilaterally liberalize trade restrictions and investment policies to make your country look more attractive to firms. This is also reflected in the willingness of East Asian nations to join more free trade agreements (FTAs), especially regional free trade agreements (RTAs), such as the ASEAN Free Trade Area (AFTA) and FTAs signed between ASEAN and China, Japan and South Korea. These RTAs facilitate faster movement across borders of goods, allowing for further growth and more rapid movement up the chain.

As developing nations join GVCs, they receive more than compensatory wages. Two vital spillovers occur: technology and management know-how. As workers and managers become accustomed to increasingly complex technology employed by MNFs, they are able to easily move between factories and, in some cases, industries. They are also able to help grow domestic industries.

Domestic firms in a developing country that has joined GVCs begin by doing what is known as “Original

Equipment Manufacturing,” or OEM. This means that the firm is producing parts and components designed by another firm for the second firm’s final product. In other words, they are a subcontractor.

Sometimes they will receive a license to use the technology only in the manufacture of the good they have been contracted to make, and other times they will be allowed to continue to use that technology.

Either way, the workers and managers are now familiar with the technology and will be able to use it in the future. This allows firms in the country to move up the chain.

In addition, good management skills are learned. In a country like North Korea, factories and state-owned firms have never truly been subject to actual, sustained management techniques. Instead, the government chose “on-site guidance” as its method of directing workers on how to best complete tasks. This involved Kim Il Sung, then Kim Jong Il, and now Kim Jong Un going directly to farms and factories, instructing the workers and managers on how to do their jobs, how to handle conflicts, and how to improve efficiency, even if it happens to be an industry about which the leaders know nothing.

In addition to this, the workers and overseers absolutely must abide by whatever guidance the leaders

70 give.173

Many developing nations also are not aware of proper management techniques. When MNFs decide to invest directly in a country by building a factory, they will often send some of their own people to directly manage the work in order to ensure that the work is properly and efficiently done. Of course these managers will need to hire locals with a higher level of education to become assisting managers.

In time, these local managers can move up in the ranks or move to other firms knowing that they are more qualified with their managerial experience and knowledge.

However, when a firm moves up the chain, what happens? It is usually expected that this means it will move on to more complex industries; say from garment and textile manufacturing to simple electronics to heavy industry. However, there is somewhat more to it than that. There are four kinds of innovation. The first is “process innovation,” in which firms will try to improve their internal efficiency and thus become more competitive with other firms in the same industry and thus attract more contracts from MNFs. The next is “product innovation,” in which domestic firms who actually create original products (more on this in a moment) try to improve upon those products through learned technology or new market relationships. The third is “functional innovation,” in which the firm tries to expand its capabilities and thus provide more value-added to goods (whether intermediate or final) which it produces. The final is “inter-chain innovation,” in which a firm seeks to move to a higher- level value chain, say from radios to televisions.174

When choosing to innovate, there are two essential pathways one can take. Both paths begin in the lower left-hand corner of the square (Figure 4-2) when domestic firms are OEM firms. Should one desire to greatly expand their market and move into the world of logistics as opposed to production, one would move from OEM to GLC, or “Global Logistics Contracting,” in which MNFs place orders with

173 Armstrong, Tyranny, 110. 174 Olga Memedovic, ed., “Inserting Local Industries into Global Value Chains and Global Production Networks: Opportunities and Challenges for Upgrading, with a Focus on Asia,” United Nations Industrial Development Organization working paper (Vienna, 2004), 9-10.

Figure 4-2: Leveraging Strategies for Developing Countries in GVCs firms with whom they have worked in the

past to produce certain products; these

contracted firms then sub-contract out

the work to firms lower on the value

chain (with whom they have made

contacts in the past) in countries with

lower wages, thus making profits as

middle-men. Successful GLC firms will

have networks in dozens of countries with

Source: Memedovic, “Inserting Local Industries,” 11. hundreds of firms. For this, highly specialized managerial skills with a strong focus on coordination are required. From here, the firm can eventually move into OBM, or “Own Brand Manufacturing,” in which they may choose to buy out a brand and distribute this brand’s products themselves. The Fung Group, based in Hong Kong, moved from being an OEM supplier of Liz Claiborne products in the 1970s and 1980s into eventually providing retailing of their own. They now distribute for several retail brands (many exclusively) in Asia, including

Circle K, Toys “R” Us and Hang Ten.175 This kind of chain is usually considered a “buyer-driven” chain and is most prevalent in developing countries, as it is primarily concerned with light industries, such as agriculture, toys, footwear, garments and textiles. Developing powerful brand names and protecting intellectual property are the foci of firms in this type of chain.176

The other path involves moving horizontally across the square in order to upgrade one’s technology and capabilities. As firms grow, they will start to make their own designs while still manufacturing products for other companies. They attempt to master crucial technologies and then to

175 “Fung Group Retailing,” accessed April 12, 2015, http://www.funggroup.com/eng/businesses/retailing.php. 176 Memedovic, “Inserting Local Industries,” 10-12.

72 develop their own. They begin releasing products in conjunction with other firms in the same industry, as Hyundai did in the 1960s and 1970s. In 1968, Hyundai released the Cortina after signing a technology-share agreement with Ford Motor Company that allowed them to design their own car. In

1975 they did the same with the Pony, only this car was designed even more by Korean engineers, with the only significant non-Korean part being the engine, which was taken from the Mitsubishi Colt in cooperation with Mitsubishi Motors.177 As time went by they were able to develop their own designs first with other companies, and then eventually on their own. As firms do this, they eventually are able to fully create products under their own brand and distribute them either by themselves or through a retailer, having reached OBM status. This type of chain is usually called a “producer-driven” chain, as it is characterized by the firms steering the direction of production towards what they wish to design and produce. There is heavy emphasis on R&D and maintaining control of supply chains by sharing technology only with trusted firms. Heavy industry-focused nations are typical of producer-driven chains, with the NIEs of East Asia being the best examples.178

Vietnam is a success story of a developing nation that chose to join GVCs as part of its EOI growth method. Since the Doi Moi reforms in 1986, Vietnam heavily focused on the textiles and garments industry as an engine of growth. Since that time it began to rapidly advance, and after signing the Bilateral Trade Agreement with the United States, it was able to join many value chains created and maintained by Western firms throughout East Asia (Figure 4-3). This allowed it to accelerate its growth even more since that time, as it used the same technique in other industries.179 Following Vietnam’s accession to the WTO in January 2007, access to even more markets and firms was guaranteed, allowing

Vietnam to continue to expand its goal of growth through GVCs. Until the 2008 Global Financial Crisis

177 “Hyundai Pony Engine,” accessed April 14, 2015, https://www.asapmotors.com/used-hyundai-pony-engine-p- 7303.html; “Hyundai Brand History,” accessed April 14, 2015, http://www.autoevolution.com/hyundai/history/. 178 Memedovic, “Inserting Local Industries,” 10-12. 179 Kenta Goto, “Industrial Upgrading of the Vietnamese Garment Industry: An Analysis from the Global Value Chains Perspective,” Ritsumeikan Center for Asia Pacific Studies, Working Paper No. 07-1 (June 2007), 4.

Figure 4-3: GDP of Vietnam, 2000-2013 (Billions of current US$)

180 160

Billions 140 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: World Bank

Figure 4-4: Vietnam's Annual GDP Growth Rate, 2000-2013 (%) 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Source: World Bank exposed some flaws in the foundations of the Vietnamese economy, it was able to maintain growth between 6~8% annually. However, since the crisis, it has still managed to maintain 5~6% annual growth, and is seeing further growth due to the central government’s efforts at privatizing many SOEs (Figure 4-

4).180

While choosing to embrace export-oriented industrialization is essential, a developing country cannot hope to grow very much if it does not attempt to join and grow within global value chains. These have allowed the nations of ASEAN, as evidenced by Vietnam, to experience rapid growth over the last

180 Nguyen Dieu Tu Uyen, “Vietnam to Accelerate Privatization with Share-Sale Reboot,” Bloomberg, October 27, 2014, accessed April 14, 2015, http://www.bloomberg.com/news/articles/2014-10-27/vietnam-to-form-working- group-to-spur-state-firms-share-sales.

74 fifteen years. They have also allowed the NIEs in East Asia to maintain their leading position as drivers of industry in the region and indeed around the world. It will be crucial for North Korea to make this part of their strategy in the future, which I will expand on in Chapter 6. However, the question of where to operate factories and allow foreign firms to invest while still maintaining political control over the country is the topic for the next chapter.

Chapter 5 – The Role of Special Economic Zones

Special Economic Zones (SEZs) have played a special role in the strategies of developing economies for growth. They have provided a proving ground for experimentation as well as an opportunity for surgical separation of liberalized trade from the main economy in order to maintain stability. North Korea, during the late Kim Il Sung era and throughout the Kim Jong Il era, has made several attempts at development through SEZs; however, none of these have been particularly successful. Since Kim Jong Un has come to power, though, there has been a stronger emphasis on SEZs as a means of development and limited reform. In addition, the opportunity provided by China’s

Changjitu Project in Jilin Province gives a new importance to North Korean SEZs, Rason SEZ in particular.

In this section, I will first give a brief explanation on the significance of SEZs to development, and then outline the founding of Shenzhen SEZ in China in the 1980s, followed by an analysis of North Korean

SEZs, keeping Rason SEZ as the central focus.

1. Significance of SEZs

What exactly is meant by the term “special economic zone?” A general definition provided by the World Bank states that SEZs are:

“[D]emarcated geographic areas contained within a country’s national boundaries where the rules of business are different from those that prevail in the national territory. These differential rules principally deal with investment conditions, international trade and customs, taxation, and the regulatory environment; whereby the zone is given a business environment that is intended to be more liberal from a policy perspective and more effective from an administrative perspective than that of the national territory.”181

In simpler terms, an SEZ is a place where a country can have an entirely different economic structure

181 Claude Baissac, “Brief History of SEZs and Overview of Policy Debates,” in Special Economic Zones in Africa: Comparing Performance and Learning from Global Experience, ed. Thomas Farole (Washington DC: World Bank, 2011), 23.

Table 5-1: Summary of Types of Zones Development Typical Type of Zone Typical Size Activities Markets Examples Objective Location Free Trade Entrepôt and Zone Domestic, re- Colon Free Support Trade <50 hectares Port of Entry trade-related (Commercial export Zone (Panama) activity Free Zone) Manufacturing Traditional Export Bangladesh, <100 hectares None or other Mostly export EPZ Manufacturing Vietnam processing Free Manufacturing Enterprises Export Mauritius, No minimum Countrywide or other Mostly export (single unit Manufacturing Mexico processing EPZ) <100 hectares; Manufacturing Export Export and La Krabang, Hybrid EPZ only part of None or other Manufacturing domestic Thailand area is EPZ processing Internal, Integrated Aqaba, Freeport/SEZ >1000 hectares None Multiuse domestic and Development Shenzhen export Source: Thomas Farole & Gokhan Akinci, ed., Special Economic Zones: Progress, Emerging Challenges, and Future Directions (Washington DC: World Bank, 2011), 2. than that of the domestic economy, with this structure usually being far more liberal. According to

World Bank publications, there are five broad categories into which most zones fall (Table 5-1), and four main reasons for creating zones. Out of the five categories, I will be using the term “export processing zone” (EPZ) to cover the first four categories, and SEZ to cover the final category. In a very general sense, an EPZ refers to a zone whose focus is manufacturing for export. An SEZ, on the other hand,

“usually combine[s] residential and multiuse commercial and industrial activity.”182 The key difference here, then, is that an EPZ usually only houses the factories and necessary offices for a firm, while an SEZ will also, in general, contain residential areas and other firms providing support services for the primary firms. However, there can be some overlap between these two. In general throughout this chapter and the next, I will use the term “SEZ” unless specifically referring only to export processing zones.

The World Bank’s four reasons sum up the reasons to create an SEZ rather succinctly. The first is to attract foreign direct investment (FDI). Nearly every SEZ in the world has this purpose in mind. For poorer countries, access to investment capital is extremely limited, and so building new industries can only occur with outside assistance. Rather than financing development through massive debt, FDI can

182 Farole and Akinci, Special Economic Zones, 3.

77 ensure that the investing firm will have a stake in the continued success of any of its investments. The second reason for zones is to ease unemployment by acting as “pressure valves.” Even if a zone does not bring the economy-changing miracle some countries hope for, the tax incentives and low wages offered by the government will at least provide stable employment for those who could not find work in the domestic economy, due either to saturation or lack of skills. The third reason is to serve as the foundation for wider economic reform. This allows for the protection of domestic industry while gradually introducing reforms that defy “anti-export bias.” Finally, the last reason is to serve as experimental labs where new policies and approaches can be tested. Different labor, financial, industrial or legal policies can be tested within these small areas without having any significant effect on the rest of the economy. Should certain policies prove to be beneficial, they can then be introduced nation-wide.183

There are many cases of both success and failure in SEZs, and it is important to learn from both.

Success is hinged on how well SEZs are introduced and managed. The host countries first need to attract firms that create jobs (a static measure of success). This involves choosing a clear definition of which industry one wants to develop (in line with comparative advantage), advertising it well, and offering the right set of incentives for firms to both come and stay. Incentives usually involve tax holidays, reduced tax levels, reducing regulatory burdens and waiving import and export duties.

Additional “unwritten” incentives involve removing constraints by clarifying vague laws, having a commitment to stand against corruption, and providing proper infrastructure. Next, host countries should make zones economically sustainable in that they facilitate upgrading, structural transformation and economic reforms (a dynamic measure of success). More specifically, how much do the SEZ and the domestic economy work together? How strong are backward linkages and technology transfers? Do workers and managers move “out of the walls” into the domestic economy and help grow domestic

183 FIAS, Special Economic Zones: Performance, Lessons Learned, and Implications for Zone Development (Washington DC: World Bank, 2008), 12.

78 firms (or start their own)? Can new industries be created without much hassle, as comparative advantage changes within the country? The answers to these questions determine the rate of success of an SEZ with regard to sustainability and growth. Lastly, success is determined by non-economic benefits to society; i.e., institutional, social and environmental benefits. Are workers’ and women’s rights guaranteed? How much upward social mobility is attained? Though this third measure lies outside of the scope of this paper, it is an important area that should be addressed by the host country when devising zone policy.184

There are several causes of failure in SEZs, but I will mention the most prominent ones. The first is choosing a poor location for the zone; that is, a lack of proximity to necessary areas. It should have access to a port that is on a common shipping route or could become part of a common shipping route.

If not, access to an airport is a second-best strategy (though having both is ideal). It should also be located near a heavily-populated area in order to draw on a steady pool of labor. Should the manufacturing firms require natural resources, being in close proximity to mines is optimal. All of this allows for minimal capital expenditures by both firms and the government. Transportation and infrastructure costs could be kept to a minimum. The next cause is having uncompetitive policies. For example, maintaining an overreliance on tax holidays (many countries allow for tax holidays of 10 years to firms located in SEZs). In fact, Baissac notes that “reduced tax levels rather than tax holidays or exemptions are correlated with higher levels of investment.”185 In addition, if there are poor labor policies or practices, this can have negative consequences. These uncompetitive actions combine to form a race to the bottom amongst competing economies and can hinder growth. If no revenue whatsoever is collected, it is hard for the government to invest in further infrastructure. If firms are able to pay the lowest possible wages at all times, workers will have a difficult time making ends meet and there will be less of an incentive to work within the SEZ. Uncompetitive practices can also infer that the

184 Farole and Akinci, Special Economic Zones, 7-18. 185 Claude Baissac, “Which Factors Matter for the Performance of SEZs?” in SEZs in Africa, 123.

SEZ has nothing else of benefit to offer. Firms will of course be attracted to tax incentives, but they are looking for quality infrastructure, quality labor and most importantly, long-term sustainability.

Cumbersome regulations, procedures and controls can also prevent SEZs from being successful, as firms may not wish to invest, and those who do invest will be spending valuable time and resources on complying with these regulations. Related to this, governments need to be clear when assigning who is in control of SEZs, what they are responsible for, and what they have the power to do (and not to do).

Having more than one authority responsible for administration over zones can be confusing for governments, firms, and workers, leading to less than optimal outcomes. A problem like this can lead to coordination issues between firms and governments, especially with regard to labor disputes and infrastructure provision.186

Keeping in mind these recipes for success and failure, we will now turn to analysis of Shenzhen

SEZ in China, followed by Rason SEZ in North Korea.

2. Shenzhen SEZ

Shenzhen began as a tiny fishing village on the Hong Kong border in Guangdong Province.

Located in the right place at the right time, it became the first SEZ during the initial stages of China’s reform and opening up in the late 1970s. In 1979, it had a population of 314,000, which by 2013 grew to just under 10,630,000 (Figure 5-1). In 1979, its GDP was US$31.68 million. By 2013 this grew to just under US$244 billion (Figure 5-2). It was the first location in China to attain per capita GDP of

US$10,000 (Figure 5-3).187 When it began, it was 396 km2 (covering four districts), and in 2010 Bao’an

186 FIAS, Lessons Learned, 5. 187 Xiangming Chen and Tomas De’Medici, “The ‘Instant City’ Coming of Age: China’s Shenzhen Special Economic Zone in Thirty Years,” Trinity College Center for Urban and Global Studies, Working Paper No. 2 (Spring 2009), 12.

Figure 5-1: Population of Shenzhen SEZ, Registered and Non-Registered, 1979-2013 (millions of persons)

12 10

8 Millions 6 4 2 0

Registered Non-Registered

Source: Shenzhen Statistical Yearbook, 2014

Figure 5-2: GDP of Shenzhen SEZ, 1979-2013 (billions of current US$)

250

200 Billions 150

100

Source: Shenzhen Statistical Yearbook, 2014

Figure 5-3: Per Capita GDP of Shenzhen SEZ, 1979-2013 (current US$) 25000

20000

15000

10000

5000

Source: Shenzhen Statistical Yearbook, 2014

81 and Longgang districts were added, increasing its size to 1,953 km2.188

Shenzhen began as a testing ground for the “socialist market” principles espoused by Deng

Xiaoping and the Third Plenum of the 11th Central Committee Congress of the CCP in 1978. It was designed with four pillars of activity in mind: 1) securing foreign funds for investment, 2) establishing foreign-domestic joint ventures and allowing for foreign-owned enterprises, 3) focusing on export- oriented manufacturing, and 4) continuing the principles of the socialist market economy.189

The proximity of Shenzhen to Hong Kong has been its most beneficial aspect. In the early days,

Hong Kong businesses opened up shop in the SEZ and made partnerships with businesses inside and outside of the zone. Much of the initial investment for infrastructure came from Hong Kong.190

Infrastructure in the early 1980s was lacking, and what was there was highly insufficient. There were major problems with electricity supply, and even by the mid-1980s there were not many paved roads.191

Electricity would continue to be a problem until 1992 when newly-constructed nuclear power plants in the Dapeung Peninsula came online, ending a cycle of “3-day supply and 1-day outage.”192 With investment from both Hong Kong and the central government, ports, highways and an airport were constructed, along with direct telephone connections to Hong Kong. The ports were expanded over time, with Shenzhen (as of 2013) now operating the world’s third largest container port (with Shanghai and Singapore in first and second place, respectively), with a volume of 23.28 million TEUs.193

Financing for the SEZ came from three sources: local banks, foreign banks, and the central government’s public financing schemes. Between 1979 and 1985, the number of local banks grew from

20 to 175, while the number of trust and insurance companies grew from 0 to 28. These local banks

188 “China expands Shenzhen special economic zone,” China Daily, June 2, 2010, accessed April 24, 2015, http://www.chinadaily.com.cn/business/2010-06/02/content_9925392.htm. 189 Im Geum-Suk, “Lessons for Rajin Special Economic Zone: The Shenzhen Experience,” in Outside Looking In: A View into the North Korean Economy, ed. J. James Kim and Han Minjeong (Seoul: Asan Institute, 2014), 113. 190 Ibid, 116-126. 191 Chen and De’Medici, “Instant City,” 11. 192 Im, “Shenzhen Experience,” 115. 193 “Top 50 World Container Ports,” World Shipping Council, accessed April 24, 2015, http://www.worldshipping.org/about-the-industry/global-trade/top-50-world-container-ports.

Figure 5-4: Overnight Tourism to Shenzhen SEZ, 1992-2013 (International and Domestic)

50 40

Millions 30 20 10

2007 2012 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2008 2009 2010 2011 2013

International Domestic

Source: Shenzhen Statistical Yearbook, 2014 Note 1: The figures of overnight tourists from 1990 to 1999 have been collected from hotels and guesthouses, and from 2000, include hotels, guesthouses, public houses and residential houses (from source). Note 2: International includes tourists from Hong Kong, Macau and Taiwan. were integral in financing infrastructure projects during this period. After 1985, foreign banks were allowed to invest capital in the SEZ with the “Regulations Governing Foreign Banks and Joint Chinese-

Foreign Banks in Special Economic Zones of the People's Republic of China.” Fourteen foreign banks were the first investors to come on board under this arrangement. Financing from the central government took on three main forms. First, the government utilized regional banks to create sources of capital, including the Shenzhen Special Zone Development Bank and the Shenzhen International Trust and Investment Corporation. Second, the government made long-term land leases available to firms who wished to operate in the zone. There were various types of leases depending on the purpose of land use: agriculture/livestock (twenty years), industry (thirty years), travel (thirty years), commercial residential properties (fifty years), and education/science/health (fifty years). The third form was revenue from tourism. The central government believed that Shenzhen would become a viable tourist area, as it would be the first to receive and utilize the latest technology and had close proximity to Hong

Kong. The number of tourists grew rapidly in the 1980s, providing a hefty source of foreign capital for infrastructure investment. The government promoted tourism by encouraging joint- venture schemes between foreign and domestic partners. Foreign companies were given a majority of the profits for ten

Figure 5-5: Total Foreign Exchange Earnings from Foreign Tourists in Shenzhen SEZ, 1992-2013 (billions of current US$)

4 Billions 3

Source: Shenzhen Statistical Yearbook, 2014 to twenty years, after which the tourism organization would be turned over to the Chinese firm. Hong

Kong companies provided the vast majority of foreign partners during this time. Tourism has grown tremendously since the 1990s (Figures 5-4 and 5-5). The growth in tourism has also expanded the retail and hospitality industries within the SEZ, providing further tax revenue to the Shenzhen government.194

There has been continued massive migration of labor from all over China to Shenzhen since its inception. This was difficult in the early 1980s, as the central government had heavy controls over travel between provinces within China. As the government wished to provide firms with enough skilled labor to maximize productivity, they began easing controls, so that over time more and more Chinese laborers made the journey to Shenzhen (Figure 5-1).195 Rather than basing employment on government appointments, as Chinese SOEs were doing, the firms based their selections completely on merit. From

1980 on, wages in Shenzhen were therefore flexible and based on similar merit criteria and market rates

(Figure 5-6). This wage structure would later, over time, spread to the rest of China.196 Like wages, the

Chinese government allowed prices to be set by the market within Shenzhen (except for strategic commodities). This allowed the costs of construction to be kept to a minimum during the infrastructure

194 Im, “Shenzhen Experience,” 116-118. 195 Chen and De’Medici, “Instant City,” 20. 196 Im, “Shenzhen Experience,” 122.

Figure 5-6: Average Annual Wage in Shenzhen SEZ, 1980-2013 (current US$) 12000 10000 8000 6000 4000 2000 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Source: Shenzhen Statistical Yearbook, 2014

Figure 5-7: Consumer Price Index in Shenzhen SEZ for Food and Services, 1979-2013 (1979=100) 2,000

1,500

1,000

500

Food Services

Source: Shenzhen Statistical Yearbook, 2014 building stage. Prices rose gradually over time (Figure 5-7).197

Trade through Shenzhen had been growing strong since the early 1990s, and really began to take off after China joined the World Trade Organization in 2001 (Figure 5-8). In fact, for roughly two decades Shenzhen has maintained the position of China’s top export city.198 In addition, it has managed to maintain roughly 12-15% of China’s total trade volume since the early 1990s (Figure 5-9). It has also

197 Ibid, 123. 198 Li Jia, “Shenzhen holds on as China’s top export city for 18th year,” People’s Daily Online, January 17, 2011, accessed April 25, 2015, http://en.people.cn/90001/90778/7263369.html; “Top trading cities in China,” Starmass International, accessed April 25, 2015, http://www.starmass.com/china-review/imports-exports/top-trading- cities.htm.

Figure 5-8: Total Imports and Exports for Shenzhen SEZ, 1982-2013 (billions of current US$)

350 300

Billions 250 200 150 100 50 0 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Imports Exports

Source: Shenzhen Statistical Yearbook, 2014

Figure 5-9: Shenzhen Total Imports and Exports as Percentage of China's Total Imports and Exports, 1982-2013 25 20 15 10 5 0 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012

Imports Exports

Source: Shenzhen Statistical Yearbook, 2014; World Bank brought in a great deal of FDI.199

Shenzhen was a testing ground for Chinese economic reforms, and they passed the test. Today there are dozens of SEZs of various sizes and purposes all throughout China (see Table 5-1 for different types). The foremost reason for its success is the commitment from the central government. Though there were members of the CCP who did not quite agree ideologically with the path envisioned by Deng

Xiaoping, the gradualist approach helped sway those who were in opposition. Success was ensured with

Deng’s southern tour in 1992. The fact that the Chinese leadership stays in power for a long time compared to Western democracies and that only one political party is in power means that there is

199 Douglas Zhihua Zeng, “How Do Special Economic Zones and Industrial Clusters Drive China’s Rapid Development?” World Bank Policy Research Working Paper 5583 (March 2011), 18.

86 stability and continuity with policy-making. This helps to ensure that once a decision is made, it is less likely to be abandoned with changing political winds or elections. The next reason concerns the preferential policies given to firms that chose to invest in Shenzhen. These included (but were not limited to): “inexpensive land, tax breaks, rapid customs clearance, the ability to repatriate profits and capital investments, duty-free imports of raw materials and intermediate goods destined for incorporation into exported products, export tax exemption, and a limited license to sell into the domestic market.”200 Though some of these preferential policies have been watered down or rescinded over the years as the entire domestic economy of China further opens, they undeniably were a large part of the reason Shenzhen grew so big and so fast. The leadership and firms in Shenzhen were also given a great deal of autonomy in decision-making. This allowed for more efficient on-the-ground management of the zone without having to wait for word from Beijing. Infrastructure was also a key reason for Shenzhen’s success. Both the central government’s and the local government’s commitment to building sufficient infrastructure contributed to the zone’s attractiveness to foreign firms. Not only hard and soft infrastructure, but business, financial, and legal assistance from the SEZ administration was readily available to those firms which invested. The methods of attracting FDI contributed to

Shenzhen’s advancement as well. The Chinese government targeted the Chinese diaspora, especially those living in Hong Kong, Macau, and Taiwan, to establish their factories in Shenzhen as their own economies were growing beyond light industry. The high rate of technology transfer and backwards linkages to the domestic economy certainly spurred Shenzhen’s growth. According to Chen and

De’Medici, Shenzhen and the other Chinese SEZs “permitted China to induce, digest and then adapt western technology through the [sic] controlled channels without exposing its entire political economy to fierce competition with more efficient multinational corporations.”201 More recently, Shenzhen has linked itself closely with regional and global value chains as the last link in the chain. A spirit of

200 Ibid, 16. 201 Chen and De’Medici, “Instant City,” 14.

87 innovation and entrepreneurship were also critical to Shenzhen’s success. Many of the innovative paths taken by the local administration came from ideas from the workers and managers themselves. These same workers and managers were able to found their own firms either within the SEZ or in the domestic economy, having taken what they learned and melded it with their own ideas. Finally, Shenzhen’s location was vital to its success. Being just across the river from Hong Kong, it had access to a great deal of FDI, tech transfer and managerial skills transfer. It lies in an area rich in natural resources and abundant labor, giving it a boost relative to other SEZs in China.202

The picture is not 100% perfect, however. As mentioned before, Shenzhen suffered from severe energy shortages throughout the 1980s, negatively affecting its growth. Most figures in this chapter on

Shenzhen show that it did not truly take off until the early 1990s, when a continuous power supply was finally installed in the area. While the electricity issue may not be a direct cause, a strong correlation does exist. As for upgrading its technology, the administration attempted to skip the heavy industry phase of industrialization, choosing to go straight from light industry to high-tech. This created a number of imbalances. It has been making up for this over the last ten years by going back and promoting the growth of certain heavy industries.203 Migration into Shenzhen has been a delicate situation. Many Chinese left their farms or small towns to try and make better lives for themselves by traveling to Shenzhen throughout the 1980s, 1990s and 2000s. These migrants were granted the status of “temporary population,” or “non-registered,” as they were registered to their hometowns and not

Shenzhen (Figure 5-1). Though many became either mildly or very successful, there have been many who have not seen as much success and even feel discriminated against in the city. They were not given equal access to healthcare or education and received lower wages than those registered in the city. As a result, in the last ten years the Shenzhen government has taken several steps to improve the lives of the temporary population through better healthcare and education access. However, the most promising

202 Zeng, “China’s Rapid Development,” 16-23. 203 Chen and De’Medici, “Instant City,” 18.

88 act was the introduction of permanent resident cards for the temporary population in 2008, giving them all the same rights as the registered population.204

3. Rason SEZ

Rajin-Sonbong, or Rason, SEZ was created in 1991 during the late Kim Il Sung era as a means of attracting foreign investment. The idea was based partially on Shenzhen SEZ. Like Shenzhen, it was placed far from the capital or any place remotely political so as to not have undue influence either from the government or over the government.205 The hope of many North Korea watchers at the time was that Rason would help the reclusive communist country to reform and open as China had done in the early 1980s. Instead, the country remained as inward-looking as ever and suffered through a severe famine as a result. Rason did not succeed and was for a long time discredited through a combination of government neglect and an extreme lack of investment.

Rason SEZ lies in the northeastern corner of North Korea (Figure 5-10). Its total area is 746 km2

(almost twice the initial size of Shenzhen). The vast majority of the land is forest, with a significant amount of the rest dedicated to agriculture.206 Only a small area is devoted to industry and residential space. As of 2008, it had a population of 196,954 people, with 158,337 living in urban areas and 38,617 living in rural areas.207 Economic data on the zone is scant, though it is becoming increasingly available.

Up until the last five years, roads in Rason were in poor condition, with most of them still being dirt roads. However, several consortiums of Chinese companies have invested in their improvement. In

2011, work began on paving the road from Rajin port to Wonjong, at the Chinese border with Quanhe.

Work on this project was completed in 2013.208 This has cut down travel time within the zone and

204 Ibid, 22-26. 205 Abrahamian, ABCs, 9. 206 “Information on Entry & Investment into Rajin-Sonbong District,” 1997, accessed April 29, 2015, http://www1.korea-np.co.jp/pk/014th_issue/97102203.htm. 207 Central Bureau of Statistics, DPR Korea 2008 Population Census (Pyongyang), 18. 208 Abrahamian, ABCs, 24.

Figure 5-10: Location of Rason SEZ in North Korea (top Figure 5-11: The Three Piers of Rajin Port right corner)

Source: Google Earth

allowed for more bus routes. A private bus company has even opened and runs routes between different cities within the zone.209 The primary port of Rajin contains three piers and nine berths (Figure

5-11). The first two piers had been rumored to be leased by Chinese consortiums, but as of 2014 this has been shown to be false and control of the two piers remains in the hands of North Korea.210 Plans to build deeper piers (15m) that would be able to service ships that could reach as far as the Americas have been scrapped.211 The third pier is being leased by a Russian company for fifty years, and was refurbished in 2012.212 Unfortunately the ports at Sonbong and Unsang are too shallow and thus rarely used, except for timber.213 The Russian company RZhD Logistika (a subsidiary of Russian Railways) also

209 Andray Abrahamian, “The Honeymoon Period is Over,” Choson Exchange (August 2012). 210 Curtis Melvin, “Who uses Rason’s ports? Lease confusion explored,” North Korea Economy Watch, last updated May 7, 2014, accessed April 29, 2015, http://www.nkeconwatch.com/2014/05/07/rason-port-lease-confusion/. 211 Andray Abrahamian, “A Convergence of Interests: Prospects for Rason Special Economic Zone,” Korea Economic Institute (February 2012), 4. 212 Warren Park, “China and Changjitu: Two Reasons for Rason,” Hana Insight, 3Q (September 2012), 31; Abrahamian, “Honeymoon Period.” 213 Abrahamian, “Convergence,” 5.

Figure 5-12: Cranes at Rajin Port in Rason SEZ

Source: Vladimir S, December 6, 2014, accessed April 30, 2015, http://static.panoramio.com/photos/original/114535836.jpg. upgraded the railway connecting the port of Rajin to the Russian city of Khasan, just over the border.214

Further improvements have allowed for a pilot project of shipping Russian coal to South Korea via Rason to thus far be successful. In November 2014, a shipment of 40,500 tons of coal traveled via rail from Khasan to Rason, then via boat from Rason to Pohang in South Korea. In April 2015 a second shipment was sent, this time carrying 140,000 tons. This project originally involved POSCO, Hyundai

Merchant Marine Company and Korail Corp, but now includes Korea East-West Power Co. and Korea

Midland Power Corp., showing that it has solid corporate backing from strong South Korean firms.215 At the Rajin Port stand 11 five-ton DPRK cranes, 5 ten-ton Russian cranes and 2 thirty-ton Russian cranes.

These are somewhat inefficient compared to cranes in other countries, as they can only make so many

214 “North Korean Opens Russian Financed Wharf,” Open Source IMINT, July 26, 2014, accessed April 29, 2015, http://osimint.com/2014/07/26/north-korea-opens-russian-financed-wharf/. 215 “N. Korea improves coal shipment capacity at Rajin port,” The Korea Herald, April 27, 2015, accessed April 29, 2015, http://www.koreaherald.com/view.php?ud=20150427001274.

91 moves per hour.216 However, in December 2014 it was observed that there were several brand new cranes being used by the Russians (Figure 5-13).217 A somewhat dated assessment from 1997 showed that Rason SEZ contains 2 million m2 of timber, 1.5 million m3 of gravel, 6.2 million m3 of sand, and 1.8 million m3 of gravel/sand mixture, all ready for industrial use.218 Electricity is still a major issue throughout the SEZ. Power is brought in from the national grid and distributed from the Sonbong Power

Plant, which itself has not generated any electricity since 2009 due to a lack of fuel.219 Plans were made in 2011 to link Rason’s power grid with that of the Yanbian Korean Autonomous Prefecture in China, with work actually commencing in November of that year.220 After the 2013 North Korean nuclear test,

Rason officials claimed that the plan to link the power grids was still “on track.”221 However, later that year it was claimed that “[t]here is a deal in place to bring power from Jilin Province, but the Chinese have been holding it up using the pretext of an environmental impact study.”222 In a 2014 report, North

Korea expert Andray Abrahamian claimed that the Chinese government halted the plan because of the nuclear test.223 While the exact reason may not yet be clear, the fact that Rason still does not have an adequate power supply and suffers from frequent power outages is all too apparent. Firms operating within the zone utilize backup generators for this very reason. Internet access and telecommunications are still tricky issues within the zone. The email system is described as “sporadic” and most communication still relies on telephone landlines and fax machines. There is a Koryolink mobile network in the zone that was set up by the Egyptian telecom company Orascom, but North Korean citizens and

216 Abrahamian, “Convergence,” 4-5. 217 Rüdiger Frank, “Rason Special Economic Zone: North Korea as It Could Be,” 38 North, December 16, 2014, accessed April 29, 2015, http://38north.org/2014/12/rfrank121614/. 218 “Information on Entry & Investment into Rajin-Sonbong District.” 219 Abrahamian, “Honeymoon Period.” 220 Abrahamian, “Convergence,” 4. 221 Charlie Zhu, “China moves ahead with North Korea trade zone despite nuclear test,” Reuters, February 28, 2013, accessed April 29, 2015, http://www.reuters.com/article/2013/03/01/us-china-northkorea-trade- idUSBRE92005I20130301. 222 “Things Are Brewing In North Korea’s Rason Zone,” Forbes, November 20, 2013, accessed April 29, 2015, http://www.forbes.com/sites/forbesasia/2013/11/20/things-are-brewing-in-north-koreas-rason-zone/2/. 223 Abrahamian, ABCs, 24.

92 foreigners must use different networks. International calls are all highly restricted and expensive. 3G is available for foreigners on their smart phones, but equally expensive.224 The issue of private property is, however, more positive, as Rason is the only place in North Korea in which residents can purchase newly-constructed apartments.225 The most visible example of this is a 47,000 m2 mixed-use complex being built in Sonbong for the purposes of commercial, retail and residential use. 50-year leases will be available for the commercial and residential areas, with the possibility high that apartments will actually be for sale.226

Laws for Rason have been improved over the last five years, and are beginning to model those made for Shenzhen and the other early Chinese SEZs in the 1980s. Several provisions of the “Law of the

Democratic People’s Republic of Korea on the Rason Economic and Trade Zone” are worth mentioning here (the entire law is attached as Appendix A).227 In Article 4, it explicitly states that “Koreans residing outside the territory of the DPRK” are allowed to invest; while this is primarily targeting Koreans residing in Japan, there is no reason to believe that South Koreans are not welcome to invest in the zone. This may be an attempt to replicate what the Chinese did in the 1980s in regards to reaching out to the

Chinese diaspora for initial investment in Shenzhen and the other early Chinese SEZs. In Article 6, the law states that investment for infrastructure construction within the zone is especially encouraged, though what exactly “encourage” means in this regard is not properly defined, but tax benefits is the most likely reward. Article 7 explicitly guarantees that the state “shall not nationalize or expropriate the property of investors,” but is quickly followed by a somewhat troubling caveat: “Where an investor’s property is, for unavoidable reasons, to be expropriated or used temporarily for public interest, notification thereof shall be made before going through prescribed legal procedures, and sufficient and

224 Ibid, 21, 31; Abrahamian, “Convergence,” 5; “Brewing.” 225 Abrahamian, ABCs, 24. 226 Abrahamian, “Honeymoon Period.” 227 All references and quotes in this section are from “Law of the Democratic People’s Republic of Korea on the Rason Economic and Trade Zone,” DPRK, (Pyongyang 2011), unless otherwise noted.

93 effective compensation for its value shall be made without any discrimination.” In other words, “we won’t take your property, but we can if we want.” Now, even Western democracies have laws allowing for eminent domain, including the United States, in which the right of eminent domain is enshrined in the Fifth Amendment to the Constitution. However, it would be wise for the North Korean leadership to perhaps make this law much clearer and provide specific instances in which eminent domain would be carried out. Article 8 declares that the zone is to be managed and operated by the local Rason committee, with the central government only providing “guidance and assistance.” (Article 27 lists all of the major responsibilities of the management committee.) In 2012, this was shown to be the case, as one Rason official “stated that 80% of decision-making is now made locally while only the most important decisions require consultation with Pyongyang.”228 As for investment, Article 14 declares that licenses of operation within the zone shall be granted by the management committee. This is further proof that decision-making is devolved, as the centralized Ministry of External Economy (MoEE, the ministry in charge of SEZs) is not the organ to grant licenses. Article 16 guarantees that land lease terms shall be fifty years “from the date of issuance of the land use certificate.” Article 17 guarantees that firms can purchase property for their use, with Article 18 allowing for firms to rent or lease out purchased property. Within Chapter 3 of the law, Article 23’s most striking note is that Rason should be managed on the principle of “complying with objective laws of the economy and principles of [the] market.” The guarantee that the zone should work in the spirit of the free market is a major step for

North Korea. Article 29 requires the management committee of the zone to submit annual statistics of industry in the zone to the central government; the hope is that one day North Korea will release these statistics to the public. Chapter 4 provides the rules and regulations of establishing a business within the zone. Article 40 in particular, the “Rights of enterprises,” is a positive sign: “Enterprises in the Zone shall, at their discretion, have the rights to lay down rules for operation and management, to work out

228 Abrahamian, “Convergence,” 5.

94 plans for production, sale and financial management and to determine the forms of employment, wage standard and form of its payment, price of products and plan for profit distribution.” Essentially, firms have complete control over all decision-making at the firm level with no interference from the state.

Article 43 allows for contracts to be made with firms in North Korea outside of Rason SEZ. This is a positive first step in allowing backwards linkages to the local economy. In the future, this will hopefully lead to managers and workers opening firms outside of the SEZ and working with firms within the SEZ, allowing domestic firms to move up global value chains. Article 44 allows for prices to be set by market mechanisms, except in the case of “basic consumer goods such as food and essential foodstuff and charges for public services,” which are set by the municipal people’s committee in Rason (a separate institution from the management committee). One of the most surprising facets of the law is Article 48, which allows for domestic institutions to purchase goods made in the zone. This could be extended in the future to ordinary consumers, though it is highly unlikely for infant industries which the government is trying to grow. Article 50 provides for wage decisions; monthly minimum wages are to be determined by agreement of the municipal people’s committee and the management committee together. Chapter

5 covers customs duties. Duty-free items (Article 54) include:

materials needed for development of the Zone; imports needed for production and operation of enterprises, and goods produced to be exported; materials brought into the Zone for processing, transit trade and barter trade; office articles and daily necessities for the investors; transit cargoes of other countries; donations of foreign governments, institutions, enterprises or organizations, or international organizations; and other designated articles.

This is quite typical for most SEZs, which allow for speedy importing and exporting of goods. However, according to Article 56, customs duties can be levied on goods to be sold in North Korea outside of the zone. Article 60 allows for banks to be set up in the zone by foreign enterprises, with Article 63 allowing for insurance companies. However, thus far the only major bank in the zone is the Golden Triangle

Bank, established by the North Korean government. Chapter 7 lists the incentives and preferential

95 treatment for those investing in the zone. Article 65 is encouraging right off the bat: “Such income as profits, interests [sic], dividend [sic], rentals, service charges and proceeds from property sale that are legitimately earned in the Zone may be repatriated outside the territory of the DPRK without any restrictions” (emphasis mine). This is one of the most important points in the entire law. Many investors are somewhat skittish about investing in North Korea because they fear the state may simply confiscate their earnings or not allow them to repatriate profits. This thought process was encouraged by a rumor that Orascom could not repatriate its profits in 2013 (later proven to be false).229 Article 67 provides for the amount of corporate taxation. While outside of the zone the corporate tax rate is 25%, inside the zone it is 14% and 10% for those in priority sectors.230 Priority sectors, as listed in Article 6, include “infrastructure construction, state-of-the-art science and technology and production of internationally competitive goods.” While this seems rather vague, it is highly likely that, given North

Korea’s past economic planning, heavy industry is yet again being encouraged (this will be discussed further in Chapter 6). In order to encourage firms to remain in the SEZ, a promise of reduction or elimination of corporate income tax is made to those who stay for ten years or more in Article 68. This seems to be a better option than simply granting tax holidays for ten years, as some other zones in Asia tend to do. Tax holidays simply represent a race to the bottom and show that the zone is already uncompetitive and lacking the essentials for firms to establish themselves. Promises of future tax reduction or elimination show confidence that this zone already has what a firm needs to be properly set up, with the opportunity for future gains to be even higher if they remain in the zone. Article 71 provides for refunds on certain levels of income tax if dividends are reinvested in the SEZ “to increase the registered capital or to set up a new business for more than 5 years’ operation.” If the reinvestment is for infrastructure, “the whole of the enterprise income tax that had been paid on the reinvested

229 Curtis Melvin, “Orascom seeks repatriation of profits – or new opportunities?” North Korean Economy Watch, last updated December 8, 2013, accessed April 30, 2015, http://www.nkeconwatch.com/2013/12/06/orascom- seeks-repatriation-of-profits/. 230 Abrahamian, ABCs, 13.

96 amount shall be refunded.” It is hoped that this provides a “win-win” situation for all involved, and there is no doubt that that was the intention behind the clause. Chapter 8 provides for settlement of disputes by arbitration, mediation or courts depending on the agreement of the parties involved.

Though the law is still somewhat vague, it does provide a great deal of information for potential investors. Should the government of North Korea prove that it will faithfully enforce the laws of Rason and be just and fair, this will go a long way toward boosting investor confidence. Investors are of course looking for sufficient infrastructure and logistical planning, but they also most certainly want to be in a situation in which laws are clear, enforced and consistent. Unfortunately, only time will tell whether or not the North Korean government is truly committed to putting investors at ease.

As for sources of investment, China has been and remains the largest place of origin, with Russia coming a distant second. In 2009, Jilin Province in China formulated the “Changjitu Plan” (a portmanteau of Changchun-Jilin-Tumen), with approval from Beijing coming in the same year. This development plan is one of China’s main programs to re-develop the northeast, which had traditionally been China’s industrial heartland. “Re-develop” here means to make northeast China into a logistics base, industrial base and international cooperation base for the region. The goal was to double Jilin’s

2008 GDP by 2012 and quadruple it by 2020. This would mean that it needed 728 billion RMB in 2012; its 2012 GDP ended up being over 1.19 trillion RMB.231 Unfortunately for Jilin, the province has no outlet to the sea. For this reason, the planners of Changjitu have realized that Rason SEZ will be integral for Jilin’s economic growth under this plan. Using Rason instead of Dalian to transport goods will save time, as Dalian is highly congested and somewhat distant from Jilin. To facilitate this, a major highway was first constructed between the capital city of Changchun and the city of Hunchun, an important economic center in Yanbian. During this time, work also began on a road from Hunchun to the North

231 Lee and Kang, “Changjitu Project,” 5; “Overview of Jilin Province,” Consulate General of the United States in Shenyang, China, accessed April 30, 2015, http://shenyang.usembassy-china.org.cn/jilin.html.

Korean border at Quanhe. The bridge between Quanhe and Wonjong was also renovated.232 The use of the port in Rason is extremely beneficial to Jilin. For example, in 2011, a test-run of 20,000 tons of coal was sent by the Hunchun Mining Group to Shanghai via Rason instead of going via its traditional route.

Even with all roads at the time not being completely paved, travel time was cut from eleven days to three days. After this successful test run, plans were made to increase output.233 As of 2015, the project has been quite successful, with not only new infrastructure having been quickly built, but new industries being launched and economic growth continually expanding, reaching higher than the national average.234 The development of Changjitu will only mean good things for Rason and North

Korea. However, the overreliance on China carries some costs, which is the main reason North Korea should attempt to diversify its pool of investors.

By looking at these aspects of Rason SEZ, we can surmise, based on the previously discussed reasons for success and failure, where Rason stands with respect to its prospects for success. The location of Rason is certainly a prime position, given the needs of the Changjitu project and even the needs of the Russian Far East. Should North Korea manage to solve its disagreements with Japan and

South Korea, and come to an understanding with the United States, Rason stands to become the center of trade in Northeast Asia. Even allowing for what the Chinese will ship through Rason should make it rather successful. The natural resources located all along the Chinese border will help in the future when there is requisite capital for a heavy industry push. However, there are a few problems with its location. The closest airport is in Chongjin, 149 km from Rajin Port. The ports themselves are not fully up-to-date, as they do not have the capacity to handle ships that can travel as far as the Americas. The northeast area of the Korean Peninsula is not heavily populated, and many of the workers that come in

232 Park, “China and Changjitu,” 30. 233 “’조선 라진항 열린다’…훈춘 석탄업계 대량 증산,” China Central People’s Broadcasting, August 29, 2012, accessed April 30, 2015, http://www.krcnr.cn/xw/cxzfs/201201/t20120113_252801.html. 234 Dong Jidong, “Jilin plans for ‘new normal’ growth,” China Daily, March 12, 2015, accessed April 30 2015, http://www.chinadaily.com.cn/cndy/2015-03/12/content_19786982.htm.

98 are transported from other parts of the country and are deemed politically reliable. As for policies, the labor practices are seemingly on the positive side. The minimum wage in Rason SEZ is US$80 per month, which is quite competitive but still gives a lot of purchasing power to workers. However, it is possible, though unreported at this time, that the North Korean government can take a large amount of the workers’ wages as a fee or tax, just as is done in Kaesong. There are few matters of paperwork with regard to the North Korean government, but there is a massive amount when it comes to working within the parameters defined by international sanctions. For this reason, most of the companies operating within the SEZ are of Chinese and Russian origin, countries which do not give priority to adhering to international sanctions. It will be somewhat difficult for countries of other nationalities to deal with this paperwork if the matters are not settled within the foreseeable future. The matter of who is in control of the SEZ has finally been answered: the Ministry of External Economy (MoEE). This helps to clear up any confusion as to with whom firms should deal when operating in the zone.

Turning to the first measure of success discussed, how well Rason is introduced and managed, one can only speculate for the most part. We unfortunately do not know how well they are attracting firms that create jobs, but they are certainly bringing in many Chinese firms and the zone has been given a great deal more autonomy, which leads us to believe that the central government sees it as a success, meaning that it should be at least providing a stable source of employment for the area. We also cannot yet know what types of firms are there, though the law is encouraging those firms leaning towards heavy industry and advanced science, which could be a mistake for the time being. The right set of incentives are being offered, it seems. Rather than tax holidays, relaxed taxation and even partial tax refunds are offered for investment back into the zone, which results in a win-win for everyone involved.

The laws are getting clearer as time goes by, but there will always be room for improvement. A deep study of the laws on Shenzhen will do the policymakers well in this regard. Unfortunately, corruption is rampant throughout the country, and Rason is no doubt a victim as well. This is an issue that the

99 leadership will be facing for years to come and will not be quick and easy to stamp out; Kim Jong Un’s attempts at enforcing discipline through increased punishments will not be enough. Proper infrastructure is most certainly being built, though most of it is financed and built by the Chinese. This is fine for the moment, but the North Korean leadership needs to take charge of building the infrastructure itself once it has accumulated enough capital to finance this, or is given preferential loans by development banks in the region. The biggest infrastructure problem remains electricity. Just as

Shenzhen was not able to pick up speed until it had a steady source of power, so will Rason lag. As for whether Rason facilitates upgrading, structural transformation, or economic reforms remains to be seen, as it has only been an actual effective SEZ for the last half-decade. Likewise, it is too soon to tell whether or not Rason is working well with the domestic economy. Perhaps by the end of this decade one will be able to see what backwards linkages and technology transfers it has given to the rest of

North Korea.

Given this assessment, one can speculate that Rason is on the road to success, though there are some issues to work with. Should it continue on its current track, it will no doubt be moderately successful, given its prime location and the Changjitu Project, but it will not be able to reach its full potential. If the leadership truly desires for the SEZ to succeed beyond all expectations, there needs to be a firm commitment to providing electricity, and soon. Disagreements with its neighbors need to be settled, so as to make Rason a true nexus of trade in the area. An airport should be constructed for more efficient travel of businessmen and women, as well as tourists who may not wish to enter Rason through China. Finding a way to end, or at least lessen the burden of, international sanctions will go a long way towards encouraging firms to invest in Rason without the headache of mountains of paperwork.

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Chapter 6 – A Plan for Economic Growth in North Korea

How exactly should North Korea seek to develop without losing political control? The path that it has taken since the beginning of the Kim Jong Un era is a good start, but is lacking speed and breadth.

The path that I suggest does not veer incredibly far from where North Korea is heading now, but there are important differences. The structure of this chapter will follow the form of the suggested method of development by economist Justin Lin in his book The Quest for Prosperity, which I discussed in Chapter

3. Included will be my own augmentation of the process, which includes an emphasis on SEZ usage

(Chapter 5) and joining GVCs (Chapter 4), while trying to overcome the obstacles to development discussed in Chapter 2.

1. Targeted Industries

Which industries should North Korea target? The best way to approach this issue according to

Lin is to find a fast-growing country with similar endowment structures whose per capita GDP is twice the size of the country in question. Reliable data on North Korea’s GDP per capita (PPP) is limited, so we must rely on CIA estimates. The CIA gives an estimate of US$1,800 (2013 US$) for the year 2013 for

North Korea. Doubling this, we come to US$3,600. Allowing for a degree of variation, we widen the criteria from strictly 100% higher to 80% - 120% higher. This gives us a range of US$2,880 – US$4,320.

Seventeen countries fall within this range, with ten meeting “fast-growing” criteria (here defined as an average GDP growth rate of 4.5% or more between 2003 and 2013). Table 6-1 provides the estimated

GDP per capita (PPP) in 2013 USD as given by the CIA, along with a comparison of factor endowments with North Korea for nine countries that meet these criteria. These countries are still “factor-driven” and have not yet reached the status of “efficiency-driven” in their development. The two countries chosen from the list are Ghana and Cambodia, as they not only meet the criteria but also have similar

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Table 6-1: Ten fast-growing countries with double GDP of North Korea, along with their comparative factor endowments GDP per $120~$140 / Abundant Garment / 10-30% Literacy Country capita month current Natural Textile Arable Tourism Rate (PPP) minimum wage Resources Industry Land North Korea 1800 99% (Rason $80/month) ✔ ✔ ✔ ✔ Lesotho 2900 79% ✔ ($130/month) ✔ ✔ Sao Tome 3100 75% ✔ and Principe Kenya 3100 78% ✔ ($139/month) ✔ Cambodia 3300 77% ✔ ($128/month) ✔ ✔ ✔ ✔ Mauritania 3400 52% ✔ Kyrgyzstan 3400 99% ✔ Bangladesh 3400 61% ✔ Zambia 4100 63% ✔ Ghana 4200 76% ✔ (in the past) ✔ ✔ Source: CIA World Factbook, UNESCO Institute of Statistics, UNICEF Note 1: Estimates are in the 2010-2015 range Note 2: Money for GDP per capita (PPP) is in 2013 US$; Money for minimum wage is in international dollars factor endowments to North Korea.

Before fully discussing which areas to target, there is need to briefly discuss the level of human capital in North Korea by looking at the state of education within the country. Fortunately, German economist and expert on North Korean demographics and economy Daniel Schwekendiek has done a great deal of research on the education system in North Korea, from which we can extrapolate the level of education there.235 This research is based on both official statistics released by the North Korean government and surveys done both within North Korea and of defectors living in South Korea. Primary and secondary school attendance is near universal in North Korea (though significantly less during the famine), as this is the main tool that the government uses for political instruction among the populace.

Though officially the government provides for all schools and students, in reality much of the funding is completely left up to individual schools, teachers and classes. The pupil-teacher ratio is actually quite good, at roughly twenty students per teacher. Tertiary education levels are somewhat surprising, with the 2008 census showing that 16% of the population is either attending or has graduated from a post- secondary or tertiary education institution (54% male, 46% female).236 Since Kim Jong Un came to

235 Information for this section taken from: Schwekendiek, Socioeconomic History, 68-74, unless otherwise noted. 236 “DPR Korea 2008 Population Census,” Central Bureau of Statistics (Pyongyang: 2008), 150.

102 power, there has been a strong push for improvement on and expansion of education in order to increase the amount of human capital so as to meet the demands of economic reforms. More secondary schools for gifted students have been opened, especially near the Rason SEZ.237 In September

2012, the government expanded the number of years of mandatory schooling from eleven to twelve, and divided the schools to more reflect the system used in South Korea. The state has also devoted extra resources to training more teachers, as there is a shortage due to the extra year.238 However,

Schwekendiek believes that the education system is somewhat deficient, as it “promotes political loyalty rather than ability,” and the “higher educational sector is not really prepared for the challenges in marketization and technocratization.” While true, further changes are somewhat promising, as the top universities have added majors in business and economics.239 In addition, in 2010 the government opened the Pyongyang University of Science and Technology (a joint effort by the North and South

Korean governments), and in 2014 opened the Pyongyang Tourism College, both of which aim to use foreign-learned knowledge in the development of both the economy and science.240

Natural Resources

The three countries also have ample supplies of natural resources. North Korea contains an estimated US$6 trillion in natural resources alone, including gold, iron, copper, zinc, tungsten,

237 Joon-ho Kim, “North Korea Opens More Secondary Schools for Gifted Students,” Radio Free Asia, April 16, 2014, accessed May 5, 2015, http://www.rfa.org/english/news/korea/schools-04152014163511.html. 238 Curtis Melvin, “Changes made to North Korean education system,” North Korean Economy Watch, February 14, 2014, accessed May 5, 2015, http://www.nkeconwatch.com/2014/02/10/changes-made-to-north-korean- education-system/; Kang Mi Jin, “Learning Style Shifts Amid Teacher Shortage,” Daily NK, March 11, 2015, accessed May 5, 2015, http://www.dailynk.com/english/read.php?cataId=nk01500&num=12981. 239 Curtis Melvin, “New business and economics related majors established in top universities in North Korea,” North Korean Economy Watch, March 28, 2014, accessed May 5, 2015, http://www.nkeconwatch.com/2014/03/28/new-business-and-economics-related-majors-established-in-top- universities-in-north-korea/. 240 “First university founded by two Koreas to open in Pyongyang next week,” Yonhap News, October 22, 2012, accessed May 5, 2015, http://english.yonhapnews.co.kr/northkorea/2010/10/22/58/0401000000AEN20101022006600315F.HTML; “North Korea Establishes Pyongyang Tourism College,” The Institute for Far Eastern Studies, April 24, 2014, accessed May 5, 2015, http://ifes.kyungnam.ac.kr/eng/FRM/FRM_0101V.aspx?code=FRM140424_0001.

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Figure 6-1: North Korean GDP by Economic Activity, 2013

molybdenite, nickel, manganese, Other 5% Agriculture, Forestry & graphite, limestone, barite, Government Fishing Expenditures 14% 13% apatite, magnesite, and anthracite,

as well as huge deposits of coal. Mining & Manufacturing Services 22% The biggest investor in the mining 18% industry in North Korea is China,

Mining & with very little investment from Heavy & Quarrying Chemical 8% Construction Industry domestic sources, leaving room for 5% 9% Electricity, Gas Light Industry & Water Supply a new home-grown industry to 4% 2% develop. 241 However, mineral Source: Statistics Korea exploitation is still a highly significant part of the North Korean economy (Figure 6-1). The mineral industry in Ghana is especially important, covering 5% of GDP and 37% of exports, with gold covering

90% of all mineral exports. In addition to gold, bauxite, manganese and diamonds are also significant.

The government of Ghana has been utilizing the country’s endowment of natural resources to help finance its economic growth, with favorable legislation, financial incentives and new state institutions all made to facilitate growth of the industry for the benefit of the country.242 Cambodia’s mineral resources have remained largely unexploited up until the last few years. Cambodia is endowed with not insignificant amounts of oil, gas, bauxite, copper, gold, iron ore, gemstones, limestone, phosphates, salt, silica and zircon. Beginning in 2001, new legislation was introduced to bring investment into the mining industry, with total investment in 2005 coming to US$181 million (2005 dollars). It is expected that the

241 Andray Abrahamian and Geoffrey See, “North Korea’s Resource Headache,” The Diplomat, May 1, 2012, accessed May 5, 2015, http://thediplomat.com/2012/05/north-koreas-resource-headache/; Choi Kyung-soo, “The Mining Industry of North Korea,” NAPSNet Special Reports, August 4, 2011, accessed May 5, 2015, http://nautilus.org/napsnet/napsnet-special-reports/the-mining-industry-of-north-korea/. 242 “Mining in Ghana,” MBendi Information Services, accessed May 5, 2015, http://www.mbendi.com/indy/ming/af/gh/p0005.htm#5.

104 industry will continue to grow with sufficient government support.243

Tourism

Tourism is an essential part of the economy for all three countries. 20-30% of Cambodia’s export earnings come from tourism-related sales, and is continually rising as the number of tourists grows every year (Figures 6-2 and 6-3). The government has facilitated the tourism industry by creating a simple visa-on-arrival system for most international visitors and allowing for a great deal of tourism infrastructure to be built, and a special Ministry of Tourism dedicated just to this aspect of the economy.244 In Ghana, the number of annual tourists is lower than that of Cambodia, but still significant enough for the economy. The amount contributed to the economy in actual numbers continues to grow steadily along with the number of tourists, but its overall contribution in terms of percentage of exports continues to decline, as other industries have begun to contribute more and more. However, the government of Ghana believes that the tourism sector will continue to grow, with one estimate from the

Minister of Tourism stating that by 2027 the country will earn US$8.3 billion from tourism alone.245 A possible impediment to more drastic growth is that a visa is required even for short-term visits.246

However, Ghana continues to rise in the ranks of tourist destinations, and is considered one of the top destinations in Africa.247 North Korea has a very limited tourism infrastructure, but with ample room to grow. Tourism is very tightly controlled by the government, and so the number of visitors is measured in the hundreds of thousands annually. However, the government has been opening the borders more and more to foreign (especially Chinese) tourists as a way of raising revenue over the last few years. In

243 John C. Wu, “2006 Minerals Yearbook: Cambodia,” US Geological Survey (July 2007), 1. 244 A great deal of information can be found on the website of the Ministry of Tourism of Cambodia, http://tourismcambodia.org/. 245 “Ghana to Earn 8.3 Billion USD From Tourism By 2027,” Ghana Online News, April 3, 2014, accessed May 5, 2015, http://www.ghanaonlinenews.com/ghana-to-earn-8-3-billion-usd-from-tourism-by-2027/. 246 “Visas and Diplomatic Missions,” Ministry of Tourism, Culture and Creative Art, accessed May 5, 2015, http://www.touringghana.com/visas.php. 247 “Forbes: Ghana is eleventh friendliest nation,” Vibe Ghana, March 20, 2011, accessed May 5, 2015, http://vibeghana.com/2011/03/20/forbes-ghana-is-eleventh-friendliest-nation/.

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Figure 6-2: Number of tourists entering Ghana and Cambodia, 2000-2013 (millions of persons)

5 4

Millions 3 2 1 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Ghana Cambodia

Source: World Bank Note: Figures for Ghana for 2011-2013 not available

Figure 6-3: Tourism Receipts for Ghana and Cambodia, 2005-2013 (% of total exports) 35 30 25 20 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 2012 2013

Ghana Cambodia

Source: World Bank the Rason SEZ Chinese tourists can even drive around in their own cars without a tour guide.248 Though statistics on tourism have never been released by the North Korean government, the pro-North Korean

Choson Sinbo, widely regarded as a mouthpiece of the Workers’ Party, released a story in 2014 detailing that tourism had grown 20% compared to 2013, citing reasons of “tour-package diversity,” “military enthusiasts” and “railroad enthusiasts.”249 In addition, eight of North Korea’s newest SEZs have a tourism theme (Table 1-8). Should the government begin to put more emphasis on the tourism

248 Frank, “Rason.” 249 “Foreign Tourism in DPRK Increases by 20 Percent in the First Half of 2014,” The Institute for Far Eastern Studies, July 25, 2014, accessed May 5, 2015, http://ifes.kyungnam.ac.kr/eng/FRM/FRM_0101V.aspx?code=FRM140725_0001.

106 industry, it can grow rapidly, earning a great deal of revenue for the state for the financing of light and heavy industry growth.

Garments and Textiles

Textile production is no longer a significant part of the Ghanaian economy, though it “was once the leader in Ghana’s industrial sector.”250 However, as the government has liberalized trade and grown higher value-added industries, the textile industry has withered. This is actually a positive move, as it means that Ghana’s economy is growing. This fits the model that Lin advocates: as a developing economy grows, it will outgrow certain industries and move on to higher value-added industries. This further makes Ghana a good candidate for North Korea to emulate. Cambodia, however, is still heavily dependent on its garment and textile industry for exports and employment. Beginning in the 1990s and continuing through to 2005, the year in which the Multi-Fiber Arrangement (MFA) ended, Cambodia drastically expanded its garment manufacturing industry, as it had “low wages, plentiful labor, proximity to Asian raw materials, and favorable tax treatment.”251 FDI in this sector has been tremendous; however, there has yet to be any major growth in domestic shares of the industry (Figure 6-4). The garment industry has suffered from focus on heavily competing with China since the end of the MFA and later additional safeguards placed against China that expired in 2008.

In North Korea, the garment industry is still rather small (a part of “Light Industry” in Figure 6-1), but has major room to grow. The biggest impediment so far is that a great deal of inputs must be imported at less-than-favorable prices (Figure 6-5). Though exports of finished goods are much higher than imports of finished goods (Figure 6-6), when combined, imports of inputs and finished goods are higher than exports of the two (Figure 6-7). Allowing the market to take control of this industry inside of

250 Felix Dela Klutse, “Who’s Collapsing the Textile Industry?” Joy Online, February 25, 2014, accessed May 5, 2015, http://www.myjoyonline.com/business/2014/February-25th/whos-collapsing-textile-industry.php. 251 Joosung J. Lee, “An Outlook for Cambodia’s Garment Industry in the Post-Safeguard Policy Era,” Asian Survey, Vol. 51, No. 3 (May/June 2011), 560.

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Figure 6-4: Cambodian Garment Factory Ownership by Nationality, 2011 USA Others 3% 6% Singapore 4% Taiwan Malaysia 27% 6%

Cambodia 7%

South Korea 12% China 19% Hong Kong 16%

Source: Garment Manufacturers Association in Cambodia, 2011 Annual Bulletin Note: 269 factories

Figure 6-5: North Korean Imports and Exports of Textile Inputs, 2010-2013 (millions of current US$)

400

300 Millions 200

100

0 2010 2011 2012 2013

Imports Exports

Source: Statistics Korea, KOTRA Note: “Inputs” covers HS codes 50-56: Silk; Woolen & Woven Fabric; Cotton; Other Vegetable Textile Fibres/Woven Fabrics of Paper Yarn; Man-made Filaments; Man-made Staple Fibres; Wadding, Felt and Nonwovens/etc.; Does not include trade with South Korea

SEZs would allow efficient allocation of inputs, meaning that firms would order them at better prices and use them more efficiently. Improved manufactured goods would also mean that the domestic market would be more likely to purchase the domestically-produced goods rather than imports, giving a further boost to the industry. A further impediment, however, is the fact that Cambodia and

Bangladesh are both strong competitors in the garments and textile sectors. These countries have gradually taken over the industry as regional neighbors graduated from it, and have begun moving up the value chain. Is there room for North Korea? Certainly. Chinese investors who represent textile

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Figure 6-6: North Korean Imports and Exports of Finished Textile Goods, 2010-2013 (millions of current US$)

800

600 Millions 400

200

0 2010 2011 2012 2013

Imports Exports

Source: Statistics Korea, KOTRA Note: “Finished Goods” covers HS codes 57-63: Carpets; Special Woven Fabrics; Impregnated Textile Fabrics; Knitted Fabrics; Articles of Apparel & Clothing Accessories, Knitted or Crocheted; Articles of Apparel & Clothing Accessories, Not Knitted or Crocheted; Does not include trade with South Korea

Figure 6-7: North Korean Imports and Exports of Textile Inputs & Finished Textile Goods, 2010-2013 (millions of current US$)

700 600

500 Millions 400 300 200 100 0 2010 2011 2012 2013

Imports Exports

Source: Statistics Korea, KOTRA Note: Does not include trade with South Korea companies on the high-end of the value chain are looking for countries which have skilled yet very cheap labor. Cambodia’s minimum wage for the garment sector is $128/month (Table 6-1), while North

Korea’s in Rason is only US$80. Additionally, as China attempts to develop the northeastern corner of the country through the Changjitu Project and similar endeavors, there will be greater demand for a much closer labor force for simple labor-intensive textile manufacturing. Bangladesh’s minimum wage is far lower ($68/month), but it is also higher on the value chain than North Korea currently. North

Korea will be able to, in time, take over the steps on the value chain from which Cambodia and

Bangladesh graduate.

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To conclude this section, it is clear that North Korea should follow the paths that Ghana and

Cambodia have laid in the textile, mining and tourism industries. Over a period of 10-20 years they would be able to play catch-up to these economies by effectively doubling their GDP per capita (PPP).

The rest of the chapter will illustrate how that is done.

2. Removal of Constraints

What are the constraints binding the tourism, textile and mining industries in North Korea, and how can they best be removed to facilitate growth while allowing the government in Pyongyang to maintain political control?

The tourism industry is heavily controlled by the central government. All tourists must be accompanied by guides at all times. A visa is needed, even for short visits. Interaction with the local population is highly discouraged. Tour schedules are strict and usually only allow tourists to visit places with high propaganda value and of arguably little interest to sight-seers. There are many restrictions on photography. A few external companies are allowed to bring tourists in (such as Koryo Tours, Young

Pioneer Tours, and KTG), but everything is internally managed by the state-run Korea International

Travel Company.252 The only exception to this rule seems to be Rason SEZ, in which photographs are in general allowed (except for in the markets). One is more free to walk around without a guide (especially

Chinese tourists, who can drive around in their own car without a guide) and talking with locals is seemingly encouraged.253

The government has taken a few steps to expand tourism. Though in the past the only areas open to tours were Pyongyang, Kaesong, Mt. Kumgang, Mt. Baekdu and the DMZ, the government has designated eight of the new SEZs announced in 2013 and 2014 to be geared towards tourism, in addition to Rason and Sinuiju (Table 1-8). The Munsu Water Park was opened in Pyongyang in

252 Karla Cripps, “How to travel to North Korea,” CNN, February 4, 2013, accessed May 7, 2015, http://travel.cnn.com/how-travel-north-korea-042681. 253 Frank, “Rason.”

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November 2013 in an attempt to boost tourism, along with the Masikryong Ski Resort in Wonsan, which opened in early 2014. Americans, who once were only allowed to visit North Korea to attend the

Arirang Mass Games, are allowed to visit at any time since 2010.254 In 2014, the Pyongyang Tourism

College was opened “with the hopes of educating and training specialists in the tourism and travel industry.”255 The end goal for the leadership is to increase the number of tourists from 200,000 per year up to 1 million by 2016.256

These are lofty goals, and one might wonder if it is possible to attain them. It almost certainly is possible, but it involves further effort. The tourism college is probably the best place to start. Should the government still require tour guides, they should begin producing more, as they will need them for larger groups of tourists. Tourism infrastructure –especially hotels – needs to be upgraded.

Negotiations need to be made with neighboring countries to allow for more energy to be imported so that more tour buses can run and electricity shortages occur less frequently. Most importantly, there needs to be far more competition in the industry. Only a few tour companies are allowed to operate, driving prices sky-high. For example, Koryo Tours, the leading tour company specializing in North

Korean tourism, has a standard six-day trip that costs roughly US$1,860.257 This does not include any airfare expense. As a comparison, one can go on a twenty-six day tour to Cambodia, Thailand and

Vietnam for US$100 less through a different company.258 The key difference is competition. There are hundreds of tour companies that operate even in Vietnam, a country that only opened up a little over two decades ago. There is most certainly interest in touring North Korea among both Westerners and

Asians (the South Korean Ministry of Unification claims that over 2 million South Korean tourists alone

254 Chris Anderson, “Visit anytime! North Korea lifts restrictions on U.S. tourists,” January 15, 2010, accessed May 7, 2015, http://travel.cnn.com/explorations/none/north-korea-lifts-travel-restrictions-americans-529062. 255 “Pyongyang Tourism College.” 256 “Mounting problems,” The Economist, February 14, 2014, accessed May 7, 2015, http://www.economist.com/blogs/banyan/2014/02/skiing-north-korea. 257 “Late May Tour Itinerary 2015,” Koryo Tours, accessed May 7, 2015, http://www.koryogroup.com/travel_Itinerary_2015_late_may.php. 258 “Vietnam Tours,” Geckos Adventures, accessed May 7, 2015, http://www.geckosadventures.com/south-east- asia/vietnam.

111 visited Mt. Kumgang, Kaesong and Pyongyang between 1998 and 2009).259 If more tour companies were allowed to operate within North Korea, prices would go down, meaning far more tourists would come, providing a great deal more revenue for the government and jobs for the citizens.

The textile industry is somewhat more established, though still operated through state-run companies and joint ventures outside of the SEZs. Rather than producing their own brands, however, nearly all of these companies manufacture for foreign companies. The majority of these companies are based in China, but there are several European firms who have been using North Korea as a production base since the 1970s. The reputation of Korean garment and textile manufacturers is surprisingly high, as it has a wide base of existing infrastructure, a highly-skilled workforce, and very low production costs.

Even inside the SEZs the production costs are lower. For example, the minimum wage in Rason SEZ is

US$80 a month, which is 30% lower than in Northeast China, right across the border.260

What is then constraining this industry? Outside of the SEZs, all companies are state-owned enterprises or SOE joint ventures (see Appendix B for a list of garment and textile companies outside of the SEZs). Therefore, most of their decision-making has been centralized in regard to quotas, manufacturing processes, wages, business partners and management techniques. This is most likely a holdover from the “on-the-spot guidance” tours of Kim Il Sung and Kim Jong Il. Rather than learning from personal experience and the experience of other firms, the words of the leaders are the only advice that needs following. Though these companies are noted for their high efficiency, they could be far better – and far more competitive with their Asian neighbors – if they chose a less centralized path.

Allowing for more of these decisions to be made “on the ground” among factory managers and workers would go a long way towards reaching this goal. Inside of the SEZs (apart from Kaesong), the issue seems to be a lack of textile companies. The main constraint here is that foreign companies simply are

259 “Inter-Korean Exchanges of People and Goods,” Ministry of Unification, accessed May 7, 2015, http://unikorea.go.kr/download.do?filename=42602_201504011309360482.pdf. 260 Paul Tjia, “Garment Production in North Korea,” 38 North, August 30, 2012, accessed May 8, 2015, http://38north.org/2012/08/tjia082912/.

112 not aware of the zone, or do not trust in the North Korean state, in addition to inadequate infrastructure

(a problem both inside and outside of the SEZs). There is a lack of useful information on the Internet.

The website Naenara, a North Korean government-run website used to introduce the country to foreigners, does a fairly adequate job of introducing domestic companies (though not ones in the SEZs), though upon reading the information on the site, one gets a sense that it is mostly propaganda, as every company is “state of the art,” “modernized,” and “on the rise.”261 There is very little information about production numbers, statistics, actual skill level of workers or anything else that investors actually want to know. To find this information, one must physically travel to North Korea and go on a tour of a factory.262 The development of informative websites and improvement of infrastructure would be most beneficial for removal of constraints in this industry. After all, it has only been in the last few years that

North Korean factory managers have been allowed to use email in Rason SEZ.263

The mining industry is even more developed and profitable than the textile industry (compare

Figure 6-8 with Figure 6-7). There exist dozens of companies dedicated to all stages of the mining industry (see Appendix B for a list of mining companies in North Korea). The biggest trading partner is

China (73% of North Korea’s 2012 trade with China came from natural resources, and they participated in twenty out of twenty-five foreign mining projects in North Korea between 2003 and 2011). Trade with China in the mining industry grows every year as it shrinks with that of other countries as a result of international sanctions.264 This is not so beneficial to North, as only having one trade partner for minerals means that it is subject to the whims of this partner. There is mounting evidence that China was paying below-market values for natural resources from North Korea during the late Kim Jong Il era,

261 “Korea Sonhung Trading Corporation,” Naenara, April 22, 2015, accessed May 8, 2015, http://naenara.com.kp/en/trade/?company+1+1. 262 “Garments and Textile Production in North Korea (DPRK),” GPI Consultancy (Rotterdam 2012), accessed May 8, 2015, http://www.gpic.nl/Garments%20production%20in%20North-Korea.pdf. 263 Abrahamian, “Convergence,” 5. 264 Kang Hyun-kyung, “Rare earth elements boost NK income,” The Korea Times, July 27, 2014, accessed May 8, 2015, http://www.koreatimes.co.kr/www/news/nation/2014/07/116_161757.html; Choi, “Mining Industry.”

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Figure 6-8: North Korean Mining Industry Imports and Exports, 2010-2013

2.5 2

Billions 1.5 1 0.5 0 2010 2011 2012 2013

Imports Exports

Source: Statistics Korea, KOTRA Note: Covers HS codes 25-27 and 68-83. Does not include trade with South Korea. while charging North Koreans more for resource-related goods, including mining machinery and tools.265

The profitable mining industry could be even more profitable if there were more aggressive attempts to find trading partners, which would be easier if the SOEs involved were “let off the leash.” Allowing them to further seek joint ventures without the constant attention of the central government would lead the most efficient firms to rise to the top and have the other firms follow their lead. The other main obstacle is again, infrastructure. The average mine in North Korea is operating at “below 30 percent of capacity due to restricted financial assistance and the deteriorating infrastructure of the mining facilities,” including the limited power supply.266 Were the government to remove this constraint by firmly investing in infrastructure, or offering further incentives for foreign firms to invest in infrastructure, profits would most likely soar.

Apart from infrastructure and decentralizing decision-making, there is one very important constraint on the development of any industry in North Korea: sanctions. Though the nuclear issue is beyond the scope of this paper, the sanctions that have resulted from it are not. Four UN Security

Council Resolutions (1718, 1874, 2087, and 2094) target the creation, import, and export of military goods or goods used in the making of weapons of mass destruction, specifically nuclear weapons. The

265 Szalontai and Choi, “China’s Controversial Role,” 281. 266 Choi, “Mining Industry.”

114 latest resolution, 2094, also further allows nations to prevent North Korean aircraft or ships from entering their territory (even overflying), and makes it difficult for North Korea to move large sums of cash. Both 2087 and 2094 also list specific people and companies within North Korea with whom UN members cannot do business. The United States Treasury has been keeping a record of all North Korean companies, personnel, and vessels with which US businesses are not allowed to work.267 In addition to international sanctions, sanctions from both South Korea and Japan have had a very noticeable effect on the North Korean economy. Throughout the 1990s and early 2000s, these two countries were the

North’s biggest trading partners. However, when the issue of North Korean abduction of Japanese citizens came up in the early 2000s, public opinion in Japan suddenly turned. The Japanese government began imposing harsh sanctions over the issue in response to public pressure (Figure 1-2). There is virtually no trade between the two nations now. For South Korea, the sinking of the Cheonan and the shelling of Yeonpyeong Island in 2010 forced the Lee Myung-bak administration to impose restrictions on trade between the two countries (the so-called “May 24th Measures”), which has essentially driven all trade between the two countries to only take place in the Kaesong Industrial Complex (Table 1-9).

These constraints can very easily be lifted. Though negotiations between Japan and North Korea in early 2015 have stalled with no end in sight, it would be a simple matter for the North to comply with

Japanese wishes to further investigate abduction issues.268 The sentiment of the Japanese public has not waned with time, and it seems that this will continue to be a sticking point in any negotiations between the two countries. There are many Japanese business interests who are keen to invest in

North Korea for either their cheap labor or abundant natural resources, so it would behoove the

267 “Specially Designated Nationals List,” United States Treasury Department, accessed May 8, 2015, http://www.treasury.gov/ofac/downloads/ctrylst.txt. 268 “Japan extends North Korea sanctions amid stalled abduction probe,” BBC News, March 31, 2015, accessed May 8, 2015, http://www.bbc.com/news/world-asia-32126588.

115 leadership to try to solve this issue as quickly as possible.269 With regard to South Korea, it seems that over time the public – as well as many of those in the National Assembly from both major parties – have more or less forgotten about the Cheonan and Yeonpyeong Islands incidents.270 This situation requires an even simpler solution than the Japanese abduction issue. Should North Korea only admit its guilt (it could even claim that these acts were carried out by rogue factions within the military) and apologize, the South would most likely immediately lift the sanctions, giving a huge boost to the North’s economy and allowing them to further vary their sources of investment and not be so dependent on China.271 The

UN Security Council sanctions, however, will be far more difficult to contend with. It seems that the only viable method of finding a solution so far is to work through the failed Six Party Talks. Actual solutions are far beyond the scope of this paper, but it must be said that the lifting of the sanctions will be vital to keeping investors interested. There is simply too much paperwork and risk involved in investing in North Korea for highly-developed countries that have little or no prior experience there.

Removal of constraints on the target industries – tourism, textiles and mining – will be vital not only to foreign investors but also to the growth of domestic firms. However, as North Korea does not have much investment capital, it will need to first bring more and more foreign investors into the country. The next section details ways to attract FDI that the North can implement.

3. Attracting FDI

North Korea is not at all a capital-rich nation. As detailed in Chapter 1, the government cannot even afford most of its own spending, and forces the different ministries to finance themselves through

269 Christopher W. Hughes, “The Political Economy of Japanese Sanctions Towards North Korea: Domestic Coalitions and International Systemic Pressures,” Pacific Affairs Vol. 79, No. 3 (Fall 2006), 477-478. 270 Ahn Jong Sik, “Clear Approach Needed for May 24th Measures,” Daily NK, October 17, 2014, accessed May 8, 2015, http://www.dailynk.com/english/read.php?cataId=nk03600&num=12437. 271 There is a precedent for North Korea apologizing for an act after initially denying it. In 1996, a North Korean submarine dropped several spies off on the South Korean coast. Several South Korean citizens and soldiers were killed and nearly all of the spies were caught. The North apologized for the incident. Detailed in “Record of North Korea’s Major Conventional Provocations since 1960s,” Center for Strategic and International Studies (May 2010), accessed May 8, 2015, http://csis.org/files/publication/100525_North_Koreas_Provocations.pdf.

116 foreign currency-earning enterprises. Even North Korean embassies have to self-finance in whatever ways possible.272 Not having a comparative advantage in capital, they are forced to try to attract FDI.

This section first explains the current methods already employed by the North Korean state to attract

FDI (the law for Rason is specifically discussed in Section 3 of Chapter 5), and then explains how these measures could be improved.

Current Laws

North Korea has a special law on foreign investment that was enacted in 1992 and was amended six times through to 2011.273 Here I will discuss the most important articles of the law.

According to Article 2, preferential treatment shall take place only in SEZs. This is understandable, as it keeps economic reform manageable. Article 4 discusses investors’ legal rights, but only in one sentence.

Article 6 merely explains that investment can be done in any sector while giving examples of certain sectors without clarifying if those are specifically sought-after sectors of investment. Articles 7 and 8 are perhaps the most important; Article 7 highlights the priority sectors (“…investments that are conducive to the introduction of high technologies and other state-of-the-art technology, manufacturing of internationally competitive goods, construction of infrastructure facilities, scientific research and development of technology”), while Article 8 lists the preferential treatment that investors in these sectors will receive (“…such benefits as reduction and exemption of income tax and other taxes, favourable conditions of land use and preferential bank loans”). There is nothing else in these articles, though Article 9 goes into a little more detail: “…foreign-invested business that are set up in the special economic zones are provided with preferential conditions for business activities in such areas as purchase, bringing-in and taking-out of materials, marketing of products, employment of labour,

272 Colin Freeman, “Under-paid diplomats at North Korean embassy forced to shop at car boot sales,” The Telegraph, December 20, 2014, accessed May 10, 2015, http://www.telegraph.co.uk/news/worldnews/asia/northkorea/11305540/Under-paid-diplomats-at-North- Korean-embassy-forced-to-shop-at-car-boot-sales.html. 273 “Law of the Democratic People’s Republic of Korea on Foreign Investment,” 2011. Most information for this section will come from this law, unless otherwise noted.

117 payment of taxes and land use.” Article 10 gives assurances that entry to and exit from the country for investors shall be made so as to “suite [sic] their convenience.” Article 11 is somewhat interesting in that it gives a list of restricted areas: those “detrimental to national security, public health and healthy social and moral life,” those for “exporting natural resources,” those violating “environmental protection criteria,” those that are “technically outdated,” and those that have “low economic efficiency”

(emphasis mine). Though there are no definitions given for these terms or what exactly they encompass, the clause restricting natural resources export is interesting since that is one of the most heavily-invested sectors of the economy by foreign firms. Article 12 ensures that the “value of the assets and property rights invested” are determined by “the prevailing world market price,” showing that the government understands the value of using market mechanisms to determine pricing. Article

14 differentiates between “foreign-invested enterprises, foreign-invested banks and wholly foreign- owned banks” and their branches or agencies by stating that the former shall be corporate entities while the latter cannot. Article 15 provides that land may be leased for fifty years maximum. Article 16 requires that the investors must employ North Korean workers except for some managers, technicians and “skilled workers for special jobs,” subject to agreement “of the investment management organ.”

Articles 17 and 18 briefly state that investors must pay income tax, turnover tax and property tax, but if they reinvest in North Korea, they can receive “whole or part” of the tax back as a refund. Article 19 provides for the protection of investors’ property, but just like the Rason law, it provides for the state to expropriate said property should it be required “for public interests.” Remittance of all profits is guaranteed under Article 20.

There are also laws for equity joint ventures, contractual joint ventures, wholly foreign-owned enterprises, and foreign invested banks. These laws use generally the same language and express the same conditions and allowances, though the law on equity joint venture gives preferential treatment

118 not only to priority sectors but also to overseas Korean investors.274 The law on wholly foreign-owned enterprises is a bit more specific on the areas in which investment is allowed: “electronics, automation, machine-building, food-processing, garment-processing, daily-necessities [sic], transport, service and others” (emphasis mine).275

Preferential tax treatment is outlined in greater detail in the law on taxation of foreign-invested businesses and foreign individuals.276 This law gives a more specific explanation on what is to be taxed, though there are still vague phrases like “other earnings.” For businesses outside of SEZs, the tax rate is

25%. Inside of SEZs it is 14%, and those in priority sectors pay 10%. Income from “dividends, interest, rental charge, royalties or other sources” is taxed at 20% (emphasis mine). With respect to Article 18 of the foreign investment law, Article 15 of this law gives further information on what reinvestment into

North Korea would look like, and how much of a refund the firm would receive (or tax break). These include giving loans to the government or domestic firm, being in a priority sector (one would “be entitled to an exemption from enterprise income tax for 3 years from the first profit-producing year and to a reduction of up to 50% for the following 2 years, provided that it is to be operated for more than 10 years,” though it is not explained whether this is on top of the 10% taxation rate, instead of it, after, before, or any other explanation), or developing infrastructure.

Areas for Improvement

The main law on foreign investment is a good start. It seems to be mimicking the early

Shenzhen laws, a positive sign, yet is also somewhat vague. The vagueness could be an effort at giving the North Korean government “wiggle room” in the event of a conflict with an investor, so they could point to a law and say, “we interpret it to mean X, which works in our favor.” This is quite unappealing

274 “Law of the Democratic People’s Republic of Korea on Equity Joint Venture,” 2011, Article 7. 275 “Law of the Democratic People’s Republic of Korea on Wholly Foreign-Owned Enterprises,” 2011, Article 3. 276 “Taxation Law of the Democratic People’s Republic of Korea for Foreign-Invested Businesses and Foreign Individuals,” 2011.

119 for investors, who are searching for countries with clear laws that have sufficient definitions of all terminology so that risk can be as minimal as possible. Fortunately, the taxation law cited above and the “Labour Law for Foreign Invested Enterprises” give a great deal more detail, though there are still vague terms used throughout the laws such as “other sources,” “and others,” “some,” and the most common, “guidance organ,” which refers to the relevant government agency that handles whichever issue is being discussed in that part of the law. This last one should be cleared up by giving the name of the actual ministry, agency or office involved so that investors will know exactly with whom they should deal in any situation. The most alarming is still the clause allowing for the expropriation of property “for public interests.” Though every country has a law allowing for eminent domain, it is absolutely essential that this be defined better (e.g., situations of war or total economic collapse) so as to reassure investors.

Some of the laws themselves are fortunately available on Naenara’s “Economy/Trade” page, but it would be more beneficial to provide all relevant laws on this page.277

The preferential tax treatment cited above mirrors that provided by Shenzhen. It is much better than merely providing 10-year tax holidays for all investment, as some countries are wont to do (e.g.,

Bangladesh) in a race to the bottom (see Chapter 5, Section 1). However, as the world is far more competitive in terms of search for FDI now than it was in the 1980s, tax incentives should be coupled with perhaps discount rates on electricity, gas and Internet access.

In addition, according to the labor law, all workers “shall be provided by the labour administration institution in the seat of the enterprise concerned,” and that the labor administration may “refuse to employ such persons that fail to satisfy the prescribed criteria.”278 As this is North Korea, a country that uses a politically-motivated, government-defined classification system (Songbun) to separate people into three classes (“core” or loyal, “wavering” or tolerated, but not fully trusted, and

“hostile” or undesirables), it is in my opinion assured that the government will have a litmus test on who

277 These laws can be found at http://www.naenara.com.kp/en/trade/. 278 “Labour Law of the Democratic People’s Republic of Korea for Foreign-Invested Enterprises,” 2011.

120 can and cannot work for foreign enterprises.279 This is severely detrimental to potential investors.

Shenzhen was able to succeed because it had access to all labor and was able to hire based on merit and ability; North Korean SEZs and foreign businesses will only have access to those deemed politically suitable, or who can bribe the right officials. This leads to inefficiencies in the system. The best thing to do would be to remove this part of the law and allow for firms to make hiring decisions completely on their own.

The final area of improvement to woo investors is to provide a stable political environment.

While investors dislike ambiguity, they absolutely fear instability. For example, the central government intervening and stopping several joint ventures in the Rason, Sinuiju and Wihwa/Hwanggumpyeong

Islands SEZs in the wake of the purge and execution of Jang Song Thaek in late 2013 was for many investors a reason to skip over North Korea when looking for potential investment targets.280 It also caused investors already present to have second thoughts. This all followed the disastrous spring and summer of the same year in which the North Korean leadership unilaterally shut down the Kaesong

Industrial Complex (KIC) over South Korea’s strong endorsement of the UN sanctions condemning the

2013 nuclear test, causing losses of nearly US$1 billion (2013 dollars).281 Forty-six firms also decided to no longer invest in the KIC and established their operations elsewhere.282 The third most drastic example is that of the North Korean government unilaterally demanding that South Korean factory owners in the KIC raise wages for North Korean workers, without having first consulted the South

279 For more information, see: Robert Collins, Marked For Life: Songbun North Korea’s Social Classification System (Washington DC: Committee for Human Rights in North Korea, 2012). 280 Koichiro Ishida, “Jang’s execution halts China-N. Korea joint venture, alienates investors,” The Asahi Shimbun, December 19, 2013, accessed May 10, 2015, http://ajw.asahi.com/article/asia/korean_peninsula/AJ201312190064. 281 “South Koreans head back north to reopened Kaesong complex,” The Guardian, September 16, 2013, accessed May 10, 2015, http://www.theguardian.com/world/2013/sep/16/south-north-korea-kaesong-reopen. 282 Kim Hee-jin, “46 firms giving up on Kaesong,” Korea Joongang Daily, July 4, 2013, accessed May 10, 2015, http://koreajoongangdaily.joins.com/news/article/Article.aspx?aid=2974038.

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Korean government (which it is required to do).283 This political instability is not conducive to a positive investment environment. The best solution, unfortunately, is to simply be stable. Over time, as stability is maintained, investors will notice that the leadership has learned from its past and is not repeating the same mistakes. Assurances and promises are words, but like all people, investors are far more interested in actions.

Types of Firms to Target

Entering Global Value Chains (GVCs) is of paramount importance, as was shown in Chapter 4.

Rather than trying to create entire garments, workers and firms in the North should become experts at certain steps of garment production (e.g., a factory devoted entirely to putting buttons on otherwise- finished suits). Therefore, the kinds of firms that should be especially targeted are those who have a high degree of fragmentation in their production process—especially if it is fragmented throughout East

Asia. As SEZs or other industrial parks become specialized areas in one step of garment or textile production, it will allow for that comparative advantage to be even more evident to foreign firms, creating a snowball effect. This also ensures that external economies of scale will develop, as secondary firms related to the garment/textile sector will establish shops within these zones, or adjacent to them.

This is the most efficient method of development, as factories can move step by step up the chain, and slowly but surely import technology and spread it to the local economy, allowing domestic firms to take advantage. The best way to target these specific firms is to first of all show that your workers are especially skilled in the targeted industry (and are able to learn the next step of the process quickly). If a firm can show that it plans to gradually upgrade the role of its factory in North Korea in the production process over time as the workers learn new skills, that firm should be offered special incentives for doing so.

283 “South Korea to punish factories for raising wages,” The Guardian, April 21, 2015, accessed May 10, 2015, http://www.theguardian.com/world/2015/apr/21/south-korea-punish-factories-raising-wages-kaesong-north.

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Attraction of FDI is absolutely essential these days for a developing country. North Korea is not a capital-rich country, and so it should rely on capital-rich countries to invest. This means looking beyond countries such as China and Russia. Solving its issues with South Korea and Japan would go a long way to bringing in investment, and making positive overtures to highly-developed Western countries would bring even greater results, as “Factory Asia” is beginning to run out of countries with cheap labor and abundant resources. The next section returns to domestic industries.

4. Rewarding Self-Discoveries

Successful entrepreneurship should be rewarded. In North Korea, entrepreneurship is hard to come by, and has so far been mostly restricted to the jangmadang. Had the central government rewarded those resourceful individuals during the famine of the 1990s who journeyed into China and brought back food and goods for sale for their clever method of making up for the deficiencies of the failed public distribution system, rather than punish them and attempt to limit their activities as much as possible, a strong industry in food trade might have been achieved and food security would most likely have been assured. Instead, the government offered no reward and only worked as hard as possible to hamper their efforts (though now they have become somewhat institutionalized at a very basic level).

This was a major mistake.

Entrepreneurial activities are the lifeblood to new industries. Centrally-planned economies cannot fathom the possibilities of new industries that might be able to take off and improve the economy, focused as they are on specific sectors (especially in North Korea, where they unfortunately continue to place most emphasis on heavy industry). The targeted industries for North Korea that I have suggested are tourism, mining and garments/textiles, but this does not mean that there are not any other industries in which North Koreans could excel right now. A good way to encourage entrepreneurial activity is to perhaps hold competitions throughout the entire country on ideas for products or services that would most benefit the people of North Korea, and give rewards or seed

123 money to the inventors/discoverers of these ideas and remove any strong, binding constraints that would inhibit their growth. Another possible method is to review the jangmadang, see which sellers are doing best, and inquire as to how they are able to do so well, what methods they employ, and what products or services they provide. From this, the government can begin encouraging similar vendors by providing loans at preferential rates or removing other binding constraints, such as harsh taxes. Indeed, simply not restricting these marketplaces would be a great first step in allowing for self-discoveries to be made.

This action should accompany gradual decentralization of economic decision-making. Economic planners in Pyongyang most likely have very little idea of what conditions are like on the ground in

Manpo, or Hoeryong, or Munchon. Average citizens know better than anyone else in these and other cities what consumers most desire. This is already beginning to catch on with stores called hwanggumbol, which try to “provide a wide range of goods, with a stable supply, reasonable prices and reliable quality.”284 Not only allowing this trend to continue, but offering incentives for it, will greatly benefit the domestic economy.

5. SEZs

Special economic zones, fortunately, are an area in which North Korea seems to have a head start

(relative to the other steps in this process), as shown previously in Chapter 5. As previously noted, there are now a total of twenty-five SEZs in North Korea as of the 2013 and 2014 announcements (Table 6-2), serving several purposes. This is the wisest path to follow if the North Korean leadership desires to reform the economy while maintaining political control over the country.

The leadership has finally abandoned the archaic method of control used by Kim Jong Il (at least in this one regard), in which rival government or party organs would compete against one another for

284 “In shifting economy, shops aim to please N. Korea consumers,” Komo News, March 3, 2015, accessed May 10, 2015, http://www.komonews.com/news/business/In-shifting-economy-shops-aim-to-please-N-Korea-consumers- 294867231.html.

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Table 6-2: Categorical Breakdown of the DPRK's Planned Special Economic Zones Export Industrial Agricultural Tourism Economic International Green High-Tech Pre-existing / Processing / Development Development Development Development Economic Demonstration Development Others Trade Zones Zones Zones Zones Zones Zones Zones Zones Gangryong Songrim Wiwon Pukchong Onsong Island Chongjin Unjong High- Sinuiju International Hwanggumpyeong Export Industrial Agricultural Tourist Economic Tech International Green and Wihwa Islands Processing Development Development Development Development Development Economic Zone Demonstration Economic Zone Zone Zones Zone Zone Zone Zone Zone Nampo City Hangman Orang Sinphyong Hyesan Waudo Export Industrial Agricultural Tourist Economic Rason Special

Processing Development Development Development Development Economic Zone Zone Zone Zone Zone Zone Hyondong Sukchon Manpo Jindo Export Chongsu Tourist Industrial Agricultural Economic Kaesong Industrial Processing Development Development Development Development Complex / Region Zone Zone Zone Zone Zone Chongnam Amrok River Industrial Wonsan Special Economic Mt. Kumgang Tourist

Development Tourism Zone Development Zone / Region Zone Zone Source: Andray Abrahamian, The ABCs of North Korea’s SEZs, 35. Note: Reconstructed by author. Many zones serve more than one purpose; this is simply the primary category. control over certain sectors of the state. For SEZs, this had been the Daepung Group and the Joint

Venture and Investment Committee. Members of both of these government agencies were not entirely aware of who had control over what, and whose authority under the Kim family was absolute.285

However, in 2013 the state passed a law creating the Ministry of External Economy (MoEE), which has control of all SEZs except for Rason, Hwanggumpyeong/Wihwa Islands, Mt. Kumgang (which are governed by the MoEE, but under separate laws), and the KIC (which is not governed by this law or the

MoEE). This makes it very clear to investors who has the authority to handle all investment matters, and with whom they should be working.

Abrahamian, in discussing the prospects for these new SEZs, claims that “[w]hile most of these zones will languish as underfunded and under-connected, a handful will be positioned to attract moderate investment should North Korea’s relations with neighboring countries improve,” and that

“they will open up spaces in which further policy experiments can take place.”286 It seems that the leadership most likely anticipates this, and is casting a wide net in order to attract as much investment as possible, in hopes that the best SEZs will rise to the top. While this strategy is not terrible, it would probably best serve them to consolidate a few of the zones or quickly drop the most under-performing

285 Abrahamian, “Convergence,” 3. 286 Abrahamian, ABCs, 7.

125 ones altogether. North Korea should not wait around to face the same problems that the Chinese had back in 2006, in which many of their 6,866 zones had escaped strong government regulation and violated the land-use plan. This led to the abolishment and consolidation of many of the zones, so that afterwards there were only 1,568 zones left.287 Consolidation or abolishment now can help the leadership to ensure that those zones that are left will receive proper attention from the central government. This does not mean, however, that decision-making should be left up to the central government. As with Rason, decision-making should be as decentralized as possible. This allows for more efficient management, which is pleasing to administrators, investors and workers. Rason should be treated as the gold standard SEZ, as it has received the most attention (apart from the KIC, whose special status leaves it outside of the scope of this paper), and with the coming development of

Liaoning, Jilin and Heilongjiang, stands to be the most profitable. Just as Shenzhen became the model for the rest of China due to its prime location and first-comer status, so should Rason. All economic experiments should first be tried there before being passed onto the other zones, and eventually, to the rest of the country. This will also help the impoverished northeastern provinces to become balanced with the rest of the country. It is wise that the zones have been spread around the country (Figure 1-2), as this will avoid the issue that China is now facing in which some areas are very, very rich while others are very, very poor. However, it is not a perfect situation, as there are very few inland zones compared to those on the coast or in the border region. This is to be expected, however, as these zones primarily serve as export processing zones, which need ready access to the sea or at least a major river. Putting zones in the vicinity of areas with rich natural resource deposits would be beneficial to growing that industry.

287 Simon Alder, Lin Shao and Fabrizio Zilibotti, “The Effect of Economic Reform and Industrial Policy in a Panel of Chinese Cities,” Center for Institutions, Policy and Culture in the Development Process, Working Paper No. 207 (April 2013), 8.

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6. Limited Incentives to Targeted Industries

The first firm to enter an industry often has a difficult time, in contrast with the firms that follow. These followers can learn from the successes and mistakes of the pioneering firm, and thus have less to lose. If the pioneering firm does not see some sort of incentive from its actions, it may not put forth the effort to innovate or upgrade in the first place.

The North Korean government should offer these incentives most especially to domestic industries, but should not disqualify foreign firms from taking risks within the country as well. For the moment, it truly is a brave firm that is willing to invest in the politically unstable country, and those firms deserve special recognition.

Outside of SEZs, firms must pay 25% in corporate income tax. Pioneering firms should instead be given the same tax rates (and reduction incentives) as those inside of the SEZs. This will ensure that they have enough capital to make up for the losses incurred by being first movers. In addition, the

North Korean central bank can easily provide favorable loans at heavily discounted rates to finance investments, especially when said investments will benefit future firms in that industry. Infrastructure in North Korea is lacking, especially in terms of industrial equipment in factories, which is often outdated.

Rather than directly purchasing and importing new equipment itself, the government should provide funding for firms to do this themselves, as they will be seeking the most efficient route possible to do so.

Of course, there are already many established firms in both the mining and garments/textiles industries. However, the tourism industry only has a few firms, and they are decidedly niche. Should a new type of tourism firm (that focuses on, for example, homestays or skydiving) attempt to enter this new market, it should be provided with these limited incentives. As long as these firms are following along with the targeted industries that do not go against the comparative advantage of the country, they should be rewarded for their first-mover status. Firms in established industries that begin to upgrade to higher levels of the value chain should be rewarded just as those who enter new industries,

127 as this can be just as risky sometimes. As North Korea graduates from these three industries and moves into higher-level or higher value-added steps of the chain, they should continue to supply these incentives to pioneers.

It is also important to make sure that corruption and graft do not develop from this behavior.

Keeping these incentives temporary is key. Should the firms get used to them (as has happened even in developed countries), they will fight every attempt to remove them. For this reason, the central government must make the firms understand that these are only temporary incentives and will be revoked once the firm becomes profitable. If free (or even cheap) money is given to firms without any oversight, corruption amongst executives and managers will develop immediately, costing the workers, citizens and government dearly.

7. Further Suggestions

Though the first six sections covered the theory of New Structural Economics as explained by

Justin Lin, there are a few other areas in which the North Korean state could improve in order to better develop.

As mentioned in Chapter 2, North Korea continues to focus on heavy industry as a hoped-for miracle in “catching up” to developed countries. This hoped-for miracle has not produced any good, tangible results since the late 1950s, a time in which the move for heavy industry was only successful due to heavy distortions (see Chapter 1, Section 1 and Chapter 2, Section 1). For now, it would be best for the North Korean government to put heavy industry on the back burner until the light industry firms have matured enough that the country can graduate to the next level. For this reason also, the government should keep a great deal of the resources which it mines as reserves for when they can be more easily utilized by domestic heavy industry firms. Using these resources for heavy industry now is a waste, as heavy industry is far too capital-intensive for a country with no capital. For now, wait until light industry is developed and enough capital has been accumulated to begin investing in these sectors

128 that have so far only been a drain on the economy and people’s livelihoods.

The idea behind Juche is, on the exterior, heartening. Ensuring that one’s country is never taken advantage of by outside forces is an admirable goal. However, in this globalized world, competition is rampant, but the only way to ensure success is through cooperation. It is the quest for self-sufficiency that led to a complete reliance on the ISI method of industrialization, which has given nothing but grief to North Korea since the 1960s. Understanding that one need not support entire industries—or even every step of one industry—will greatly help North Korea to more rapidly catch up with other developing and developed countries than if it continues to pursue isolationist policies. Likewise, giving the North Korean people a more objective understanding of foreigners and their cultures will go a long way towards helping workers get along with management in foreign-run factories as the country develops. This can be achieved by introducing more objective television programming and even events honoring foreign cultures throughout the country, just as South Korea has successfully done.

The “limited development strategy” that many in the North Korean leadership want to pursue will only hurt the nation’s growth and development. Under this idea, the country would only grow to the point that it would be able to remain isolated and in firm control. This is impossible; the country would not be able to maintain any positive standard of living for a significant amount of time under this strategy. The leadership needs to understand that political control is possible even when economic decision-making and control has been decentralized. This has become evident in China and can happen as well in North Korea. Abandoning any notion of limiting the economic development of the country is essential ensuring the happiness and livelihoods of the North Korean people.

Finally, decentralization of agricultural decision-making and allowing for the import of agricultural products will erase the food security problems that have plagued North Korea for two decades. The 6.28 measures (Chapter 1, Section 3) have gone a long way toward this goal, but the most promising news is that of the central government completely ending the collective farm system in April

129 of 2015.288 Under the latest decision, families keep 50% of their harvest, while giving 30% to the central government and 20% to the provincial government.289 In addition, the government is willing to buy crops off of the farmers at market rates. This can only lead to more efficient decision-making by farmers, which will lead to increased food production, eventually allowing for better mechanization, which will in turn increase the labor supply as the [hopefully] growing light industry sector requires more workers.

288 “N. Korea Gives Up on Big Collective Farms,” Chosun Ilbo, April 28, 2015, accessed May 11, 2015, http://english.chosun.com/site/data/html_dir/2015/04/28/2015042801736.html. 289 Some reports say 60% is kept rather than 50%.

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Conclusion

The prospects for economic reform in North Korea are not dim. In fact, the people and government have already started down a path from which it will be hard to reverse-course. What is important now is for the government to learn what the people already have: the market is the best determiner for efficient allocation of resources, and “playing catch-up” means first building a strong foundation in light industry that is supported by food security. Understanding what the country’s comparative advantages are—and what they are not—is essential for the government to take the right path.

North Korea is now abundant in natural resources and cheap labor. It is not abundant in capital.

Therefore, capital-intensive industries (like heavy industry) should be placed “on the back burner” until there is sufficient capital accumulation for investment in such sectors as heavy industry. North Korea was never abundant in capital, except when it received massive amounts of aid during the 1950s and early 1960s, aid which it squandered on projects that would not provide usable inputs that could be reinvested into the economy. It absolutely should not make the same mistake twice. Once a strong light industry sector emerges which can help build the entire economy, then the result can be reinvested into heavy industry. It seems that with Kim Jong Un, emphasis is being slowly taken away from heavy industry and being put into light industry, so it might be that the proper changes are finally being made.

The ending of collective farming and allowing farmers to keep up to 50-60% of their harvest is a huge step in the right direction that will provide food security, making the light industry base that much surer.

The emergence over the last three decades of global value chains (GVCs) has transformed the way that developing countries grow their economies and catch up with developed economies. Rather than manufacturing entire products in one factory, firms take a cue from Adam Smith on a global scale and manufacture different parts in different locations. This requires countries to allow their domestic firms to heavily engage with the outside world and even more so to be reliant upon the international

131 economy. This flies in the face of Juche ideology. The North Korean government will soon have to choose whether to continue down the failed path of Juche and self-reliance or to link their economy into the global economy via GVCs. Of course, it need not be the entire economy that is linked—and it should not be. Rapid economic changes cause massive instability both economically and socially, resulting in the terrible crises of the former Eastern Bloc countries in the 1990s.

The best way to limit economic changes is to first only allow them in the special economic zones

(SEZs). North Korea is doing exactly this now. Rason SEZ, after having a rough near-two decade start, has been given the boost it needs by both the North Korean government and the Chinese government, and looks set to become the most profitable SEZ in a few years, even if it only ends up serving as a hub for transporting Chinese and Russian goods (though all signs point to it becoming much more than this).

Though many of the new SEZs will most likely wither away, there are several that look promising, which

Andray Abrahamian does an amazing job of outlining in his work The ABCs of North Korea’s SEZs. Even if successful policy experiments are not allowed in the domestic economy, the backwards linkages of management know-how and technology transfer will be of great benefit to the domestic firms that are already in place. However, it would behoove the North Korean government to allow for greater entrepreneurship in order to make the domestic economy a stronger, more resilient force over time and less dependent on a few large, state-owned enterprises.

The idea of a “limited economic development strategy” is a failure from the start. Capitalist economies require constant growth and dynamism to stay alive; they are sharks, not sloths.

Maintaining political control will only now be possible by giving up economic control. The people do not strongly desire the right to vote for multiple parties or to engage in political debate. They desire food and jobs. The legitimacy of a communist party lies in its ability to provide everything for its people.

When it cannot do this, it is no longer legitimate. Should it require capitalism to achieve this goal, so be it. As Deng Xiaoping said, “It doesn’t matter whether a cat is black or white, as long as it catches mice.”

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Despite the obvious benefits of this proposal, the North Korean leadership is still following, roughly speaking, the same ISI method that it has been following since 1953. Why? As explained in the first chapter, there have been significant reforms since 2002, with the strongest reforms coming with the ascension of Kim Jong Un. With his goal of simultaneous development of the economy and nuclear weapons and seemingly pushing back his father’s Military First policy, it does appear that he has a genuine interest in improving the economic well-being of the North Korean people, whatever his motivations may be. In addition, since he came into power, there have also been a great number of purges of “old guard” party members and military figures that held power under Kim Jong Il. With every purge come more reforms. Though one can only speculate, it would appear that further reform is being blocked by conservative party members who desire to remain on the same track that has always been followed—thus the adherence to the limited economic development strategy discussed in the second chapter. Though those outside the central decision-making apparatus of North Korea cannot truly know what decisions are being made or the reasoning behind them, an analysis of the results of these decisions can give us a strong educated guess. If this assessment is true, and should then Kim Jong Un succeed in completely removing his conservative rivals, then there is no doubt that stronger reform programs will be implemented, and one can hope that they follow the method prescribed within this paper.

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Appendix A – Law on Rason

LAW OF THE DEMOCRATIC PEOPLE’S REPUBLIC OF KOREA ON THE RASON ECONOMIC AND TRADE ZONE

Adopted by decision No. 28 of the Standing Committee of the Supreme People's Assembly on January 31, 1993, amended by Decree No.484 of the Presidium of the Supreme People's Assembly on February 26, 1999, amended by Decree No.3400 of the Presidium of the Supreme People's Assembly on November 7, 2002, amended by Decree No.1083 of the Presidium of the Supreme People's Assembly on April 19, 2005, amended by Decree No.2367 of the Presidium of the Supreme People's Assembly on September 26, 2007, amended by Decree No.583 of the Presidium of the Supreme People's Assembly on January 27, 2010 and amended by Decree No.2007 of the Presidium of the Supreme People's Assembly on December 3, 2011

CONTENTS [Note: Page numbers removed for this version] CHAPTER 1 FUNDAMENTALS CHAPTER 2 DEVELOPMENT OF THE ZONE CHAPTER 3 MANAGEMENT OF THE ZONE CHAPTER 4 ESTABLISHMENT OF ENTERISES, ECONOMIC AND TRADE ACTIVITIES CHAPTER 5 CUSTOMS DUTIES CHAPTER 6 CURRENCY AND FINANCIAL MATTERS CHAPTER 7 INCENTIVES AND PREFERENTIAL TREATMENT CHAPTER 8 COMPLAINTS, SETTLEMENT OF DISPUTES APPENDIX

Chapter 1: Fundamentals

Article 1 (Objective) This Law is enacted to provide strict guidelines for the development and management of the Rason Economic and Trade Zone, thereby contributing to developing it into an area of international transit transport, trade, investment, financing, tourism and service.

Article 2 (Status of the Economic and Trade Zone) The Rason Economic and Trade Zone (the Zone) is a special economic zone of the Democratic People's Republic of Korea (the DPRK), where preferential policy is pursued in the economic sector.

Article 3 (Establishment of industrial parks) The State shall ensure that industrial parks mainly of high-tech industry, international logistics business, equipment manufacturing, primary processing industry, light i [sic], service business and modern agriculture and established in the Zone in accordance with the plan.

Article 4 (Investors) The Zone is open for investment by corporate bodies, individual persons and economic organizations of different countries. Koreans residing outside the territory of the DPRK may also invest in the Zone in accordance with this Law.

Article 5 (Principle of provision of conditions for economic activities) Investors may freely conduct economic activities in the Zone through the establishment of companies, branches, representative offices and the like. The State shall ensure that investors are preferentially provided with conditions for their economic activities in such areas as land use, labour employment, payment of tax and access to markets.

Article 6 (Sectors of priority, prohibition, limitation) The State particularly encourages investment in the Zone for infrastructure construction, state-of-the art science and technology and production of internationally competitive goods. Investments shall be prohibited or restricted in those projects that are detrimental to national security, public health, healthy social and moral life, protection of environment and growth of animals and plants, and projects that are economically and technically outdated.

Article 7 (Principle of protecting investors' property, interests and rights) The property, legitimate income and invested rights of investors in the Zone shall be protected by the law. The State shall not nationalize or expropriate the property of the investors. Where an investor's property is, for unavoidable reasons, to be expropriated or used temporarily for public interest, notification thereof shall be made before going through prescribed legal procedures, and sufficient and effective compensation for its value shall be made without any discrimination.

Article 8 (Manager and operator of the Zone, principle of non-involvement in the work of management committee) Management and operation of the industrial parks and designated areas of the Zone shall be undertaken by the management committee under the guidance and assistance of the central guidance authority of special economic zones and the Rason municipal people's committee. Other institutions shall not get involved in the work of the management committee except in such cases as are prescribed by this Law.

Article 9 (Protection of personal safety and human rights, prohibition of illegal detention and arrest)

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Personal safety and human rights of citizens in the Zone shall be protected by the law. No one shall be detained or arrested, nor his/her place of residence be searched without a legal warrant. Any treaty concluded between the DPRK and a foreign country in respect of personal safety and criminal matters shall prevail.

Article 10 (Applicable laws and regulations) Applicable to the development and management of the Zone, business operation and other economic activities therein are this Law, and its implementing regulations, rules and general standards. Where the laws and regulations governing the Zone contain provisions different from treaties like conventions, memorandum of understanding and agreements concluded between the DPRK and a foreign country, the latter shall take precedence. Where the laws and regulations for the Zone differ from those in effect outside it, the former shall prevail.

Chapter 2: Development of the Zone

Article 11 (Principle of development) The Zone shall be developed on the principle of: • ensuring comparative advantage of the Zone over the surrounding areas in natural and geographical conditions, natural resources and requisites for production; • making economic and rational use of land and resources; • protecting the ecological environment of the Zone and the surrounding areas; • raising international competitiveness of production and service; • providing facilities for economic activities like trade and investment; • guaranteeing public interest; and • ensuring sustained and balanced economic development

Article 12 (Development plan, modification) The Zone shall be developed in accordance with the approved development plan. The development plan shall include master plan, regional plan and detailed plan. Approval for modification of the development plan shall be granted by the authority that approved the plan concerned.

Article 13 (Mode of development of the Zone) Development of the Zone may be conducted in various modes: an enterprise may comprehensively develop a certain area of land and operate it, an enterprise may be granted a special license to construct, manage and operate an infrastructure and public establishments and parties to development may agree upon a certain mode of development. The developer enterprise may invite other enterprise to participate in the construction of infrastructure and public establishments.

Article 14 (Approval for developer enterprise) Approval for the developer enterprise of the Zone shall be granted by the central guidance authority of special economic zones by issuing to him/her a development license via the management committee of the Rason municipal people's committee. Authorization of the developer enterprise and application for development license shall be the undertaken by the management committee of the Rason municipal people's committee.

Article 15 (Land lease contract for comprehensive development and operation of land) The developer enterprise that wishes to conduct comprehensive development and management of land shall enter into a land lease contract with the land management institution. The land lease contract shall specify the term of lease, area, compartment, purpose of use, term and method of payment of rental charge and other necessary particulars. The land management institution shall issue a land use certificate to the developer enterprise upon receipt of the rental charge.

Article 16 (Terms of land lease) The term of land lease in the Zone shall be 50 years from the date of issuance of the land use certificate to the enterprise concerned. Upon the expiry of the term of lease, the enterprise in the Zone shall re-enter into a contact for the continued use of the leased land.

Article 17 (Acquisition of real property, issuance of certificates) An enterprise in the Zone may, according to the regulations, acquire the rights to use land and ownership of building. In this case the institution concerned shall issue a certificate of land use of registration certificate of building ownership.

Article 18 (Assignment of rights to use land and building, rental charge) A developer enterprise shall have the rights to assign or lease the developed land and buildings as the infrastructure construction progresses in accordance with the development plan. In this case the value of assignments or lease shall be determined by the developer enterprise.

Article 19 (Modification of rights to use land and building ownership, registration thereof) An enterprise in the Zone may, within the term of validity, assign, lease of mortgage the rights to use land and building ownership through sale, exchange, donation or succession. In this case particulars of modification of the rights to use land and building ownership shall be registered, and the certificate of land use and registration certificate of building ownership shall be re-issued.

Article 20 (Removal and relocation of buildings and attachments) An institution or enterprise that is in charge of removal or relocation of public buildings, dwelling houses and attachments shall remove or relocate them and have the inhabitants moved to a different location so that the development process may not be interrupted.

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Article 21 (Time for commencement of development process, development in a planned manner) The developer enterprise shall commence development upon completion of removal and relocation of buildings and attachments within the development area.

Article 22 (Development and use of farmland, forest land and hydric land) The developer enterprise may, under contract system, develop and use the farmland, forest land and hydric land in the Zone. In this case a contract shall be concluded with the institution concerned.

Chapter 3: Management of the Zone

Article 23 (Principle of management) The Zone shall be managed on the principle of: • strictly observing and enforcing laws and regulations; • ensuring autonomy of the management committee and enterprises; • offering preferential treatment to trade and investment activities; • complying with objective laws of the economy and principles of market; and • referring to international practices

Article 24 (Establishment of management committee, status) A management committee shall be set up for the management and operation of the Zone. The committee is a local management authority that is in charge of the management and operation of the industrial parks and other designated areas.

Article 25 (Composition of management committee) The management committee shall be composed of the chairperson, vice-chairperson, secretary and other members as may be required. The management committee shall have such departments as are necessary for the development and management of the Zone.

Article 26 (Chief of management committee) The chief of the management committee shall be its chairperson. The chairperson shall represent the management committee and be in charge of its work.

Article 27 (Functions of management committee) The management committee shall, within its competence, perform the following functions: • preparing rules required for the development and management of the Zone; • fostering investment climate and attracting investments; • approving establishment of enterprises, registering and licensing; • making a list of sectors of priority, limitation and prohibition and announcing it; • granting permission of specially-ordered construction projects and conducting inspection of completion of construction work; • taking custody of design for ordered projects; • establishing independent financial management system; • registering rights to use land and building ownership; • managing property under its custody; • rendering cooperation in the management of enterprises; • undertaking supervision of and cooperation in construction and management of infrastructure and public establishments; • taking measures for environmental protection and fire-fighting in the area under control; • rendering cooperation in the work concerning entry and exit of personnel, vehicles and goods; • preparing articles of association of the management committee; and • carrying out other assignments of the central guidance authority of special economic zones and the Rason municipal people's committee with regard to the development and management of the Zone.

Article 28 (Setting up of office of management committee) The management committee may set up an office and the like in case of need. The office shall conduct work within the extent of its functions assigned by the management committee.

Article 29 (Submission of work program and statistics) The Management committee shall annually submit its work program and the statistics of the industrial parks and other designated areas to the central guidance authority of special economic zones and the Rason municipal people's committee.

Article 30 (Functions of Rason municipal people's committee) The Rason municipal people's committee shall perform following functions for the development and management of the Zone: • preparing implementing rules for the law and regulations of the Zone; • providing workforce required for the development and business activities of the Zone; and • carrying out other work assigned by the central guidance authority of special economic zones with regard to the development and management of the Zone

Article 31 (Functions of central guidance authority of special economic zones) The central guidance authority of special economic zones shall:

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• prepare development strategy for the Zone; • contact local institutions for the development and construction of the Zone; • cooperate and contact with foreign governments; • approve screening criteria for establishment of enterprises; • select local enterprises to make investment in the Zone; and • render cooperation in the sale of the products of the Zone in local areas outside it

Article 32 (Compilation and execution of budget) The management committee shall compile and execute a budget. Documents concerning the compilation and execution of budget shall be submitted to the central guidance authority of special economic zones and the Rason municipal people's committee.

Article 33 (Cooperation in work of management committee) The central guidance authority of special economic zones and the Rason municipal people's committee shall render active cooperation in the work of the management committee.

Article 34 (Operation of advisory committee) An advisory committee may be formed in the Zone for the purpose of consulting and coordinating problems arising in the development and management of the Zone and business operation. The advisory committee shall be composed of the members concerned of the Rason municipal people's committee and the management committee, and the representatives of major enterprises.

Article 35 (Control of work concerning place of origin) Work concerning the place of origin in the Zone shall be undertaken by the institution in charge of the control thereof. The institution in charge of the work concerning the place of origin shall conduct its work in compliance with the law and regulations of the Zone and the international practice.

Chapter 4: Establishment of Enterprises, Economic and Trade Activities

Article 36 (Streamlining of screening and approval procedures) All forms of screening and approval procedures concerning economic and trade activities in the Zone shall be streamlined through the unified and concentrated method of handling.

Article 37 (Application for business establishment) An investor shall submit to the management committee an application for the establishment of an enterprise inside the industrial park, or to the Rason municipal people's committee if the enterprise is to be set up outside the industrial park. The management committee or the Rason municipal people's committee shall either approve or reject the application within 10 days of its receipt, and notify the applicant of the result.

Article 38 (Registration of enterprise, incorporation) An enterprise shall, upon obtaining approval for its establishment, register its establishment, register with the customs office and taxation office within the prescribed period of time. The enterprise so registered shall be a corporate body of the DPRK.

Article 39 (Establishment and registration of branches and offices) Where a branch or an office is to be set up in the Zone, approval shall be obtained according to the prescribed procedures from the Rason municipal people's committee or the management committee, and relevant registration shall be made.

Article 40 (Rights of enterprises) Enterprises in the Zone shall, at their discretion, have the rights to lay down rules for operation and management, to work out plans for production, sale and financial management and to determine the forms of employment, wage standard and form of its payment, price of products and plan for profit distribution. Illegal interference in the operation of business shall be prohibited, and expenses and obligations that are not prescribed in the laws and regulations shall not be imposed.

Article 41 (Business category, approval for modification) An enterprise shall conduct its operational activities within the range of approved business category. Where business category is to be extended or modified, approval shall be obtained again.

Article 42 (Fulfillment in good faith of contracts) Enterprises shall give priority to implementing contracts, abide by the terms of credit and fulfill the contracts in good faith. Parties to the contracts shall adhere to the principle of equality and mutual benefit in concluding and implementing contracts.

Article 43 (Economic transactions with the DPRK enterprises outside the Zone) Enterprises may, under contracts, purchase in the DPRK territory outside the Zone raw and other materials and supplies required for their business operation or see their products therein. Processing of raw and other materials and components may be consigned to the institutions, enterprises and organizations of the DPRK.

Article 44 (Prices of commodities and services) Prices of commodities and services sold and bought between the enterprises in the Zone, and the prices of the commodities between enterprises in the Zone and the DPRK institutions, enterprises and organizations outside it shall be determined by the parties concerned by

137 reference to the prevailing international market price. Prices of basic consumer goods such as food and essential foodstuff and charges for public services shall be fixed by the Rason municipal people's committee. In this case monetary compensation shall be made for the damage caused to the enterprise concerned.

Article 45 (Trade) Enterprises in the Zone may conduct various forms of trade such as processing, transit trade and barter trade.

Article 46 (Special license for operation) Infrastructures and public establishments in the Zone may be given special license for operation. Where an enterprise that has a special operation license wishes to assign or distribute it to other enterprises, a contract shall be concluded and approval thereof shall be obtained from the relevant institution.

Article 47 (Permission for exploitation of natural resources) An enterprise in the Zone may, subject to the approval of the relevant institution, exploit the natural resources in the Zone for the provision of raw materials and fuel for production. Exploitation of natural resources outside the Zone shall be conducted via the central guidance authority of special economic zones.

Article 48 (Purchase of products of the Zone) The DPRK institutions, enterprises and organizations outside the Zone may, under contract, purchase the goods produced or sold by the enterprises in the Zone.

Article 49 (Employment of labour) Enterprise in the Zone shall primarily employ the labour of the DPRK. Where foreign labour is to be employed as circumstances require, notification thereof shall be made to the Rason municipal people's committee or management committee.

Article 50 (Minimum monthly wage) Minimum monthly wages of employees of the enterprises in the Zone shall be determined by the Rason municipal people's committee through consultation with the management committee.

Article 51 (Advertising, approval for installation of outdoor advertisements) Advertising business may be conducted and advertisements may be put in the Zone in accordance with the regulations. Where advertisements are to be put outdoors, approval shall be obtained from the relevant institution.

Article 52 (Accounting of enterprises) Enterprises in the Zone may apply internationally accepted accounting standards to their accounting and settlement of accounts.

Chapter 5: Customs Duties

Article 53 (Introduction of preferential tariff system) Preferential tariff system shall be introduced in the Zone.

Article 54 (Duty-free articles) The following articles shall be duty-free: • materials needed for the development of the Zone; • imports needed for the production and operation of enterprises, and goods produced to be exported; • materials brought into the Zone for processing, transit trade and barter trade; • office articles and daily necessities for the investors; • transit cargoes of other countries; • donations of foreign governments, institutions, enterprises or organizations, or international organizations; and • other designated articles

Article 55 (Levying of customs duties on duty-free articles) Where duty-free articles, except for the goods of the duty-free shops, are sold in the Zone, customs duties shall be payable.

Article 56 (Levying of customs duties on imported raw and other materials and components) Where goods produced in the Zone are not exported but sold to the DPRK institutions, enterprises or organizations in or outside the Zone, customs duties may be levied on the imported raw and other materials, supplies and components used for production of the goods.

Article 57 (Declaration of inward or outward materials) Duty-free articles shall be brought into or taken out of the Zone subject to declaration. Where duty-free articles are to be brought in or taken out, declaration form shall be filled truthfully for submission to the customs concerned.

Article 58 (Retention of customs documents) Enterprises shall retain for a period of 5 years documents of customs duties payment, customs inspection, goods invoice and the like.

Chapter 6: Currency and Financial Matters

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Article 59 (Circulating money, settlement currency) Circulating money and settlement currency in the Zone shall be Korean Won or designated currency. Exchange rate of foreign currency for Korean Won shall determined by the foreign exchange control institution of the Zone.

Article 60 (Establishment of banks) Investors in the Zone may, in accordance with the regulations, set up banks or branches and conduct banking operations.

Article 61 (Accounts of enterprises) Enterprises shall open accounts with the DPRK banks or foreign-invested banks set up in the Zone. Where accounts are to be opened with foreign banks outside the territory of the DPRK, approval shall be obtained according to prescribed procedures from the foreign currency control institution of the Zone or the management committee.

Article 62 (Loaning) Enterprises in the Zone may, for their economic and trade activities, obtain a loan from a DPRK bank or a foreign financial institution. Korean Won so loaned or exchanged for foreign currency shall be used while being deposited at a bank designated by the Central Bank.

Article 63 (Establishment of insurance institution, insurance) Investors in the Zone may set up and operate insurance companies, while foreign insurance companies may set up and operate branches and representative offices. Enterprises and individuals in the Zone shall take out the policy of the insurance companies in the territory of the DPRK, and obligatory insurance shall be insured at a designated insurance company.

Article 64 (Transaction of securities) Foreign-invested enterprises and foreigners may, in accordance with the regulations, transact securities in the Zone.

Chapter 7: Incentives and Preferential Treatment

Article 65 (Repatriation of income, taking-out of invested property) Such income as profits, interests, dividend, rentals, service charges and proceeds from property sale that are legitimately earned in the Zone may be repatriated outside the territory of the DPRK without any restrictions. Investors may take out of the Zone without any restrictions the property that they had brought therein and the property that had been legitimately acquired therein.

Article 66 (Encouragement of export and import) Enterprises of individual foreign businesspersons in the Zone may, under contracts with the enterprises in or outside the Zone, conduct transactions of commodities, services and technology, and conduct agent's business for export and import.

Article 67 (Rate of enterprise income tax) Enterprise income tax in the Zone shall be 14 percent of the net profit. Income tax for the enterprises in top priority sectors shall be 10 percent of the net profit.

Article 68 (Exemption or reduction of enterprise income tax) Designated enterprises operating in the Zone for more than 10 years shall be entitled to exemption or reduction of enterprise income tax. The period and rate of exemption or reduction of enterprise income tax and the starting point of calculation shall be as stipulated in the relevant regulations.

Article 69 (Preferential treatment concerning use of land) Land for the use of enterprises in the Zone shall be provided in consideration of the actual demand, and depending on the sector and the purpose of land use, different preferential treatment shall be accorded in respect of term of lease, rental charge and mode of payment. Enterprises investing in infrastructure, public establishments and top priority sectors shall be given a prior lien in selecting the location of land, with the land use rent exempted for a designated period of time.

Article 70 (Preferential treatment for developer enterprise) The developer enterprise shall have a preferential right in obtaining the right of management of tourist business, hotel business and the like. Tax shall not be levied on the property of the developer enterprise and the infrastructure and public establishments that he\she operates.

Article 71 (Refund of income tax on reinvested amount) Where dividends are reinvested in the Zone to increase the registered capital or to set up a new business for more than 5 years' operation, 50 percent of the enterprise income tax paid on the reinvested amount shall be refunded. Where reinvestment is made in infrastructure construction, the whole of the enterprise income tax that had been paid on the reinvested amount shall be refunded.

Article 72 (Protection of intellectual property rights) Intellectual property rights of the enterprises and individuals in the Zone shall be protected by the law. The Rason municipal people's committee shall establish a work system for the registration, use and protection of intellectual property rights.

Article 73 (Services for managerial work) Services for managerial work such as banking, insurance, accounting, legal work and measuring may be provided in the Zone in accordance with

139 the regulations.

Article 74 (Tourist Business) International tourism shall be extensively promoted in the Zone by developing favorable tourism resources such as seaside pine grove, sand beach, islets and other peculiar scenic beauty, and folk culture. Investors may conduct tourist business in the Zone in accordance with the regulations.

Article 75 (Provision of facilities) Mail, telephone, fax and other communications devices shall be freely used in the Zone. Residents and visitors shall be provided with facilities in the area of education, culture, medical care and physical culture.

Article 76 (Free entry and exit of goods) Goods may be freely brought into the Zone, which can be stored, processed, manufactured, sorted and packed to be taken out to other countries. Controlled goods shall not be brought in or taken out.

Article 77 (Provision of conditions for entry or exit of persons, vehicles and goods) Institutions of passage control, customs, quarantine and others concerned shall streamline the procedures for the entry and exit of persons, vehicles and goods in order that development of the Zone and business activities may progress smoothly.

Article 78 (Entry and exit of foreign ships and seamen) Foreign ships and seamen may enter or leave the Rajin Port, Shonbong Port and Ungsang Port of the Zone in accordance with the internationally accepted procedures for entry or exit of free trade ports.

Article 79 (Entry\exit, stay, and resident of foreigners) Foreigners may enter, leave, stay or reside in the Zone and may enter or leave the Zone through the designated route without visa upon presentation of passport or other equivalent pass. Procedures for entering the Zone from other areas of the DPRK shall be prescribed separately.

Chapter 8: Complaints, Settlement of Disputes

Article 80 (Complaints, settlement) Enterprises and individuals in the Zone may lodge complaints with the management committee, the Rason municipal people's committee, the central guidance authority of special economic zones and other institutions concerned. The institutions shall make inquiries and settle the complaints within 30 days of receipt and notify the complainant of the result.

Article 81 (Settlement of dispute by mediation) The management committee or the institution concerned may, upon request of the parties to a dispute, mediate the dispute. In this case mediation plan shall be worked out by reference to the opinions of the parties to the dispute. The mediation plan shall take effect upon signature of the parties to the dispute.

Article 82 (Settlement of dispute by arbitration) Parties to a dispute may, upon agreement, apply for arbitration to a DPRK or a foreign international arbitration institution established in the Zone. Arbitration shall be conducted in accordance with the arbitration rules of the international arbitration committee concerned.

Article 83 (Settlement of dispute by court) Parties to a dispute may bring an action to a competent court in the Zone. Procedures for administrative action in the Zone shall be provided separately.

Appendix

Article 1 (Date of entry into force) This law shall enter into force from the date of promulgation.

Article 2 (Right of interpretation) Interpretation of this Law shall be provided by the Presidium of the Supreme People's Assembly.

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Appendix B – Known Companies in North Korea290

Garment/Textile Industry Mining Industry Pyongyang Kim Jong Suk Textile Mill Korea Sonhung Trading Corporation Pyongyang Rayon Yarn Mill Tanchon Mining Machine Factory Sinuiju Textile Mill Tanchon Refinery Pyongyang Taehung Fur-tanning Factory Korea Hungsan United Company Pyongyang Pidan Shop Tokchon Area Coal-Mining Complex Pothonggang Clothing Factory Chollima Steel Complex Nyongbyon Silk Mill Hwanghae Iron and Steel Complex Hadang Unha Clothing Factory Korea Masikryong Trading Company Pyongyang Ryuwon Footwear Factory Ryongsong Machine Complex Korea Manbok Joint Venture Company Wonsan Glass Bottle Factory Pakchon Silk Mill Korea Chongjin Susongchon JV Company Hamhung Woolen Textile Mill Tanchon Magnesia Factory Pyongyang Kim Jong Suk Silk Mill Taehung Youth Hero Mine Songyo Knitwear Factory Uiam Natural Materials Technical Exchange Centre Korean Costume Association Kwangyon Mirae J. V. Company Rangnang Ponghwa Clothing Factory Pyongyang CVD Tools Development Company Korea Carpet Trading Company Pyongyang Ryomyong Corporation Pyongyang Daily Necessities Factory Kim Chaek Iron and Steel Complex Pyongyang Hosiery Factory Korea Kumsan Trading Corporation Wonsan Aeguk Garment Factory Korea Puhung General Trading Corporation Wonsan Leather Shoes Factory Musan Mining Complex Korea Amnokgang Trading Corporation March 5 Youth Mine

290 These companies are all provided by the North Korean government-run website “Naenara,” which can be found at http://www.naenara.com.kp.

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