1. General introduction

Focus throughout this text will be on the development in the group of five North East Asian (NEA) countries, Russia, Japan, China, South Korea and North Korea1. The time frame covered will mostly be the years since the late 1990s and with a focus on the development in the years 2003 – 2004. A time period that will initially be used to exemplify a large number of geographic and economic processes that take place in countries generally. It is here shown and explained in a NEA setting. In the background, to all that is being covered, are processes related to the so-called economic “globalization”, along with the Achilles’ heels of this process, trade, energy, and transport.

1.1. A changing world economy

As a result of the increasingly global setting of the world economy, with its increased interdependence in-between countries, it is becoming ever more difficult, if not impossible, to really control the economic development for politicians and multilateral organizations. This could, depending upon once personal point of departure, be looked upon as a positive, but also a negative effect. The increased mobility of money is just one such example. This has lead to that short-term speculation, in assets, but more dramatically, in the valuation of currencies, that leads to devastating effects on the economies of entire nations. This was demonstrated on a global scale with the breakout of the so-called “Asian Crises” in 1997. With capital owners having the upper hand in the process, it has become increasingly difficult, not only for companies but also for nations, to try to pursue a development agenda that is anything else than mainstream. On the domestic scene, it is still vote-seeking politicians that set the agenda, often with a preference of a status quo (best is no or only limited change), but the international reaction to the adopted policies is often best reflected by movements in currency values and changes in Foreign Direct Investment (FDI) flows.

The quick pace of economic growth that has been seen during the current millennium among Asian economies and the quick recovery from the 1997 crises has surprised many. A crises that had its origin financially in Thailand, widened to Indonesia and then came to expose fundamental structural problems in all of the regions, economies. Increased international competition has since further strengthened demands for efficiency and productivity among countries and between companies. But the process has also increased demands on governments to show transparency in their operations and accountability for costs incurred.

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- 1 - Economic institutions, inside nations as well as outside, are spatially entangled in stable as well as shifting webs of socialized and institutionalized relationships. As such, these economic institutions cannot be looked upon as economic machines that respond to external market and cost conditions as perfect representatives and defenders of the market economic system. It is also important to remember that they should be looked upon as organizations made up of social relations among individual actors, where actions are both being facilitated and hindered by the structure of the institution and the resources available. The context in which a company, organization or country, is acting is important for the understanding as it is, also and always, an integral part of the subject or object under investigation.

There is an invisible constant process at work that attempts to balance the influence between attempts to regionalize production systems and to globalize production. Each country and each region aim at retaining as much as possible the production chains, of manufactures as well as of the production of services. This is done against the will of, alternatively in co-operation with, first of all Trans National Companies (TNCs). A process that can include state subsidies as a carrot, and binding laws as sticks, to make TNCs follow what is locally or nationally, are seen as the most favorable way of action. Activities still have to be conducted inside the framework of what is ruled as being allowed by multilateral organizations, like the World Trade Organization (WTO) and the EU. Politicians and business leaders constantly face new challenges in these fields. EU enlargement in Europe and the global pressure on production costs from increasingly skilled labor in all parts of East Asia forces responsible governments in the west to rethink local employment policies. How will multinational groupings, individual nations, natural region at large and sub regions in particular, sustain competitiveness, growth and employment in an age of outsourcing?2 Employers, labor unions, researchers and politicians will be forced to reevaluate how to adjust general framework conditions for growth and prosperity, including the labor market (where applicable). In many countries, state employment regulations and labor market organizations need to adjust to new challenges from a multitude of aspects.

Workers rights, referring to issues such as pay, protection, right to organize a s o, has with increased global competition become an ever more disputed issue. What are basic rights in a highly developed country is often far from the case in third world countries. To accept a workplace that includes clearly hazardous conditions, or is low paid with long working hours, could be the only work available for some low skilled worker in a less developed country. This neglect of environmental concerns and basic workers right gives an unfair competitive advantage to this substandard employer, compared to employers in developed countries that much follow strict regulations in these respects. Also the right of

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- 2 - organization, which is another basic workers right, is still not allowed in many countries. On the other hand the existence of multiple worker unions at the same work place, as is the case in many developed countries, can be as destructive as it often leads to “hold-up” problems and slows the decision-making.

As internationalization gains momentum it not only becomes increasingly difficult to establish the ownership of assets, but also to establish responsibility. Or does it really matter who owns things? In a more globalised economy the distinction between “who is us” and “who are they” becomes increasingly blurred. If the state should give active support to improve domestic growth, or work place generation capacity, what and who should be favored? Should it be domestic outbound investments or international inbound investments, should domestic owners be favored ahead of foreign owners? Among the countries covered here, two typical such examples can be given that well show the blurredness that has emerged from the internationalization of capital flows. A lot of the capital that is moving around between Asian nations, and to an increasing extent concentrating on China, is controlled by Chinese nationals living in, or in the near surroundings of, China, frequently “lending” capital inside the extended family circle. Should this be considered to be foreign capital? In the case of Russia a similar pattern can be observed when in later years FDIs have started to flow into Russia from offshore tax heavens3. Overwhelmingly this is capital that has been “washed” and that is now returning in the form of FDIs. Should this be considered to be foreign capital?

The purpose of eventual FDIs in the different cases cannot be overlooked, if it is aimed for establishing manufacturing export, or if the production is destined for consumption on the local market. However, any FDI will still be generating new workplaces and it will generate an inflow of foreign capital, at least in the short run. Most developing and expanding economies are very dependent on inward capital flow in the form of FDIs, which is needed to balance out a current- account deficit. Without such an inflow there would be a need to raise the national foreign debt, which would mean costly interest payments. It is uncertain how long such a process can continue and, as so often, it remains dependent upon a number of other economic parameters. From the point of view of stability of the macro-economic development, this dependence also forms a medium-term risk for foreign investors operating in an economy.

The long-term determinant of the flow of FDIs is the incentive structure, allowing investors to make a profit, in the short or the long turn. Another much discussed factor is that of innovation capacity. It is not necessary investments that are made with the aim of finding the most innovative environment is not necessary, the reason could well be just low production costs, and if that is the

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- 3 - case then R & D will be conducted elsewhere inside, or perhaps outside, the company. As changes occur, e.g. in the investment and innovation climates, being the result of on-going processes, it is not very easy to quantify changes. The diversity of activities in the business society could also produce results that are positive for one kind of activity, but also be negative for another. On the other hand, for a less developed country practically any kind of FDI can be said to improve the local business and innovation climate, including the national currency balance. The intention here is not to explain the diversity of aspects around FDIs, but just briefly show its diversity. As the initial setting in different countries and regions can be expected to be very different, it is not really possible to write a brief general description of the effects of FDIs. In later parts containing the descriptions of the different countries, this subject will touched upon again, several times, when investments flows will be discussed.

1.2. NEA in the world economy

This NEA group of countries is becoming increasingly important in the world economy, with Japan already being the second most important economy in the world with China and Russia being subject to rapid economic growth. It is not only from an economic point of view that this group of countries are important, generating just under of 20% of the worlds Gross Domestic Products (GDP) in 2003 (UN-Stat, 2004-08-18). These five countries also include about 18% of the world’s landmass and 26% of its population; 28 million km2 out of 148 million km2, and 1.66 bn out of 6.3 bn, respectively (UN-PP, 2004-06-01)4. A more comprehensible perspective is probably to show the NEA countries relative to some selected economies in the world (see Table 1.1.). As shown in Table 1.1 the NEA economies covered, compare well in importance, also individually, with other countries generally considered to be important in the world economy.

The world economy is expected to grow by about 4.8% during 2004, which will be the highest in something like a generation (IIE, 2004-03-30). Growth in the US is expected to reach 4.5% for 2004 and 3.5% in the following year. At the same time, the Asian economies are forecasted to grow 7.5% during 2004 and 6.25% in 2005 (IMF, 2004-04-01). Grey clouds for such prognoses are oil prices, which are expected to decline only moderately over the next two years, but also that the US Federal Reserve will raise interest rate from its record low of around 1%. Additionally, during the course of 2004, the declining value of the USD, indirectly leads to increasing valuations for the Korean Won and the Japanese Yen. It is therefore worrying that the US, as the world’s most important economy and the world’s most important importer of goods, has maintained its position by building on a national deficit that has reached around USD 420 bn

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- 4 - for 2004, well surpassing the record since WW II, USD 375, for 2003 (CBPP, 2004- 10-01). These figures are both small compared to the total national debt, that by the end of September 2004 had reached USD 7.4 trillions (USD 25 000/ capita) (public debt, 2004-10-05). Continuous rise of the US deficits will, in the long run, lift global interest rates, to make lenders better willing to take the risk of financing such a deficit, at the same time, as the value of the US dollar would need to decrease to help offset the US current-account deficit5. The US economic recovery during 2003 – 2004 has proven different from previous economic recoveries, as it has been supported by the fastest productivity growth since World War II. As a result, the employment growth has been slower then previously in relation to the improvement of the economy. Despite constant economic growth, about 2.3 million jobs have been lost in the US only over the last three years (Council of Economic Advisors, 2004-04-01). Imports from NEA have been given the blame for much of the jobs lost, as the US runs a deficit in its international trade that for the first seven months of 2004 had reached USD 351 bn (US CB, 2004-09-10). Also the EU region has seen job losses and has faced constant unemployment levels, from 6% to over 15% in all of its 25-member countries, with an average of 10% for EU in August 2004. Over the next few years, despite productivity gains, it is still hoped that the positive economic development should lead to an increase in both jobs and wages (EUROSTAT, 2004-09-29).

Table 1.1. NEA Countries Economies Compared to other countries

GDP– Gross Domestic Product; PPP– Purchasing Power Parity, HDI– Human Development Index, GDP 2002 2003 2004 GDP/cap PPP Value PPP Rank HDI Rank Export % China(1) 1 270 1 420 1 650 1 100 5 900 119 94 22 Russia 350 430 410 3 000 8 900 82 57 43 Japan 4 000 4 300 4 300 33 600 28 500 19 9 10 Korea 550 610 660 12 600 18 000 47 28 39 Brazil 460 490 510 2 800 7 500 86 72 10 India 510 600 650 550 2 900 146 127 12 UK 1 600 1 800 1 950 30 500 27 700 21 12 26 US 10 400 10 900 11 300 37 600 37 800 4 8 11 Export % - Export in Goods and Services in Relation to GDP. (1)= In GDP/Capita and PPP/Capita Hong Kong China is 16 and 17 in 2003 world ranking; over 100 ahead of China.

Sources: GDP for 2002 – 2003 and PPP 2003 (www.worldbank.org); GDP 2004 from later chapters(i.e. national statistical offices); HDI 2003 values (www.undp.org); Export % (www.worldbank.org).

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- 5 - Many of the less developed economies in the world have shown high growth figures during later years, and in some cases for over a decade, much due to the low initial level. With a GDP growth of about 7% per year and a 2% growth in developed countries, it could still take as much as a quarter of a century to catch- up with even the middle-income level countries in the West. The slow process of change in this respect will leave the US and Japan, for a long time to come, as the unrivalled most important economies of the world, and probably also as the most important sources of FDI.

With the increase that has been seen in the cooperation inside the Association of South East Asian Nations (ASEAN) organization, and perhaps even more so inside ASEAN + 3, Asian regionalization could gather further force. Over time, such a regional organization could eventually challenge the regional cooperation between the EU countries and the North Atlantic Free Trade Area – NAFTA (which includes the US, Canada and Mexico)6. If such an Asian organization could be formed, the world’s three most important groupings would have much to gain from cooperation in a “trilateral axis”. This because such a “triad-of- regions” would dominate the world economy and, when finding common positions, similarly so in all international organizations.

During the Asian crises of 1997 – 98, there were practically no countries in Asia that, from time to time, did not have to face adjustments in the value of its currency in relation to other currencies. Changes generally depend on how the national economy develops, or is expected to develop. An increase in value, i.e., purchasing power, for the local currency will inevitably make foreign products cheaper for domestic consumers, increasing imports, as more can be bought for one unit of the local currency. An increase in the value of the domestic currency in relation to others, which is more rapid than the lowering of costs, must, normally, compensate with an increase in domestic productivity, or, eventually, a lowering of profits by the producers. That is if the same price relation for local products versus foreign competitors is to be maintained. The importance of currency movements will also affect different lines of business, depend ending on how large share of incomes and costs that are related to different currencies. The worst scenario is a company having a large share of its incomes in a falling currency and costs in a rising one, which makes the showing of a healthy profit in the domestic currency very difficult. For a company that both source and sell in the domestic currency, fluctuations in foreign currency values are often less important.

A common Asian currency, mentioned at times in the region, e.g., to be used by some countries in the ASEAN +3 group, could be in the making as a way to gain increased economic stability. The emergence of a currency unit in Asia would

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- 6 - not necessarily have to take long, and be a complicated process, as the establishing of the EURO currency in Europe. Much can probably be learnt from that process, making the establishment of an eventual “Asean” currency a somewhat easier process to handle.

Initiating major processes, like the possible introduction of an “Asean” currency, but also something smaller and less controversial will always face both support and opposition. There is no such thing as a clean sheet for anyone – geography, as well as history, will always matter!! Smaller countries that are positioned lower on the ladder of development will probably always have a bigger window of opportunity in times of change than bigger and more established countries. This is much due to the fact that existing and well-established economic institutions are more resistant and slower to change. It cannot to be taken for granted that the gains from new measures, or investments, will even be visible where the costs are being carried; often making such investments hard to motivate. Investments in environmental issues are the perfect example of this.

Environmental issues have been given very limited space in this introduction as in the following descriptions. In the near future it is probably so that no question can be addressed without paying attention to environmental concerns. To convert and maintain production processes in a way that can be sustainable for the future is becoming an increasingly pressing global issue. If countries do not take environmental issues seriously, although it could obstruct local economic development in the short run, the money and personal outlays that will be needed to overcome problems later will be many times higher. To establish responsibility, due to blurred and long distant ownership to companies, could come especially alarming from an environmental point of view, as the cost for cleaning up eventual damages, i.e., correct mistakes, could rise to near astronomic levels in this field.

Another important question that has been given a somewhat wider coverage, but still being far from touching upon all interesting questions related to the national economic development. Most questions can only be touch upon and only briefly be mentioned, but discussions in greater detail must be looked for elsewhere. Examples of such issues could be detailed descriptions of economic policy, banking, the financial sector, taxation, social relations, investment climate, retailing, legal framework, multilateral relations, domestic politics and so on.

Under current circumstances, in which private and public organizations are set to work, it has become increasingly important to stay updated and well informed about the development in once business environment. With an ever

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- 7 - more turbulent environment surrounding different types of operations, the risk of over reacting on recent information also increases considerably. Information has become increasingly valuable and respected as an asset in its own right, but the problem to make use of it. However, the “winner” will always be the person or organization who have the best judgment. In an increasing flow of information, the problem is to distinguish between what is just a short-term adjustment and when the same indicators instead show the beginning of a new long-term trend. If prognoses are built strictly on the latest information, they will practically always indicate that much larger changes are at hand than what is really about to happen.

As in any other economic process, the winners and losers from globalization, e.g. FDIs, are never the same. At the same time, the gains will seldom happen geographically anywhere near where the losses occur. Occasionally, several of the negative effects will come to affect the same country, or even region/town. Often resulting in unexpected unemployment for many.

1.3. Manufacturing

In most countries, focus is often being placed on rapid economic development as a way to increase national wealth. This is something that can be achieved in a number of ways, but in later years, and especially when concerning less- developed countries, much focus has been put on the ability to attract FDI. Investments, if discussing manufacturing companies, are often related to later stages in the development process when companies are expanding or restructuring. A much-simplified explanation to this process, when in comes to production, could be the following. Initially, a product as well as service, of which there is little or no domestic production, will be imported. In the next stage, when local production has been established, it is mostly aimed at import substitution and at expanding the local market. When efficiency has increased, it is followed by export of the product. When the scale of this export has reached a sufficient volume, it could be time to establish new production units in one or several of the larger export markets. It is today increasingly likely that the production is being restructured inside the company, with the aim of specializing the production at different units, as a way of increasing internal efficiency. This kind of regional specialization leads to the establishment of regional centers, but also increased trade. The increasing trade comes from the fact that more products now must be transported in-between the different production units and to more distant customers. Less than a generation ago, this process of transformation of industry included a dimension of letting older models of products being produced in less demanding market with a lower

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- 8 - purchasing power. This kind of company behavior has become increasingly difficult to pursue today. In an information society, differences of this type, between countries and between companies are getting increasingly unsustainable. All over the world, consumers today have the possibility to read the latest product releases on all major manufacturers home pages and to follow the results from tests done of these products by the leading magazines in the concerned line of business. Irrespective of if the company is based in Japan, the potential consumer lives in Cambodia and the magazine is being published in New York. A dissemination process of information that would probably had taken years not many years ago.

Generally, it is easier for smaller countries to internationalize, like for small states in Europe and near city-states like Singapore. In the same states where the spread of Information and Communication Technology (ICT) has been both rapid and wide, further increasing the technological gap to underdeveloped countries. With increased usage of ICT, these are states that have been able to relocate labor-intensive parts of their production abroad (or simply lost it) and instead specialized in higher value-add products, R&D, design, finance, insurance and legal support. This development has allowed an increased functional integration among industrial companies units that are geographically dispersed. It should be observed that much of the future focus will be placed on the delivery of services. Manufacturing is often the activity in society that is frequently focused upon in economic discussions; as well as here. This is an unfairly large degree of attention as there are practically no countries where manufacturing employs half the workforce or contributes to half the GDP. The contribution from manufacturing is normally in the range around 30% of both employment and GDP contribution in most developed countries. Instead it is actually the service sector that is generating the largest economic contribution and generally also in employment terms. If discussing a less developed country, it is instead often farming that is the biggest generator of employment, but that rarely is the largest economic contributor.

Developed states in North America and Europe have long comforted themselves with the reassurance that manufacture might be moving to low wage locations, but in the new era of service and software's the main skills and systems would stay in the serve-rich developed markets. This has particularly been said to apply to high-level financial services where cities like London and New York still appear to command the global scene. The sector in focus has instead been manufactured of goods in developed countries that are generally in the process of searching for ways to lower costs. In just the last few years, this search for low cost has also come to affect routine and labor intensive service-related functions. Relocation abroad can reduce cost significantly, but would have been impossible

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- 9 - without dramatic advances inside the ICT sector. Not only for service functions like customer support has this practice started to occur, but also for more advanced services like computer programming. With wages often at a level of 20%, or less, compared to the developed countries, any kind of job could be at risk (MercerHR, 2004-10-12). However, it is seldom so that one single factor can be said to explain this kind of trend, as there are also a desire among firms to improve business conditions and expand markets. Relatively few firms in developed countries, however, are moving out the R&D activities of their parent company; thus far. On the other hand, to achieve their aims of cost reduction, firms often face different new problems in less developed countries. They have to put up with the handicap of the deficient infrastructure and public administration; for which costs are difficult to assess and are therefore, perhaps, too readily accepted.

The often-simplified answer to increased efficiency is to strive for a higher degree of specialization. One company can often become more efficient this way, but such a step also increases the demand for coordination between companies as the level of outsourcing in a highly specialized system also increases. Actors, the activities they perform and the resources used in their processes, physical as well as in the form of services, have increasingly started to be re-evaluated. However, this is a process of change where the focus could be set very differently dependent upon the point of departure. Only a very brief mentioning will be made here of the effect of these shifts have, and will have, in different sectors. Direct effects will be seen inside e.g. manufacturing, infrastructure, transport, but here as elsewhere there are also structures restricting this process of change. As product’s life cycles in the twenty-first century has become ever shorter, which in turn and in an increasingly number of ways, it has also generated pressure on constant adaptations in-between business partners. Increased coordination between a supplier’s manufacturing department and a customer’s production process or sales department (if the products are sold for consumption) will normally increase efficiency in the total production system. But, not to be forgotten, this coordination will also result in increased indirect costs for all parties. The latter kind of cost is probably more difficult to directly quantify and, as a result of this, is often overlooked and probably underestimated. From this follows, near unavoidably, an increased focus in such a system on finding ways to make an optimal use of the resources available. This is in line with the common saying “the less the better”. This leads to a drive inside organizations towards a maximum reduction of storage levels, standardization of procedures and a desire to make the organization work as “lean” as possible. The value of a resource in a wider meaning is often given by the circumstances, but can probably never be seen as stable and will depend on in what way it is being combined with other types of resources. It logically follows that to

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- 10 - minimize the use of resources is not always the most important issue. Instead, it is the continuous search for new ideas and to find better ways to combine available resources of different kinds that should come into focus. In a time when the lifecycles for products becomes ever shorter, the economic rewards for the most innovative ideas in this field will increase further.

Changes to production patterns and the geographical locations of actors in current day production networks will see much of the twentieth century discussions as production chains become increasingly old-fashioned. This is the result of the increasing interdependence that is characterizing manufacturing networks of the twenty-first century, and the global location of customers for the products. When a company increases its dependence on outside sources to enhance efficiency and capacity, its in-house capability to create value-add will fall. The producer will now increasingly come to depend on the capacity of other companies to both adapt and to innovate. Especially so as increasingly shorter product life cycles and increasing returns are available for the manufacturer that, at a short notice, it can respond to sudden changes in demand. That is if demand from customers for the product in question surpasses or, eventually, falls below plans and expectations.

Despite the changes that have taken place inside production systems, especially larger global companies are still bound to have their base in a country that will give both owners and investors enough security to make the companies attractive. Consequently, there will also be attempts from different countries, in competition with each other, trying to attract these head offices, and indirectly attempting to obtain a larger share of the values being generated by these emerging global production networks. As these networks form in increasing numbers, they are also reshaping industrial production, and it is not only in the Asian region where this competition affects and creates competitiveness. The forming of these networks, under the label of globalization or regionalization, and their development, is rarely state projects, but spontaneous inside the line of business. There are more or less two different ways to put the emphasis when studying the diffusion of ideas and work methods needed for successfully establishing a well-working region. The geographical proximity of firms or the organizational proximity, where the latter instead see something like a shared identity or a common understanding, is more important than physical proximity.

In later years internationalization has included many more aspects than just production and currently includes sourcing of various inputs, product development, marketing, and a struggle for global market shares. The creation of new industrial clusters and regional clusters, with firms in geographical

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- 11 - proximity and often with strong state support, has not been unproblematic7. New clusters both need to attract the necessary supporting lines of business at the same time as cooperation and competition between firms are seen as important for the long-term survival of all participants. To become attractive and to achieve self-supportive growth, they must also reach a certain critical mass/size. The more or less unforeseeable speed by which the globalization process has proceeded during the last ten years, its pure scale, its increasing complexity and the ways it has come to include both finance and the transfer of technology, has often made existing national, as well as international, regulator systems outdated. This has forced into place changes in a multitude of aspects, especially in the developed world.

The facilitation of long distance information exchange, has also allowed instant feedback about all aspects of globalization. Internationalization has been far from only positive, undoubtedly, it has also come to generate a number of negative aspects. NGOs, labor organizations along with a broad spectrum of social groups in developed countries have come to backlash against these side effects. In the hunt for someone that can be called responsible in this dispersed and faceless process it has often become “global capitalism” and international organizations like the WTO and IMF has been blamed. Arguments for and against only the work of the IMF would fill at least a few books, which highlight the complexity of the process. What from one point of view is negative could often be proven to be very positive from another point of view. Analyzing and discussing only smaller parts of the occurring changes is often intended to make the changes more comprehensible. But the heart and soul of the process of globalization is that it is global, and from its nature follows that it is an extremely interrelated and complex issue. A process that is, regrettably, becoming increasingly difficult to simplify in a structured way, although this text is also such an attempt.

1.4. Trade

Free and open trade between countries still enjoys the highest moral ground. It remains to be proven that other ways exist to reach higher long-term human standards of living. International trade has seen an unprecedented increase over the last fifty years with an average growth of about 6% per year over that time period. Total world trade in 2003 had reached about twenty tree times compared to the level in 1950, with merchandise trade in 2003 being valued at USD 7.3 trillion and with trade in commercial services valued at USD 1.5 trillion. That protectionism in the current century generates little job growth, which is probably easy to find common census for. In times of weak global economic

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- 12 - development though, the arguments for free trade are often indirectly being undermined. However, studies have shown that to cut about 1/3 of today’s trade barriers could boost the world economy by up to USD 500 billions (WTO, 2004-05-10).

Up until the 1980s the world had, for nearly thirty years, remained a market with relatively free flow of goods, although the really big take-off in volume was yet to come. At the time the US had long dominated, but at the same time it looked like Japan would continue to expand, both as an export-based producer and to become an increasingly important market. Dramatic changes were to come, however, and in just a few year’s time, the emerging Japanese wonder had stalled and later, it was instead the rising star of China as a producer, and gradually also as a market, that emerged. There used to be a sort of superior view that the West, and perhaps US and Europe in particular, would do all the thinking, innovating and designing, while Eastern Asia and later Eastern Europe, with its cheap labor, would turn out the more basic items. In due course, the cheap labor would become more skilled and earn more; rising costs among second generation producers which would give room for new poorer countries to take over the low cost production. In the long run, incomes would rise for practically all and everything would be more or less evened out rather smoothly in the world trade balance. The most widely recognized positive examples during this period, and that has greatly profited from the free trade, have been the group of so called “Asian Tigers”8. The only problem is that this has never been near to happen for more than a handful of countries, and the income disparity between rich and poor countries has continued to increase. Still, by 2004 almost 50% of the children in the world continue to live in poverty, which leaves much to be desired when it comes to income distribution (UNICEF, 2004- 12-07). That is albeit the fact that the number of “very poor” in the world, i.e., earning less than USD 1/ day, seems to have stabilized around 250 million, and much so due to improvements in China (WB, 2004-10-15).

That production pattern for most manufactured products has changed dramatically over the last ten to twenty years was briefly mentioned above. Previous local production networks have often fallen short in competition with large-scale global networks with the same production focus. This has lead to a growing sense of threat from low cost production among population strata's in established developed countries, when seeing cheap components, as well as products that are being sourced from far away locations. Especially so when also white-collar workplaces, that used to be secure, has started to move out to low cost countries. As long as job creation will not pick up dramatically in the developed world, it will probably become increasingly difficult to politically defend the high moral values of free trade. What makes economic sense globally

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- 13 - and what seems to make sense in local politics can well emerge as two completely opposing ideas, which still, and somehow, must function together. The old and cozy image of trade being a two-way beneficial flow of goods between far away countries could, if not nursed with great care, be fading away.

The first man who was honored to have come up with a theory concerning the advantage for nations to conduct international trade, instead of attempts to produce most kinds of goods locally, was the Englishman Adam Smith, around 1780. The simple theory was that households should never attempt to do at home what would cost the household more to produce than to buy. If both countries made use of their, what Smith called “natural advantages” (that one country nature-given had over another country) it would give both countries more products to consume if they specialized into a production that is based on their mutual advantage. About a century later David Ricardo was able to show in figures that two countries that held the less obvious, so called comparative advantage in relation to the other would also gain a considerable advantage from specialization9. Theories around the advantages of international trade and the positive effects from specialization have since been much developed, by the likes of Hecher and Ohlin in the 1930s. Over the last thirty to forty years the increasing influence of TNCs, and other aspects around globalization, has much changed the fundamentals that applied for trade in the years when basic trade theories were developed by Smith and Ricardo.

One of the major changes in world trade over the last few decades have been the rise in importance of the TNCs when it comes to international trade. This rise in importance has been much enabled and facilitated by the phenomenal improvements that the world has seen in ICT technology. At the turn of the last century about 30% of world trade is conducted inside companies10. At the same time, about 40% of FDIs are being conducted inside of TNCs, with the second biggest component of world FDIs being TNCs that conduct mergers and acquisitions (UNCTAD – WDR, 2004-09-16). Also, the sources of the worlds FDIs has changed considerably, compared with WW II, where some 45% of the total was of British origin. Some years after the war the UK share had shrunk to about 35%, with about the same volume coming from the US. In the early years of this century, the US is the leading origin, with the UK as a distanced second. It has been estimated that there are over 60 000 transnational companies, controlling over 800 000 branches. Twenty-five out of the fifty largest international companies are based in the US, with near 90% of the total being headquartered in the US, Europe or Japan (UNCTAD, 2004-09-01). In 2004, the total flow of global FDI increased by 6%, to about USD 612 bn, which was the first increase in three years. The share directed towards developing economies increased to 42%, from just 27% three years earlier, with the Asia Pacific region growing by 55%.

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- 14 - The US reclaimed the title from China as the most favored nation receiving USD 120 bn, up four times over 2003, compared to investment of 62 bn directed towards China (UNCTAD, 2005-01-19).

A company investing abroad is most often facing an entry into a more insecure territory than its home market. As in any type of business undertakings, there is a commercial risk that something could go wrong, and so also abroad. When making an investment abroad, there is an additional risk of political changes that had not been foreseen, or perhaps could not be foreseen, at the time. This could be the introduction of new legislation that changes the working conditions for the new establishment. These kinds of risks that companies face in different countries are constantly being followed up on by a number of international companies. In the NEA group especially Russia has been moving up in such rankings, as the domestic market has been opening up and the working of the banking system has improved (see Table 1.2).

Table 1.2. Country Risk and Credit Rating Rankings in 2003 – 2005

Euromoney - Country Risk Institutional Investor - Credit Rating 20052004 2003 2005 2004 2003 Mars Sept. March Sept. March March Sept. March Sept. March China 51504549563738384238 Japan 13141517191922212320 Russia 61 64 66 72 76 58 58 59 62 64 Korea 37373738382829292827 Brazil 68 71 78 75 79 67 73 68 76 73 India 60605960615759585957 Hong Kong 26 26 25 25 26 26 26 26 29 26 Taiwan 24 25 26 26 27 24 25 25 24 24 UK 77669 55355 US 44443 63443

NB: The Euromoney Country Risk is a weighted average of nine categories, with political risk constituting 25% and economic performance 25% of the base, as the two most important indicators. The Institutional Investor Credit Rating is a weighted average based on a ranking of overall creditworthiness, but also the macro economic picture and the working of the banking system.

Source: Euromoney and Institutional Investor, through EBSCO Publishing (EBSCO, 2005-03-03)

To regulate and possibly reduce pressure from the outside world, many have seen regionalization as a possible answer. The idea to “regionalize” has appeared in a variety of different definitions. It has been packaged with different content,

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- 15 - and has been set to cover smaller as well as larger regions. Depending on the reasons behind the idea to regionalize, the structuring of a region could be looked upon as “activity based”. If so, it would then be based upon the idea that the region concerned could in some respect be, or become, largely self-sufficient. When defining regional growth-areas, these could be both small, but also larger and made to include areas in more than one country. Also, these regions are thought to be self-sufficient; in a sense that most of the prerequisites that are seen as necessary for enhanced growth, above that of other regions, generally or just in one sector, can be found inside this special region. Another alternative is the “market driven” region in the form of global-, regional- or corporate production or marketing networks. In its more formalized form, regionalism could instead be, or become, “ruled-based” in the form of bilateral agreements in different suitable fields. When state driven, such initiatives conventionally have the intention to deepen co-operation in a near, or distant, future, like the case of the EU, ASEAN and APEC11. The creation of such regional trade organizations, on an international basis, involves a number of steps that are usually taken in the process of integration (see Table 1.3). Starting from the least committing form of arrangement being a Preferential Trade Area, reaching complete integration at the stage that here is being referred to as a Political Union. What in greater detail is agreed at different stages, and the speed with which the process proceeds, vary greatly depending upon the setting in which the regional integration is happening. Here though, we will concentrate on a discussion around international regionalism, where free-trade ideas are included as a basic idea of the organization.

Table 1.3. Steps in Trade Integration

PT FT C C E P A A U M U U Reduced trade tariffs for selected items X X X X X X Removal of trade tariffs between members X X X X X Common external barriers against non members X X X X Free factor movement (e.g., labor, capital, goods) X X X Common economic policies (e.g., monetary, fiscal) X X Political unification between members X PTA - Preferential Trade Area FTA – Free Trade Area CU - Custom Union CM - Common Market EU - Economic Union PU - Political Union

Source: Author

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- 16 - 1.4.1. WTO and (free) trade agreements

The General Agreement of Tariffs and Trade (GATT), that was to be restructured into the WTO in 1995, had its early focus on cutting trade tariffs on industrial products, but with its groundbreaking “most favored nation” clause as one of its fundamental innovations (WTO 2004-07-15)12. During increasingly difficult negotiation rounds held from the late 1950’s until the forming of WTO, issues brought up came to an ever larger extent to include other trade related questions, like the phasing out nontariff barriers in industrial goods13. Two sectors were long not considered when dealing with international trade issues; these were textiles and agriculture. The Multi-Fiber Arrangement (MFA), covering fibers, cloth, and apparels, was set up in 1974 and regulated, in great detail the field of textiles and its trade. With the negotiations of the membership of China, being the world’s leading textile producer, changes in the MFA became necessary14. It was eventually decided to phase out the MFA agreement by the end of 2004; after a full ten-year graze period. However, in the case of agriculture it is only during the last few years that a discussion about the eventual liberalizing of trade has been initiated. How problematic this field is has been demonstrated not only in the accelerated growth of import quotas for farm produce, but also in increased trade friction in this sector between less- developed countries and the richest countries of the world. During the ongoing round of WTO negotiations, the Doha round, agricultural products have been paid more attention than in any of the previous negotiation, but the sector remains a “mine-field” for the negotiators. It can only be hoped that the preliminary agreement to reduce both export subsidies and other forms of export support will be scaled down along with considerable cuts in direct subsidies15.

For developing countries, the membership of the WTO has become a way to gain a general international recognition for their efforts to establish a working market economic system. At the same time, membership gives trade advantages by applying the same set of regulations as among other members, which greatly facilitates trade and access to foreign markets. Membership also provides nondiscriminatory treatment against exported products, and in cases where disputes could arise it makes it possible to solve the conflict at the international dispute settlement mechanism under WTO16.

However, negotiations for new members include a more or less complete revision of all trade related aspects of the applicant’s legal system, which could have an influence on the internal market and international trade. As a result of this process, the regulations that are seen as acceptable for entry by other members indirectly streamlines countries. New members will be allowed in,

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- 17 - only if they accept all existing paragraphs in the membership charter, possibly having won a maximum ten-year grace period to adapt to the most difficult ones. Having gone through this, and final dates having been set for possible changes needed, the country in question not only becomes more likely to be seen as a trustworthy trade partner, but also as an attractive destination for FDIs. It is not only international investors that will reap the profits from the changes. It is generally anticipated that the opening up of the local market will also improve the domestic business climate. This is to be achieved though a combination of quality and quantity improvements in domestic production. This is expected to follow as a result of enhanced competition from increased exposure to foreign products. WTO negotiations have, over the last decade, not only been made to include the wider trade-related fields of services, and investments, but also to open up markets for international investors. The benefits to less-developed countries when entering the WTO most often lies in the standardization and expansion of the export market, more preferential treatment in trade and the boost to the development of national enterprises that increased competition will give17. Meanwhile, one of the major, although indirect, costs for a country is the reduced influence that the government will have in forming economic policies. A membership reduces the possibilities to support economic development, regionally or in different sectors, as that can/will distort the free competition. The results from members that have recently joint the WTO have indeed shown that membership has enhanced economic efficiency. However, the benefits are far from equally distributed among different sectors of the local economy and have resulted in economic restructuring, often with structural unemployment as an adjustment cost18. At the same time, as a WTO membership means enormous opportunities for member state’s economies, it also triggers fear and includes a certain element of risk-taking. In such a situation, it is not always easy to play down the risks and instead focus on how to seize the opportunities. An active government policy is therefore needed in relation to a WTO entry, to be able to adopt appropriate policies to handle the resulting adjustment costs. The strategic goal for countries that open-up their markets will always be to make effective use of both domestic and outside resources. That is to try to accelerate independent development and pursue a global economic policy that enhances national economic strength. The only, but sometimes domestically bitter, way to improve international competitiveness lies in swift reforms to overcome the numerous hurdles in the economic structure that restrains the ability to adapt to changes and to compete. The economic development patterns available in a situation where a country opens up is often to become increasingly dependent on TNCs, as a result of increased FDIs, or attempt to promote the growth of domestic enterprises. Less-developed countries that have joined during the last decade have mostly been facing the dual challenge of industrialization and

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- 18 - globalization, and a WTO entry has, in such cases, both facilitated and complicated what is already a huge challenge.

A common problem for many developing countries is their dependence on just a handful of export products, which is, to make matters worse, often commodity- related. This makes the exporting country overly dependent on what is often unstable international commodity markets with unstable prices. In some respects, "geographic conditions" leave many countries with few choices other than becoming commodity dependent, at least in the short run. The bigger the country the less likely is the commodity dependence risk, but with the Russian dependence on energy exports as an example of that common rules do have exceptions. The theoretical comparative advantages that a country can possess, originating in the theories of Ricardo, are often to be found in the productive forces, due to nature given factors, at national industrial-level or at the level of the individual companies. From such a position, and to widen national production into a mix of goods and services to be traded, with the aim of advancing to a level of sustainable economic growth, the path is both long and winding. There are practically no examples of countries in recent years that have managed this reorganization on their own, into becoming producers of high value goods. Often the less-developed countries end up with organizing Export Processing Zones (EPZ) where tax incentives are given to companies that establish product assembly in a designated, and often fenced, area. The effect from this is positive, when it comes to employment and GDP generation, but EPZs low wages remains the competitive advantage in relation to other countries.

As a way to improve competitiveness, countries have increasingly started to find suitable countries in their near surrounding to sign bilateral Free Trade Agreement /Area (FTAs). As an exception to the non-discriminatory and most- favored-nation treatment principles, the GATT-WTO recognizes FTAs as a first step toward realizing global-scale liberalization. In other words, the WTO approves the preferential lifting of tariff and non-tariff barriers between the FTA partners. Under the conditions, however, that trade barriers against others are not raised as a result and that tariffs will be reduced to zero within the FTA, within "a reasonable time period". Also in a maximum of ten years, trade restrictions must be abolished in "substantially all sectors" and liberalization must also target the services sector, as required by the GATS19. In the NEA group, Japan has been active in trying to find potential partners, but the problem is the "substantially all sectors" requirement. Because of its highly subsidized agriculture, Japan is constrained to look for partners, which either do not have an agricultural sector (Singapore), have similarly inefficient agricultural sectors (South Korea), or run the risk of a WTO challenge if it attempts to largely

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- 19 - exclude agriculture from an agreement (as initially with Mexico). Japan's search for a preferably Asian regional alternative to the multilateral system is currently, and has for a long time been, restricted in this respect by its own overprotective agricultural policy.

Theoretically, if a poorer country concludes an FTA with a richer country, the low wage country is likely to increase its export of more labor intensive products, e.g., apparel, leather products, and agriculture. The richer in the pair is likely to export more of its sophisticated products, i.e. machinery, advanced service and non-basic chemical products. Indicating that it is, first of all, in the already strong sectors that a country will profit the most. After an FTA has been concluded, there will still be products that, already prior to the agreement, were competitive, and for which tariffs and other barriers will remain in place. Instead, and here more important, there will now be a number of other products traded between the FTA partners in categories that, due to reduced tariffs, have gained a price advantage over alternative outside producers. Trade has been “diverted” away from what previously were the most efficient producers in the world in favor of the FTA partner – an example of “trade diversion”. The forming of an FTA area will also “create” trade, as there will be room for increased consumption as a result of liberalized trade and lower prices for imported products – an example of “trade creation”.

In the development of trade that follows after an FTA has been concluded much depend on the level of tariffs that reigned prior to the agreement and the partners that had the lowest relative average level of tariffs will probably be able to increase its export the most. As a result of an FTA, there will also be a steady increase in intra-industry trade between the partners. Both countries will mutually export and import a wide spectrum of low-end and high-end products, as well as components and finished products. Also, other sectors of the two economies will benefit, like travel, transport, construction, telecommunications, financing and other service industries. These sectors, outside what is perhaps traditionally considered to be trade, have either very low, no or tariffs, and these effects are therefore often difficult to capture by the detailed statistical analysis that precede FTA agreements. The advantages that are likely to arise from enhanced integration, intensified competition or possible strategic alliances across borders, are hard, if not impossible, to assess. It goes without saying that to make an exact estimation in advance of the positive, as well as negative, outcome of a possible WTO membership, as well as an FTA, is in its details practically impossible. As in other complex systems that are under constant evolution, it will hardly be objectively possible in advance, or later to back-role, what would have happened if a certain step had not been taken. Through a larger market, or enhanced productivity resulting in lower costs, companies

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- 20 - with a potential global competitive edge could be fostered, something that could also have happened without a WTO membership or FTA, although less likely. Together the kind of factors that has just been mentioned is collectively referred to as the “dynamic effect” that will arise from trade liberalization. Although, as mentioned, it could be very difficult to make accurate quantitative estimates of the dynamic effects of an FTA, the dynamic effect could in the long run well be much greater than those trade effects foreseen in the statistical analysis.

The most important regional initiative in Asia is the Association of Southeast Asian Nations (ASEAN) with its ten members among the smaller economies in the region. Here, none of the NEA countries are members but an extended cooperation council has been created as the ASEAN group and Japan, China, and Korea are not only neighbors but also important trade partners for each other. The most important regional initiative in Asia, outside of the ASEAN (and ASEAN+3) has become the Asia-Pacific Economic Cooperation (APEC) forum. APEC, however, includes also countries outside Asia, but inside the Pacific, most notably Canada and US. APEC was formed after an Australian initiative, and the US and Canada came to be included as some Asian countries wanted involvement from the other side of the Pacific to counterbalance Japan that were economically very strong at the time. Japan had previously been promoting a similar forum, but APECs first meeting was held in Canberra in 1989. In all APECs membership accounts for more than 2 billion people and more than half of world‘s GDP. Due to great political-economic diversity among members, no one expects it to see deep integration along the lines of the EU. Instead, much activity has been focused on business facilitation, such as streamlining trade procedures. Progress on trade and investment implementation has been uneven. Agriculture is also a highly sensitive issue here, and Japan has successfully lobbied to avoid having agriculture included from the accelerated liberalisation commitments at several leaders' meetings.

The growth of multilateral regionalism outside of Asia and the failure of the WTO Ministerial Conference in Seattle 1999 encouraged Asian countries to take a second look at regional economic integration schemes. The previous idea of East Asian Economic Caucus has been somewhat revived in the form of the ASEAN+3 initiative. The subsequent WTO failure in Cancun in 2003 gave another push to many nations across the globe to more seriously consider to negotiate bilateral agreements as the chances for a multilateral agreement started to fade20. When adapting bilateral agreement co-operation is particularly needed in sectors where countries are already internationally competitive, yet severely competing with each other. If so, this is probably a sector where inefficient overcapacities exist, and where intra-industry trade is underdeveloped. To stay competitive in the long term, cooperation and specialisation / restructuring in

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- 21 - such sectors is likely to have a positive pay off. In due time allow this kind of restructuring to happen, could be a hard medicine to swallow for the parties that end up on the loosing end.

When discussing international competitiveness and trade, it is of fundamental importance to establish to what extent products from different countries really compete. When the Japanese export is compared to the Chinese export, they at first appear to consist of relatively similar products. Still the two neighbors do not always really compete as of the roughly 10 000 kinds of items exported from Japan and China to the US, about 20% can be seen as competing (RIETI, 2004-06- 07). However, it should also be remembered that this value is on a constant increase, from a one-digit value ten years earlier.

The proof that a process of increased interest in each other’s markets is ongoing is demonstrated by the fact that the four Asian neighbors accounted for about 16% of the global trade volume in 2003. The global trade volume for the first time exceeded USD 7 trillions, while the NEA trade volume stood at just under 1.2 trillion (see also Table 1.4). Mutual trade in the region is increasing faster than world trade, having advanced from a 13% share in 1990 to about 24% in 2003. Compared to world trade that rose by just over 5%, the intra Asia trade rose by over 16% during 2003, reviling the dynamics of the region compared to the other parts of the world (ADB, 2004-05-07). Among the individual NEA countries, Korea is the country with the clearest focus on its neighbors as trade partners with over 35% of its trade inside the region. Japan is not far behind with 31%, China with 31%, with Russia standing out here on 10%. Highest share of its trade inside this group of countries have two near “outsiders”, Taiwan with 50% and Hong-Kong with 60%.

In relation to the potential of trade between the four neighbors, this figure could probably continue to increase considerably. Compared to the level of internal trade inside the NAFTA region, at around 45% and over 60% among EU members, the NEA group is still lagging behind considerably. It is in this perspective that the demands from local business circles inside NEA and among other Asian countries for the extension of FTAs, between neighboring countries in the region, should be seen. It is probably so that there are a number of win- win situations that can be released and it could be time for the ASEAN + 3 countries to unite for the common benefit and for increased prosperity (KITA, 2004-05-18).

To allow the full potential of the form of integration achieved through in FTA, open and transparent markets are needed to make room for market mechanisms and their dynamic effects. That could include issues such as taxation treaties,

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- 22 - mutual investment agreements, mutual recognition of standards and certification, intellectual property rights, promotion standardization of customs clearance and procedures, implementation of other trade facilitating measures, mobilization of capital, trade in services, mobilization of labor and open-up government procurements. Many of such measures are meant to improve the confidence of firms in the partner countries, as well as from countries not included, to invest in the economies of the two FTA partners.

Table 1.4. Trade Between Russia, Japan, China and Korea; 1998 & 2003 (values in million USD)

NB: - “% of Export/Import and % of Total” – referrers to 2003 only. - All figures related to China include Hong Kong. - Total China figures are given with exp/imp between Hong Kong and China excluded.

Source: UN Statistics Division – Commodity Trade Statistics Database; (www.un.org).

The above-mentioned ongoing restructuring of international manufacturing industries has lead to resources that are moved around the world, in search of their optimal use. At the same time what mostly still is, but more so used-to-be, labor intensive industries have been, to a large extent, transferred to the developing countries from what is now considered to be developed countries.

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- 23 - However, the remaining labor-intensive industries that are still working in developed countries are increasingly, and probably unavoidably, ever harder hit by imports from lower labor costs countries. The result of such clashes of interest is increasingly often the background to cases when developed countries resort to protectionism as a last protective measure. In international trade, the use of the words “dumping” and “anti-dumping” has increased in recent years, although the origin can be dated back to very early days of international trade. A dumping case, according to the definition given by the WTO, occurs when imports are sold in a foreign market at a lower price than the normal price, and thus causing damage to producers in the importing country. One major problem involved is the setting of the "normal price". For countries that are considered to be market economies, “normal prices”, are derived by comparing prices in the domestic market of the export country. For what is considered to be “non-market economy countries” the process of setting this price becomes much more complicated and less precise21.

During most of the first forty years of multilateral trade negotiations under GATT, tariffs have been lowered considerably, and instead made the anti- dumping actions a policy seen by some as a way to increase the protection of local manufacturers. Alternative forms of protectionism, with different forms of non-tariff barriers, has, from time to time, been gathering momentum when the use of conventional tariff barriers does not function as before.

The idea of holding back the import of products by way of using anti-dumping actions was seldom followed through until the 195022. An annual average of thirty international anti-dumping lawsuits were opened in the 1950s and 1960s, about forty in the 1970s, surged to 174 in the 1980s. (MOFT, 2004-04-30). The period of eight and a half year, 1995 to June 30, 2003, witnessed 2284 anti- dumping investigations launched by WTO members, setting the modern time average to 270 per year (WTO, 2004-04-15). Most frequent to use the anti- dumping weapon has been developing countries and regions using it to counterattack the damaged caused to local industries by what has been considered to be unfair trade. India, Argentina, and Brazil are examples, where India is leading the list initiating 344 cases from 1995 to 2003. A number that clearly exceeds that of the second country on the list, the US, which had filed 308 cases during the same period. In later years the US has become increasingly active in this respect and in 2001, alone, launched 74 anti-dumping investigations, a figure that can be compared to 14 cases in 1995 (WTO, 2004-05- 15).

Generally it is labor-intensive products that are subject to anti-dumping complaints, with products such as metal products, electrical products, and

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- 24 - textiles to top the list. If the exporter feels discriminated by an anti-dumping initiative of an importing country, the enterprise, via its trade ministry, can bring the case up to the WTO dispute settlement facility for arbitration. When the case has been investigated, if not settled through bilateral negotiations in the meantime, an anti-dumping case will be ruled. The import country often sets out an anti-dumping tax (import tax), that from its point of view, corrects the price picture and/or to protect its domestic industry. The result of the investigation could be that an anti-dumping tax is approved, but perhaps at a lover/higher level than the one originally imposed. If successful, from the importers point of view, an anti-dumping complaint will result in an opening for unilateral powers to impose anti-dumping taxes for the number of years stated in the ruling.

1.4.2. Neighbor relations

In the NEA “region” being covered here two of the five, Japan and Korea are long established market economies; two, China and Russia are in the process of transition from central planning towards a market economic status. The fifth country in the group, North Korea, has for long remained one of the most enclosed countries in the world about which much less is known with any certainty, at the same time as it the economic “Lille Putt” in the region. Still it is on North Korea that much of the regional neighbor relations are being centered. What has become known as the “North Korean nuclear stand-off” is currently the most pressing international issue in the region. Multilateral talks, called the “six party talk”, on North Korea commenced soon after the US has stamped North Korea as a country belonging to the “axis of evil” and its eventual capacity to produce nuclear weapons lifted this issue near the top of the international political agenda. At the same time the severity of the matter has brought the other countries in the NEA group together at the negotiation table. Consequently, discussions here are looked upon with a sincerity that would have been difficult to establish otherwise. Three of the countries share a land border with North Korea and therefore takes special interest in this matter, while Japan, without land border, is instead located in the direction where some North Korean test missiles have been aimed. From the whole group of countries, there is a strong interest in maintaining the non-nuclear status of the Korean peninsula. Seeking a political resolution to the prolonged conflict over North Korea's nuclear ambitions through the six-party talks, they also involved the United States. The Russian side especially also stress the security issue of North Korea, but a settlement of the ongoing conflict could not be reached without taking into consideration the interest of all parties involved. It is not a very advanced guess that the United Nations will be committed to a future role in finally resolving the conflict.

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- 25 - The concerns are based on the fact that if North Korea were in possession of nuclear missiles, it would gain a disproportionately strong position in the region. This would change the basic configuration of the geopolitical situation. It is not likely that this has happened, but there is also a growing fear in the region, or respect, in relation to the growing strength of China in the region. The rise of a big power always causes concerns, especially among neighbors, but for such an important player, changes in strength will also influence the global security network. When it comes to China, having the world's largest population and already being a considerable military force, it is easy for observers to talk about a possible "China Threat". This worry has already been voiced in the US, Japan and India. It is not only the economic might of China that is growing rapidly; it is also the military strength that is growing. Still it is probably undeniable that China's general military technology and capability is something like a decade or two behind that of the US. With the Soviet Union falling apart and the transition problems faced by Russia, China is already one of the world’s most powerful countries, eventually second only to the US (US CFR, 2004-05-19). China’s road to become a real big power, if economic development continues, could prove surprisingly short. Already long before the middle of this century, it could be considered a mid-level developed nation and by holding the undisputedly largest population in the world, it would find its new future position in the rank of what would by then have become a pair of global superpowers.

However, China has now been adopting a comparatively open policy for twenty-five years. Deep involvement in many of the global issues, including a working relationship with many international and regional organizations, are strong arguments opposing the “threat” of China and instead indicate a "peaceful rise". China has, probably intentionally, been trying to walk a different path than the one previously followed by the big rising powers. It has, during its transition years, largely attempted to observe existing international laws and regulations and has proven obedient by joining organizations like the WTO. If this path will be continuously used over time remains to be seen. However, if it will prove successful, it could result in a form of win-win situation for both China itself as well as for its neighbors, but also the world at large. What makes common understanding hard to apply when discussing the two opposing positions about the threat is that this kind of radical shift in positions in the world order has normally taken 100 years and never something like 15 - 25 that will be the case here.

Inside the region, there has been a gradual improvement of relations between China and Japan, the economically two most important nations in NEA. This has been an ongoing trend over the last ten years and has also included both countries relation towards Korea. Relations across the Korean Strait have grown

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- 26 - strong enough to absorb acts of near provocation as when Japanese Prime Minister Junichiro Koizumi's has been paying homage at the Yasukuni Shrine23. It would seem like a small step for the prime minister to retreat from this tradition, to visit the shrine, to improve foreign relations. Such an initiative would also ease tension with other neighboring countries, as the negative reaction to the Yasukuni tradition is as strong for Korea, Singapore, Indonesia and the Philippines24. However, the current (ab-)normal state of "cold politics and warm economics" in bilateral relations has proved stable enough not to derail by this. However, as a result of their visits, there has not been any official meetings at the highest level since 2001 and all meetings since has been kept short and on the sidelines of large conferences25. At the same time, cooperation in wider fields between the two big neighbors is waiting to really take off, as it is difficult for such cooperation not to be influenced by political factors and by the public sentiment. A widening of cooperation into more fields of common interest would both foster mutually beneficial economic relations and safeguard future political and diplomatic development. It still remains to be realized on both sides that a peaceful development of China is not necessarily a threat, but could instead act as a catalyst that can also help to further strengthen the Japanese economy. China in 2003 took an important unilateral step to improve relations when Japanese visitors were being exempted from normal visa requirements. Although high level state visits have been suspended, cooperation on lower levels is gaining momentum on a large scale.

The cooperation between Korea and Japan has found it easier to overcome a dramatic history. Since the Korean War in the mid 1950s relations between the nations in the region have seen improvements in practically all directions. However, there are still no peace agreements between Japan and Russia, as well as between the two Koreas. Seen from the perspective of the dramatic historic past, relations have slowly improved across all borders. The rise in importance of international business and the very rapid rise of the war against terrorism to a global issue, show that geopolitics can change quickly. Sudden changes in the outside world continue to influence the situation and, from time to time, disturb the setting of the agenda. Other difficult issues to come to terms with have been former territorial disputes, Il legal labor migration, human trafficking and the smuggling of drugs and goods. As understood, it is not self-evident anymore that states themselves and their political elite set the agenda as the world has become more complex, interdependent, and at the same time, fragmented.

The Russian position in the region is somewhat different from that of the other four. The Russian Far East is the least populated land area in the region and with the country’s political, economic and population centers being located 1 000 of kilometers away. At the same time, it is well known in the Asian region that there is a considerable potential for the export of raw materials to raw materials

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- 27 - in starved countries in Asia. Potential foreign investors in the exploration of oil, gas, coal, and various minerals in eastern Siberia, is something that has several times been mentioned by the Russian government as one of its priorities. Investments are not only hoped to find their way to the Russian Far East from its Asian neighbors, but also from the countries across the Pacific like the US and Canada. So far this has not come to materialize to any larger extent, as the problems that have faced early investors have proven to be much larger than the potential profits from their investments.

However, the constant search for energy security among the NEA countries is one of the classical fields of geopolitical competition where states and companies remain the most important actors. Especially so in the case of Russia where energy is the most important asset for the future and already the outstanding earner of foreign currency. In later years world supply of energy has been below demand, which has not only raised prices, but also given the geopolitical importance back to energy that it had in the late 1970s and early 1980s. In NEA, the discussions concerning the laying of pipelines in one or the other direction has come to enhance the Russian position in the region, and has, perhaps, created a new reason for rivalry between China and Japan

One initiative that has been missing in the region that could have helped to overcome the high-level communication problem between China and Japan, has been a cooperation organization for the NEA region. In this respect, the six-party talks on the North Korean nuclear issue has opened up an opportunity for the NEA countries to organize high-level meetings. Preparations for these meeting, as well as the actual meetings, have opened a forum that, hopefully, is there to stay also after the current North Korean stand-off has been resolved.

In discussion about international relations the NEA region, the US interest in the region cannot be overlooked. Security is the prime US interest, both here and elsewhere in the world. Previously it was the Russian Far East that used to be a considerable concern, but now that role in the region has been taken over by North Korea. On the other hand, an increased Chinese influence in the Russian Far East would not serve US security interest and especially not US interest in Russian energy resources.

1.5. Energy

Too many energy is equal to oil, which is not really correct as coal continues to supply more energy than oil. At the same time, oil remains the world’s most important traded energy resource and is to its reserves a relatively concentrated

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- 28 - resource. By a wide definition of world energy resources, including known oil, gas and coal, reserves compared to world energy consumption, reserves are well over 100 times the yearly consumption, with coal making up about 60% of the reserves (BP, 2004-06-15). During the years since the first major oil crisis in the beginning of the 1970s, world energy use has gone up by around 60%. During this period, oil production has increased from 2.900 to 3.600 mtoe and with coal production having increased from 3.800 to 5.300 mtoe (IEA 2004-07-14)26. World oil consumption by mid-2004 was in the range of 82 million bbl/day or 30-bn bbl/year27. Oil demand in the summer of 2004 stood at its highest since 1980 with OPEC countries producing at nearly 28 million b/d, or just over 1/3 of world production28. The biggest single producers during 2003 were Saudi Arabia and Russia with 8.7 and 8.6 million bbl/day, but both having increased production during 2004 to about 10 and 9.1 million bbl/day, respectively. The most significant change in supplies over the 1998 – 2003 period is the Russian increase in production, which has supplied near 50% of the increase in world supply during this period. Currently several big producers of oil have reached plateaus from which they are likely to fall back, including China, Mexico, and Malaysia, leaving FSU states and OPEC countries as the ones with spare capacity for the years to come (PFC Energy, 2004-09-09). The US stands out as the largest consumer, at around 20 million bbl/d, above even the combined production of the two biggest suppliers. The US consumption is also clearly larger than the pair behind, China and Japan, consuming about 6.3 and 5.5 million bbl/day respectively, which is about double the next consumer, Germany at 2.7. Currently there is technically no short- and medium-term problem on the supply side for oil. Oil found since the first oil crises in the early 1970 is nearly twice the volume consumed during these 30 years. At the 2003 level of consumption, known reserves correspond to about 41 years of consumption, compared to 29 years in 1980.

For what is now about five years, energy prices have been more or less stationary on a high level. First, prices were lifted by increased economic activity in the larger market economies. Then the high level has been maintained largely by a continuous complicated situation in and around Iraq, while increasing imports, to, first of all China, have made demand further out-strip supply. The only country in the NEA group that has been able to fully profit from this is Russia, as the only energy net exporter, while the other four are all net importers of energy. As a matter of fact China, during 2003, even overtook Japan in import volume to become the second largest importer of energy in the world after the US. With continued problems around Iraq, and no indication in the short-term of any major changes on the demand side, it is not unlikely that oil will take long to fall off to a level around USD 25bbl. What has changed in later years is not only that the oil companies can charge higher prices for their oil, but also that costs

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- 29 - around oil extraction has been on an upward trend as the new oil that is being explored is often found in more difficult sites than before. This could be further away from available infrastructure (e.g. western China) increasingly difficult climate (e.g., Siberia) or further offshore (e.g., deeper waters). As oil prices, by tradition, are quoted in US dollars, the simultaneous fall in the value of the dollar that has been seen during the last two years has made rising prices look increasingly dramatic. Additionally, other factors like rising steel prices and shipping rates has put further upward pressure on consumer prices. It must not be forgotten that the increased oil prices also has a widespread effect on the level of other energy prices. In the case of coal, the price per ton for internationally traded standard coal has risen by about 100% from the early autumn of 2003 and one year forward. There are of course specific supply and demand conditions that influence price levels for different energy commodities, but the connection to especially the oil price is both strong and evident.

Russia is the only country in the NEA region with a surplus in production of energy, as less than 60% is being consumed domestically, which leaves much for export. The other four countries in this group are all net importers of energy. In the case of China the import dependence has increased from about 5% ten years ago to the current level of about 10%, while the US, as the world’s greatest importer, imports about 25% of its energy needs (UN-Energy, 2004-10-14). At the same time the efforts from Japan to conserve energy has paid-off as the oil consumption in relation to GDP is by far the lowest in the region. To generate 1 USD in GDP in Japan takes about 130 grams of crude, compared to 230 grams in the US, 460 grams in Korea and 800 grams in China (ANRE, 2004-10-25).

What is discussed here are only the production and consumption of commercial energy. The use of energy from stocks, or the building up of stocks, not only influences the figures between years, but also generates a certain degree of confusion between production and consumption statistics. Additionally, generation originating from, e.g., bi-products, biomass, wind-energy, waste burning and conventional burning of wood can add to the problem. Despite this, it is the by far most important sources of energy for the world, as well as for the countries focused upon here, that are listed in Table 1.5.

China, and partly Russia, is still dominated by their big national oil companies, which is the general picture in the world on the production side. An approximate figure for the world is about 50% of world oil production is transported outside its country of production and the company that produced it (BP, 2004-06-19). It is in this, the second layer, as buyers, transporters and refiners of the oil that the big international oil companies still play a dominating role. In this respect, the international oil market today carries the reminders of

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- 30 - what it looked like in the years before the forming of OPEC and the first oil crises. That was when seven big international companies dominated most aspects of world oil production and its trade. That this pattern partly remains is demonstrated by the fact that Shell and ExxonMobil where the world’s biggest in signing contracts for oil shipments in the two largest ships categories in the world during 2004 (SSG, 2005-01-13).

Table 1.5. Average Oil and Raw Material Prices Monthly 1996–2005 (USD/bbl)

175 45

165 40

155 35 145 Crude oil price (right scale) 30 135 25 / bbl

125 USD Index 1/1985 = 100 1/1985 = Index 20 115

105 Raw material price 15 (left scale) 95 10 1/96 1/97 1/98 1/99 1/00 1/01 1/02 1/03 1/04 1/05

Source: UNCTAD, Commodity Price Bulletin (UNCTAD2, 2005-01-31)

Some aspects, in relation to the NEA group, that must be remembered is the generally high level of coal dependence, and especially so in China, that is well over the world average. Also, the production and use of natural gas as an energy source is very different inside the NEA group of countries. In Russia, natural gas makes up about 50 – 55% of primary energy production while in China, the only other country here with any major findings of natural gas, the same percentage is 2 – 3% (UN-Energy, 2004-10-14). Instead, the use of nuclear energy is considerable in both Korea and Japan. These general statements for the different countries still leave room for industrialised areas inside any NEA country, with energy intensive heavy industry, to consume energy on a US or Canadian level. At the same time, rural farming areas consume far below the national average.

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- 31 - In the longer term, it would probably benefit the countries in NEA to cooperate more closely in the energy sector. There is a need for future political strategies and framework conditions to be in order to support the market development, and to ensure a stable supply of energy as possible, while developing some form of energy consumers, cluster. This includes a discussion on how and to what extent it is possible to coordinate strategies for the energy sector. At the moment the NEA countries have adopted different positions in the WB discussions about energy, about the Kyoto protocol and when it comes to the Energy Charter Treaty. If such positions could be hard to adjust, a suitable starting point for cooperation could be a strategic energy reserves that China have decided to build up in the near future, something that is already held by Japan and Korea. However, a common clear visions and long-term strategies are required as the region currently relies heavily on multinational oil companies and sea routes that can be interrupted. It still remains to be seen if an understanding can be developed and if some form of integrated energy market can emerge among the three big buyers in the NEA group. China, Korea, and Japan in the NEA group has a common interest in securing supplies for the future while reforming the domestic energy industry to raise efficiency. All three countries have restricted freedom to act in the energy sector due to environmental demands, e.g., to limit both local pollution and CO2 emissions on the national level. Restrictions that will probably make increased energy efficiency and conservation the cheapest of all measures available. At the same time, to ensure the fulfilment of future energy demand, a continued diversification in both production and sourcing must be promoted.

Despite this seemingly ideal fit between a large potential markets and a large nearby surplus, East and Southeast bound deliveries from Siberia have remained small. So far, decision-making in Russia has remained clearly centralized to Moscow. In the Russian capital, the aim seems to have been to fulfill the needs of Europe than that of Siberia’s more neighboring countries like China, Korea and Japan. From the point of view of NEA countries, Russian hydrocarbon resources in the Far East are relatively near and large enough to attract considerable attention. In the chapter about Russia, a special sub-chapter has been devoted to the discussions around the building of pipelines for oil and gas to either China or Japan, and will therefore not be given any lengthy coverage here. It must not be forgotten though that it takes a number of years to build a long distance pipeline and furthermore, everything surrounding large pipeline project is not all rosy. A large diameter pipeline will mean that huge areas will be used up by the construction, and, if laid on the ground, it will curtail the possibility of movement for people as well as for wildlife in vast areas.

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- 32 - Table 1.6. Selected Countries Energy Consumption by Type 2003&1993 (mtoe)

1993 OilN-gas C oal N uclear H ydroTotal Russia 189 374 141 27 40 771 Japan 251 51 79 56 24 461 China 141 15 577 0 33 766 Korea79626131125 Brazil 63 4 10 0 53 130 India 6314128116222 U K 84 58 53 20 1 216 U S 789 538 499 145 63 2 034 Rest of W. 1 480 809 655 233 304 3 481 Total 3 139 1 869 2 168 495 535 8 206 2003 OilN-gas C oal N uclear H ydroTotal Russia 125 365 111 34 36 671 Japan 249 69 112 52 23 505 China 288 31 807 10 64 1 200 Korea1052451292211 Brazil 841411369181 India 113 27 185 4 16 345 U K 77 86 39 20 1 222 U S 914 567 574 182 61 2 298 Rest of W. 1 681 1 149 688 265 323 4 108 Total 3 636 2 332 2 578 599 595 9 741

Source: BP World Energy Report 2004 (BP, 2004-07-10)

With the visits of both the president of Korea and the premier of China to Moscow inside a week in September 2004, and with Putin due in Japan in late 2005, the eastern window could perhaps be made to open. Additionally, there are also other potential export products among energy resources outside oil and gas in Siberia, which are normally the only ones focused upon. Other such examples that could be of interest to NEA neighbors could be the abundant reserves of coal, uranium, different minerals and forest resources, while hydropower, peat, and geothermal resources could well be exported in the form of electricity.

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- 33 - It is a strategic question for Siberia’s Asian neighbor countries to consider to what degree they want to bet on developments in Russia to be stable enough to secure future deliveries. The present Putin government can, from the one side be said to develop in a not fully democratic way, in a European sense, while becoming increasingly stable. On the other hand, both Belarus and Latvia has, in recent years, experienced how damaging the Russian oil and energy weapon can be when it comes into use. The handling of gas deliveries to Belarus during the winter of 2003 – 2004, by the Russian state-owned gas monopoly Gazprom, showed how powerful the control over the tap to energy deliveries is. This is an incident that must have given rise to second- thoughts among potential customers elsewhere. To build up a large dependence on Russian energy could place Asian countries, or some regions in these countries, in the same position as some smaller countries in Europe.

To shift between the uses of different energy resources is seldom very easy. Investments made into the use of one type of energy often make consumers reluctant to change source, at the same time as many larger consumers are protected in the short run from price fluctuations by long-term contracts with suppliers. This gives a time lag until higher price levels will be really felt, but in the longer term, it is often when investment decisions for the future are to be taken that other energy alternatives are being considered seriously. Regrettably the development and efficiency of alternative sources of energy have still to reach a level where new technique can be economically sustainable at an energy price level below a USD 30/bbl level. In such a situation, it would have taken a strong belief from an investor to proceed with such an investment just a few years ago. However, any such initiative would have been richly rewarded at the price levels during 2004.

As for future world consumption of energy, oil will remain the world’s most important traded energy resource for another 25 years to come. From some time, around 2030, oil will start to fall off and at about that time gas is likely to have passed coal in importance to become the second most important energy resource. The second big change to come is that the reserves of non-conventional oil resources, with much still to be discovered, are at that time likely to have become larger than conventional oil reserves. This will enhance the position of e.g. Canada, as its large oil-reserves in the form of oil-shells will have come into full commercial use by that time. The increased use of both non-conventional oil resources and natural gas could not only prolong the energy crises scenario, but also these and other petroleum-based resources are nonrenewable. Inside a timeframe of about a generation from now, a new basic energy system for the world must be at least on its way to be implemented. If not, another big energy crises will soon be approaching (T&E, 2004-09-10).

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- 34 - In later chapters that cover the individual countries, there will be a number of reasons to come back to discussion concerning energy supply and energy security.

1.6. Transport

Transports are often ascribed a role as both generator and facilitator of economic growth. In the previously discussed internationalization of manufacturing, the rapid and simultaneous development of transport and ICT is somewhat being taken for grant. However, it is difficult to establish the extent of development of transport capacity and how shortened transport times have helped to enable the globalization process. The correct view could be the reverse; that demand for increased transport capacity and speed made the transport sector develop, e.g., the mega ships that are sailing around the world with containers on set schedules. Transport’s contribution as a facilitator of the globalization e.g. falling prices, increased competition, increased security, complete internalization inside shipping, much improved logistic services, wide-spread computerization, has obviously contributed massively. The parallel development inside the ICT sector that has made instant long distance communication and control possible, at lower costs, among an abundance of other achievements, has greatly supported continued globalization and the development to the transport sector.

On land, the role of build-up transport infrastructure becomes crucial as facilitator of transport and trade. In the transport of large volumes of energy resources, e.g., inside NEA, the building of new infrastructure has been turning increasingly expensive. At the same time, mounting costs have made the largest projects practically impossible to be financed by one state alone. A development that can help to establish wider cooperation and friendly relations between countries in the region, but also risk creating new divines if ideas do not work out as expected.

One of the major problems affecting the transport sector, and other service industries, is that the product, i.e. transport services, cannot be produced beforehand and stocked until demand kicks in. The pure size of a transport system is not a guarantee that it will cope with the demand from the industries as well as from the passengers who are using it. Therefore, adoptability becomes a major factor of concern in transport; at the same time as a good planning, optimal use of available transport capacity will be as important. In this field of “logistics”, much still needs to be improved, especially so in the two transition economies of the NEA group.

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- 35 - The most important shifts that have occurred in the transport sector inside of the NEA countries are occurring in Russia and China. Here there is a radical shift away from the strong position held by railway transport to roads and the use of trucks and away from state control over the different means of transport in the direction of private ownership. This involves a transformation of a system where transport is centrally planned previously; and away from a situation where relatively few, but large, producers dominated. At the time manufactures, as well as commodity extractors, all had pre-planned volumes to be produced and destinations to where the production should be dispatched. This system is still under forced revision, as it is adapting to market economic conditions. Now, the planning horizon is generally much shorter, the number of suppliers and buyers has multiplied, at the same time as the average size of consignment has fallen dramatically. A combination of processes that favors the advantages given by the use of trucks instead of rail.

In respect of domestic transport, the four countries in NEA are ready to be divided into a group of developed countries with Japan and Korea and the transition group with Russia and China. The first two have a long tradition of a well, spread car ownership and are both to a large degree dependent on road transports also for freight. The pair of transition economies could at best be said to be aiming at the same situation. Here though, the size of the two countries makes it unlikely that road dependence, neither passenger transport nor freight, will reach anywhere near that of most developed countries. In Japan and Korea, on the other hand, the construction of new roads has long since found its established state and tax-funded system of financing. Road financing is still far from having a lasting system in the transition economies. The possible privatization of roads and the building of private roads have been discussed as an alternative to the failure of the state road agencies to maintain and build roads in line with increasing car ownership. Both Korea and Japan have reached maturity in car ownership and have instead become large exporters of second- hand cars to especially Russia. In both China and Russia, private car ownership was, more or less officially discouraged, until some ten years ago, giving few incentives to increase their very low levels of road density. Both countries are also among the biggest in the world with vast sparsely populated areas that must pay a considerably higher share of product prices to the transport sector. Low population density in combination with the long distances involved multiply the needed investments to eventually upgrade the transport system in such areas, as the same time as usage is bound to remain low.

To remain attractive for investments from both inside and outside the region, close cooperation with the near neighbors in the NEA region is critical. In later years, Korea has become very active to negotiate; attempting to conclude road

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- 36 - and bilateral aviation agreements with countries that are important to its development plans. Any global or regional ambitions are currently impossible to fulfill on its own for any country in the region, and especially so if it does not include China and Japan.

Concerning international trade, it is the seaborne movement of goods that remains the by far most important. During 2004, seaborne trade is forecasted to reach about 6 bn tons, accounting for about 90% of international trade by volume, up by nearly 50% over 15 years. Shipments of crude oil and oil products are the dominating single category, with different dry bulk products together making up near half the total volume. Out of this half, or 25%, is related to the steel industry’s raw material needs and the shipping of finished products. With China becoming an increasingly important importer of raw materials, demand for ships has been near capacity during the last few years. With the rising importance of China average distances of shipments has increased between producers and consumers, further lifting the demand for capacity. Also, the Chinese container volume has increased rapidly, by approximately 1/3 per year over the last few years, setting the turnover to 35 million TEU for 2003 (SSG, 2004-07-28). Also, for manufactured products, the voyages are longer than before, further enhancing the need of capacity, which has resulted in a sharp increase in charter rates. As a result, shipping costs in some sectors have nearly tripled in just one year (Baltic Exchange, 2004-08-17).

1.7. A systematic country approach

In the general introduction, ending here, it has largely been changes occurring as a result of the ongoing globalization process that has affected the NEA countries, as well as other countries in the world, have been given a general overview. The focus in the following will shift on to the individual countries in the NEA group of countries. The five main chapters are presented in the order of Russia, Japan, China and South Korea; with only a very brief chapter covering North Korea. Leading to a final chapter; Discussion and Conclusions.

Each of the abovementioned country chapters starts with a General Introduction that includes a brief summary of major development over the last few years, but concentrating on 2003 and 2004. This is an introduction to the following subchapters that are headlined as Economy, Trade, Energy and Transport. The aim behind the selected subchapters is to describe no only the conditions forced upon, but also created by the different countries, seen from these respects. Foreign trade is at the centre of most issues mentioned, as trade greatly influences the economic development in this group of increasingly trade

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- 37 - dependent NEA economies. Trade is the generator of money economic wealth, physically conducted by way of transport and driven by energy.

To their nature these subchapters for the four countries will look slightly different. Energy in this region, to a considerable degree is an important item on the import balance, case for Russia on the export balance. As energy in of Russia is extremely important, it is therefore given a longer description. In the same way the description about shipbuilding in Russia is very small compared to the one under Korea and the description of Free Trade Agreements is large for Japan, but not so for China and Russia. Instead, the chapter on China includes a longer description about trade of textiles, which is an important Chinese export item. Also the chapters about economic issues, have slightly different focus in the different countries making, the chapters reflect what is seen as important aspects for each country. Taken together the content of the chapters are intended to give a solid picture of both the latest development and the current situation in various sectors. All with the aim of giving a wider coverage to issues that have been found to be more relevant for each individual country, the descriptions, still maintains its framework of a systematic country approach.

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- 38 - 2. Russia

2.1. Introduction to Russia29

Since the mid 1980s, after the appointment of Mikhail Gorbachev as Secretary General of the Communist Party, changes in, first, the Soviet Union, and later, Russia have speedily advanced. The processes of openness (glasnost) and restructuring (perestroika) that were initiated at the time contributed to the gathering of the momentum that lead to the final break-up of the Soviet Union on December 8, 1991. From then on, the Russian Federation, with Boris Yeltsin as its new leader, along with 14 more former Soviet states, created a new political geography in this part of the world. However, in Russia the restructuring process continued under Yeltsin, and in 1993, a new constitution was approved by way of public election. At the same time, the first democratic parliament, the Dumas, was elected30.

The reforms that have been introduced have structurally changed society, with the intention to turnaround the formerly centrally planned system to transform into a market economic system, inside a not too distant future. Reforms adopted during the early transition period, included measures like mass privatization, legal reform, the creation of financial markets, currency convertibility, and much more. Although the reforms were uneven it did make market reforms take deep root in the former centre of communism. The reforms started to show progress in 1997, when GDP turned positive for the first time since the start of reform. Soon though, the reforms were to face its biggest setback, when in August 1998, the value of the stock exchange collapsed along with the value of the Ruble. Few western companies abandoned the country in the aftermath of the crises and instead continued to focus on the potential buying powers of the near 145 million population and the abundant and largely untapped resources of oil, gas, minerals, and timber in Russia.

Already in 1999, and much as a result of increasing world oil price levels and a much devalued ruble, economic indicators again showed positive signs and the growth trend came to be reestablished. It was at this stage that Vladimir Putin was first named Premier Minister and by the end of the year offered to take over as President. It will, first of all, be the years of the 21st century, all under the rule of Putin as President of the Russian Federation, and especially 2004, that will be covered here.

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- 39 - 2.1.1. Introduction to the Russian Economy

President Putin's government under its, until the spring of 2004, Premier Kasyanov, in cooperation with the pro-Putin Duma, has managed to introduce a number of fundamental reforms during the president’s first term, 2000 - 2004. Examples of the changes that have taken place are, the introduction of the flat income tax, a new system for profit tax, the new Land Code and the new legislation on liberalisation of the currency handling. What is probably the most admirable achievement of the government has been its ability to balance the state budget, and even run a surplus, during its entire mandate at the same time as international borrowing has been sharply reduced. As a result of the devaluation of the Ruble in August 1998 and with strong support from steady, and steadily higher world oil prices, the Russian economy has grown during the last five years with the stock market hitting new highs. During the time since Putin came to power, the real per capita income has continuously improved, the national hard-currency reserve has reached its highest level ever and inflation has been kept modest, or on a slow decline.

In parallel to these positive developments on the side of economic reform and growth, Russia's political system has become less pluralistic over the years of the 2000s. During his first term, the president did very little to strengthen weak and fragile democratic institutions. He instead actively weakened them still further. The brutal and ineffective war in Chechnya has continued uninterrupted and the state apparatus has acquired de-facto control of much of the written media and major national television networks. Still, Putin has been very clear about the future development of Russia by stating:

"Russia made its choice 10 years ago. Russia wants to be, and will become, a democratic, socially oriented state with a market economy." (President Putin, 2004-09-26, RFE 2004-09-27)

Two of few economic factors that fall on the negative side are FDIs and money transfers. During the years from the falling apart of the Soviet Union, Russia has been one of the least attractive in the CIS when it comes to attracting FDIs if counted per capita. At the same time, as the FDI inflow has been relatively limited, large amounts of money has been fleeing the country destined for one or the other of the world’s tax-heavens. Improvements were seen, and the exodus of capital was clearly on the decline until the legal process against the country’s richest man and CEO of Yukos, Khodorkovsky, was initiated in October 2003. There seems to be little doubt that not only general economic reforms will continue, but also the control over natural resources will be tightened.

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- 40 - Despite the economic progress in some fields, much will demand continued attention. Examples of such problematic fields where actions have been taken, but still needs continued, or even constant attention, are the social sector, housing, banking, law enforcement as well as the administrative reform spheres. Initiatives are needed to keep up the momentum in the transition to a market economy. At the same time, there is a risk in overheating in some sectors, and it seems to be approaching especially in the real estate investment market. These markets are overheated, according to Minister of Economy, Gref, and this opinion is shared by many analysts and will, according to Alexander Baranov at Russkiye Fondy, lead to that: ''The country faces an inevitable crisis in 2005-2006” (Gazeta, 2004-02-19).

The Russian government has also started to consider a possible plan to introduce an economic amnesty that would cover violations that occurred in the late 1990s, much during the privatization process and later, incurred tax violations. The first such plan in the former Soviet Union area was introduced in Kazakhstan during early 2003, but, as the minister of Finance Kurd in concluded: “The general public is not ready for such a step”(Pravda, 2004-04-19). To make such a move possible, and acceptable to a majority of the population, could still take years, as Russia is a much more open society than e.g., Kazakhstan. Still, the most dramatic changes must find a reasonable degree of public support, which takes time in a country with a history of 70 years of collective ownership.

Economic development During 2004, the Russian GDP increased by 7.1% compared to 7.3% for 2003, and amounted to a total value of RUR 13 300 bn (USD 410 bn)31. Industrial output for the year increased by 6.1%, compared to 7% for 2003, with energy production having increased by 9% (9% in 2003), machine building and metal fabrication 12% (9%). Within the fuel industry, crude oil production increased 9% (11%), coal production 6% (8%), and natural gas production 5% (5%). In the machine building and metal fabrication category, growth was strong in the manufacture of railway equipment and rolling stock, which was driven by increased rail shipments of crude oil. In the ferrous metallurgy category, pipeline production was a fast growing product groups (FSSS, 2004-08-07). The problem with the growth during later years is largely that it has to some 2/3 been generated by growth of prices in the energy sector and only to some 20% by increased production (WB-Ru, 2004-04-20). During the later part of 2004, several of the most important indicators have shown slower increasing trend for growth, with industrial production being an example (Minfin, 2005-01-11). The sectors that have achieved the largest gain in productivity out of these have been the ones that have faced the strongest competition from foreign import.

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- 41 - The federal budget for the third year produced a surplus during 2004 of 1.5% of GDP, compared to a 1.8% during 2003, with oil and gas contributing strongly through high world market prices during the year. During the first 11 months of 2004, the surplus for that period had come to a record of 3.9% of GDP, or about 540 bn (USD 19 bn) in money terms, and a projected 1.5% for 2005 (MOEDT, 2004-12-12)32. For 2004, the assumed budget was average Ural oil price of only USD 22/bbl which has led to that record sums that have been set aside for the stabilization-fund (sometimes called the reserve-fund) established in early 2004. This fund was created in 2003 to stabilize incomes over time as a way for the government to save some of the surpluses in the state finances during years of budget surpluses, generated by high world oil prices. Transfers to the stabilization fund have been considerable, and it stood at USD 4.2 bn at the end of March 2004 and was previously expected to reach USD 9 bn by the end of the year. However, higher than expected oil prices have made the fund balloon to near 750 bn (USD 26bn) by late January 2005 when the budget surplus for 2004 had been added to the fund. Initially it was planned that when savings in the fund would reach 500 bn (app. USD 16.5 bn), it would not be extended further and surpluses will instead be included in the budget or used for special purposes. Ministers of the government have now started to voice desires about how to spend the money, e.g., education, security through the interior ministry, hydro-power, agriculture while others want to use the money to pay down foreign debt. The assets of the fund should have been placed in US, EU, or similar government debt instruments. It was not until September 30 in 2004 that Prime Minister signed the decree of investment, giving the minister of finance two months to decide about investments, which indicate that the fund had grown thus far, without any money having been invested securely (MT, 2004-10- 21). The first use of the money from the fund came to be the final repayment of USD 3 bn of the USD 19 bn loans taken out from the IMF during the financial crises in October 1998 (MT, 2005-02-02). The positive economic development over the last five years has also lifted the incomes for the Russian state and during this, time it has managed to service both domestic as well as its foreign debt. On July 1, 2004 the debt totaled 4 079 bn, having dropped by 3% since the start of the year, with 3 352 bn in foreign debt (Itar-Tass, 2004-08-31). The foreign debt stood at USD 139 bn by mid-2000 and is expected to stand at about USD 115 bn by the end of 2004. Both the size of the debt and its size in relation to GDP have constantly been declining during 2004, with the ratio of state debt to GDP estimated at a modest 26%. When the budget for 2005 passed the Duma, its revenues were expected to reach 3.3 trillion (USD 114 bn) and with spendings of 3 trillion, indicating a growth of 6.3% and another year of surplus. Incomes have been based on an average oil price of USD 28/bbl for the year and the biggest increase in spendings, some 30% will be directed to defense, law enforcement and security (RosBalt, 2004-11-30).

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- 42 - The Russian economy, with the results for 2003 included, seems to have reached a state of stability, which has continued into 2004. For 2004, GDP grew by 7.1%, and for the first nine months, investments were up by 13%, real income grew by 14%, but inflation remained higher than what had been predicted as it ended the year at 11.7%, clearly above the 10% target (FSSS, 2004-10-10 and Vedomosti, 2005-01-31)33. In his vision for the future, the president has stated that he expects the government to see to that the Russian GDP will have doubled by 2010. To achieve this goal, a growth level from 2004 onwards of about 7.5% annually will be required (Kremlin, 2004-04-24). For 2004 and 2005, the estimations for the economic development of Russia look positive and the Ministry of Economy has predicted a GDP growth of 5.8% for 2004 and over 6% for the three coming years. The predictions about the general level of economic growth in the years to come are supported by the IMF, which predicted a 6% growth level for 2004 and above 5% for 2005 (IMF, 2004-08-21). However, GDP figures are under constant revision, with changes being announced practically monthly by different ministers and ministries, and therefore the figures can only bee seen as predictions for the future.

Along with the economic restructuring that has taken place since the break-up of the Soviet Union, the importance of the different sectors in the economy has also shifted dramatically. The service sector has continuously been expanding and contributed to 60% of the economy in 2003, industry accounted for 27%, construction for 8% and agriculture for 5%. In a study presented by the World Bank in early 2004, the weight of the different sectors has been strongly questioned (WB-Ru, 2004-04-20). Seeing the importance of the oil and gas sector for the Russian economy, this sectors’ importance in GDP must be much larger. The World Bank argues that many oil companies sell their crude to middlemen, in the form of trading companies, well below market value. These companies are better positioned to profit from tax relieves and as a result of this internal trading, less value is also given to the extraction industry when calculating the GDP. According to the World Bank, it would be more correct to set the share of the industrial sectors’ importance in the GDP to 52 – 55% for the year 2000 (the year studied), instead of the 32% accredited to industry for the year (FSSS, 2004- 08-12). It is not only in the GDP where energy companies may account for about 25% of the GDP, but they also weigh in heavily in the stock market where they have accounted for about 2/3 of total stock value. Led by a very positive year in 2003 for the oil companies, the dividends paid to shareholders for 2003 by the listed companies on the stock exchange became the highest ever, reaching USD 6.5 bn (Kommersant, 2004-09-18). Also in this field, the trend points to a strong economic development as in 1998 dividends reached USD 300 million, passing USD 3 bn in 2001 and USD 4.5 bn in 2002.

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- 43 - Russian leaders have come to understand that the 21st century will be economic to its nature. Energy will continue to be one of the most important playing chips in the game, making Russia an important future player. Putin, in his December 2003 speech to the nation, strongly stressed the importance that will be put on the economic development:

"Our biggest threat is falling behind in the economic field. There is a tough, competitivebattle going on in the world. But unlike previously, this battle has moved from the realm of military conflict to economic competition." (President Putin, 2003-12-12, Reuters)

Over the last few years central control over the Russian energy complex has become much more authoritarian, at the same time as actions by the state monopolies for pipeline transport, Transneft, and for gas, Gazprom, has received strong state support. Generally it is seldom so, with the possible exception of Norway, that states with a strong energy dependence has been especially successful in building democratic governing systems and following up on human rights. A large dependence of energy from Russia could also open the way for political extortion by way of energy supplies on Asian consumers, in the same way as has been happening on the European side. A factor that possible partners in Asia must be thoroughly considering before going into large-scale agreements for energy supplies from reservoirs in Siberia.

Russia’s economic recovery, in the last five years, have much taken place despite the economic situation in the surrounding world has been problematic, if not depressed. Russia remains strongly dependent on the outside world with its economic prospects dependent on oil prices, a falling dollar value has also depressed savings in Russia. Connecting the two in a way not seen before, where changes that take place in the capitalistic world have an immediate effect also in Russia. Especially so as much of the Russian raw material exports see it prices negotiated in dollars, while much of the import has to be paid for in appreciated euros.

Several international as well as Russian surveys have concluded that problems like undivided authority, bureaucracy, and petty tyranny are the main obstacles for an effective collaboration with western partners34. So far there has been no real creative partnership established between the state and companies where the state delivers the appropriate policies while enterprising structures understand that they must both learn to follow this and to face competition. There are also the more general problems with Russian company structures related to management, as for example companies’ internal decision-making process

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- 44 - should be attended to. Public educational institutions like schools, institutes, and universities have also suffered severely in the transition process. These have generally not been able to keep up the level of teaching, little regulated forms of semi-privatizations have been seen, with money having increasingly come in to play to cover tuition fees and to secure exams and diplomas. As a result: “the poor have been excluded and the needs of the labor market has not been met” (The Nation Address, Kremlin, 2004 05-26). Just inside education, the money spent on corruption is estimated to have reached near USD 1 bn, with the most prestigious exam certificate in the country, from the Moscow State Institute of International Relations (MGIMO) being “priced” at USD 14,500 (TVCentr, 2004- 10-04). This process has been going on for many years now, at the same time as low wages have led to that many workers with special skills in the educational sector, in demand from the private companies, have found new jobs. As a result, the quality of education has become very uneven among institutions, and generally less successful than in other countries in preparing students for “real world” situations. The combat of this kind of corruption by the FSB has made some progress, having launched 900 criminal cases during the first nine months of 2004 just inside education (Itar-Tass, 2004-10-26). However, the fight against corruption seems to be an uphill battle, as 65% of surveyed people believed that it is impossible to stamp out, with about 1/3 agreeing to that the country as a whole is corrupt (VICOM, 2005-01-12). 35 Also public and corporate research, previously often conducted at independent research institutes and only to a limited extent connected to universities, has been suffering badly during the transition period. Generally, public investments in R&D have fallen dramatically. Russian investments are seldom seen to be directed towards anything that in other NEA countries would be considered as high-tech. During 2004, the government took a new initiative in this field and initiated the privatization of research institutes. A reform plan that by the Academy of Science and by the former Minister of Science has been labeled as “planned destruction of research” (Kommersant, 2004-09-09). The proposal was said to have been tailored in line with the indications from the president in reformulating the status of the Academy of Science, that has been relatively independent, but state-funded institution.

Although the democratization process in Russia has been ongoing for over ten years, and has in certain respect been very successful, it has, in relation to voters’ participation in elections, a lot left to be desired. A similar tendency can be seen in process of forming the basics of a civic society that has generally been positive, but where reforms in many oblasts have been brought to practically a standstill since years. One of the reforms that has been carried through, and that effectively has made this writing possible, is the introduction of websites at all

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- 45 - Russian ministries and agencies. After the December 2003 elections to the Duma and the March 2004 re-election of President Putin, the political system has become increasingly streamlined to deliver on presidential decisions. The need to have constitutional amendments ratified with a 2/3 majority in the Duma and a ¾ majority in the Federation Council is no more a restriction to the ruling President. A good example of the new situation was the process of approval of the highly controversial law on converting tens of millions of citizens’ in kind benefits to money payments in July 2004. This was probably the most protested law by common people in modern Russian history. Still, it took only days for its three readings in the Duma and for the approval in the Federation Council. In the form the bill was signed into law by the president, it will, from 2005, give the some groups monthly cash compensation, instead of e.g. free medicine and transport. Such examples are handicapped veterans 1 550 (USD 53), World War II veterans 1 050, and handicapped citizens 950-350 depending on their classification (3 different), plus individuals with social-welfare benefits that will receive a "social package" of 450 (RIA-Novosti & Itar-Tass, 2004-08-30). In all there is a considerable reduction in support to what is already the poorest strata of the populations. However, before the introduction of the reform and first payments, a protest movement took to the streets. In just a few weeks of January, mainly pensioners managed to exert enough pressure on both federal and regional governments to reinstate a part of the benefits and to promise raises in pensions. Still, with the 1.6 million state and regional employees were unaffected by the reform.

That was followed by a declaration from the president that for his second term, he was to focus on improving the general standard of living in Russia in the coming years. The achievements in previous yeas can be looked upon from different points of departure. The Minister of Economy Gref has declared that the number of Russians living on incomes under minimum of survival has fallen from near 34 million in 2003 to about 29 million by the end of September 2004; still making up near 19% of the population (RJ, 2004-12-02)36. At the same time, the gap between poor and rich has increased over the last few years and by the end of H1 2004, the poorer 20% of the population received 5% of incomes while the richest 20% receive 46% of incomes. The ratio between the two groups came to 8.6 for the period compared to 8.4 the year before, with comparable figures for Europe and the US at 6 and 9, respectively (RFE, 2004-08-05). Other such wide ranging public statements given by the president have been to improve the business climate, raising the efficiency of the public administration at the same time as costs should be reduced and corruption slashed.

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- 46 - In the 2004 Global Competitiveness Report, when it come to costs incurred by corrupt officials, only four countries out of 104 were given a ranking lower than Russia by business leaders (World Economic Forum, 2004-10-13). Transparency International gives Russia the same miserable ranking when it comes to corruption, giving Russia a score of 2.6, with the likes of Finland and Sweden at 9.7 on a ten-point scale, setting Russia between Nepal and Tanzania. During the eight years that Russia has been included in the ranking, the value has constantly been 2.3 – 2.6, indicating that the new Putin campaign against corruption from 2004 has quite some work to do (Transparency, 2004-10-20). The National Anti-Corruption Committee has stated that more than USD 40 billion is circulating in the form of bribes and dirty money in Russia, with half of this connected to the Customs Service, the most corrupt branch of the Russian Government (Kommersant, 2004-10-27). The prosecutor-general has stated that corruption is out of control with 39 000 alleged violations registered during 2004 and with 7 000 of these investigated during the year (Itar-TASS, 2005-01-26). A survey conducted by the World Bank has, perhaps surprisingly, assessed Russia along with 145 other countries and placed it as no. 45, based on how laws are formulated, i.e., not how these laws are being implemented. Russia shared its position in the second best of five categories with both positive and negative surprises like Armenia and Georgia, on the positive side, and Estonia, as the largest negative surprise (WB, 2004-09-09).

Despite all the positive progress in macroeconomics, not very much has changed outside the centre on the micro level. Small-scale projects like supplying collective farms and small villages with electricity and making local roads useable throughout the year have continued to be largely ignored. Agricultural output has changed little as the large farms continue to dominate for e.g. grain with 85% of the harvest, while the private dachas (gardening lots) continue to supply some 90% of the potatoes consumed and 80% of vegetables. After many years of strong economic growth, the benefits for many are sometimes hard to see. Much equipment is not being replaced, much of the infrastructure continues to disintegrate and for a large share of the population, the purchasing power remains minimal. After five years of continuous economic growth, the Russian population is still not fully convinced that this is a lasting state and remains on the outlook for, and is still preparing for, the next crises.

Economically Russia is still a relatively small country and can best be compared to a just over middle income developed country in Europe. Out of its 140 million inhabitants only some 10% has a purchasing power that would be middle class in Europe, although the richest Russians would be considered as very rich in any country of the world. Despite the low average level of living costs in Russia, the country is catching up worryingly rapidly and especially so in the economic

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- 47 - centers. The two biggest cities, Moscow and St, Petersburg, have become the third most and 12th most expensive cities in the world for a foreigner to live in (MercerHR, 2004-06-15). It is difficult to see the future might of Russia in the field of economy, although it is still a member of the G8, a group that is a supposed to be the world’s biggest economies, but Russia remains a member more from tradition and for its raw material might37.

Taxation For a country emerging out of socialism, the restructuring and reformation of the tax system become crucial as the previous “all inclusive” system has ceased to exist. Under socialism, at least theoretically, few individuals and companies have an interest and possibility for that matter, to make any serious efforts to avoid taxes, because few personal profits are there to be gained. In a market system, the company and/or individual that can avoid paying tax will often profit from this in the form of increased personal wealth. From the states, point of view, massive reforms in society are needed during a transitional period and with reforms and other improvements that falls on the state to undertake comes a price tag. Incomes for the state are needed to pay not only for the reforms, but also the running of the state, and for a state these incomes are first of all generated through taxes. Taxes are also an ever-ongoing arbitrage between fairness for the income groups that are to pay and setting the level at an optimum. That is setting the level high enough to generate the tax income needed, but still not too high making the supposed taxpayer put too much of an effort into avoiding paying.

Tax reform has been one of the long-term projects for all Russian governments and also now there has been ongoing work on amending the law. The aim has not only been, to clarify how and when taxes are levied, but also to lower the overall tax burden. It has also been so that with continued high oil and raw material prices, later amendments has had the intention to shift the tax burden from individuals and the value-added industries to the extracting industry.

Examples of later reforms are the flat income tax, set at 13%, and the reduction of the profit tax from 35% to 24%. However, continued reforms have been discussed, with income tax would be change into something like a progressive tax system, but with a direction of reform that has seen public opposition from the president. In April 2004, the Government approved a cut in social taxes from 36% to 26%, with the intention that more companies would openly declare the incomes of their employees and at the same time leave room for the use of this money inside the companies. It is expected that the reform will lower the tax rate on wages for companies from 29% to 24%. The change will be introduced from 2005 and it is hoped to encourage companies to participate in charity or social

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- 48 - project of their own choice. Aiming at something like an American sponsor system, but only after first having paid their taxes in full. One problem is this line of reasoning from the authorities is that the main priority for business is to earn money for its owners, including paying taxes, but only after that, is up to the owners to use their income from the business undertaking to their own liking.

The distribution of tax incomes is a sensitive issue both from the point of view of who should be given control of its use and how much, but also which categories of citizens that will profit. In the latest amendment to the tax code the revenues from the company 24% income tax has been set at 6.5% federal and 17.5 regional, eliminating the local level budgets are receivers (Kremlin, 2004-07-30). However, the value added tax (VAT) remains the most important of the taxes, generating about one-third of revenues that, together with excise duties, these have remained federal. The total tax revenues have reached 4.5 trillion (USD 160 bn), up by 24% over 2003 (Minfin, 2005-01-20). For the oblasts, the most important taxes are the corporate property tax, gambling, and transportation taxes.

Taxation on the Russian oil export has been an important source of revenue for the state in later years and in an attempt to adjust taxation along with world market prices, duties are revised every second month. As a result, duties have risen considerably and with the level from August 2004, the new maximum rate will be 65% instead the previous 40%. The lowest level has now been set at 35%, and applicable when oil prices are in the range of USD 15 – 20/bbl. From 2005, the general mineral extraction tax (MET), also on oil that is being consumed domestically, will be raised by 15%. In line with the legislation, the duty from October 2004 will be set at USD 88/ton, up from USD 70/ton (Interfax, 2004-09- 15).

The abovementioned increase on the tax on company dividends to 9% was done as a result of an increase in transfers to owners, as a result of higher profits. The second reason was because companies have been using the hitherto low level of 6% as a way to pay indirect wages to owners, i.e., paying a lower tax rather than the 13% income tax. Also, the VAT could be reduced further, having already been reduced to 18% from the beginning of 2004. Also a simplification of the handling of the VAT is under consideration, according to Deputy Prime Minister Zhukov. Tax on advance payments, VAT returns on exports and a general simplification of the tax administration will be addressed in the near future (RJ, 2004-09-30). At least the latest remark was set exactly in line with the findings of the Global Competitiveness Report that pointed to the vague and complex tax laws, second only to corruption, as the greatest obstacle to business in Russia (World Economic Forum, 2004-10-13).

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- 49 - A positive effect of the Yukos case, seen from the authorities, point of view, has been that the general level of taxes paid by companies is said to have increased in the aftermath of the affair (RFE, 2004-09-09)38. In the latter part of the year other oil companies have also seen similar tax demands as Yukos faced, but then nothing near the USD 13 bn claimed against Yukos. After the completion of the tax audit against TNK-BP it was presented a claim of, what in this case is a relatively modest sum, 100 million for 2001, USD 700 million against Sibneft, while Slavneft, Rosneft and Tatneft are all seeing tax audits of their operations (MT, 2004-11-12). It has not only been the oil sector that has been handed down tax claims for back taxes. In December 2004 the second biggest mobile telephone operator, VympelCom, received a claim from 2001 of 4.4 bn (USD 155 million). On the day, the value of the company fell by 20% (or over USD 2 bn) at the stock exchange, and total share value on the exchange fell by over 10% (over USD 10 bn) in two days (MT, 2004-12-10). Swings in share values of this magnitude are easy to foresee and open the possibility of highly profitable insider trading in shares for people possessing the right kind of information.

Large tax incomes are needed, because since Putin took office at the beginning of 2000, the number of state employees, “apparatchiki”, has doubled, from 660 000 to 1.25 millions by the end of 2003. That is contrary to the reduction that was promised by the then newly instated president. The figure includes officials in state and oblast governments, but not army, law enforcement, and emergency personnel, employed at an estimated cost of about USD 3 bn/year (Guardian, 2004-02-18). One of the major ideas behind the reforms in early 2004 was that the number of employees at departments and in central federal government bodies should be greatly reduced. This would leave room for considerable pay increases for those remaining under the budget. In the process, it is critical that these reductions are to be decided by the government, taking into account the needs in various bodies. When forcing through the much-criticized reform of the benefits in kind in the late summer of 2004, the only major change to the original proposal during the process was to let over 2 million state-related employees keep their in-kind benefits (RFE, 2004-08-30)39.

Investments The share of fixed investments in relation to GDP has hovered around 16 – 17 % in recent years. Seen in contrast with the large needs in the Russian society this is a small figure and can be compared to the same figure in the EU that has been over 20% during the same time period. The needs are endless as the average age of equipment in Russian industry by early 2004 was 21 years. Over the average is machinery in electrical power, metallurgical, and chemical industries. The most modern equipment can be found in wood processing and the food industry, where the average age of machinery and equipment was 12 years (BOFIT, 2004-02-12).

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- 50 - The public sector share of investments, i.e., investments made by local, regional, and state authorities, has been on a slow decline but remains very important, and accounted for no less than 25%of the total during 2003. At the same time, an increasing share of private investments had reached 44%, with mixed state and private investments accounting for an additional 18%. Joint ventures and foreign companies have seen their shares remain around 11% and 3%, respectively over the last five years.

In 2003, investments in the fuel sector accounted for 22% of Russian investments, most of it going to crude extractions and oil refining. Second largest investment sector was transportation, accounting for 18% of investments, but here, a very large share was also related to the oil sector. The two dominating sub-sectors in transport were pipeline construction, oil terminals and rail (tank) wagons, where the production of wagons increased by near 100% during Q1 2004 (BOFIT, 2004- 03-24). During 2004, indicators tell a story about stagnating investments inside the oil sector, with the telecom sector having increased the fastest (Bofit, 2004-10- 15). Also, in other sectors the locomotive is the oil sector that demands service and equipment indirectly lifting other shares further. During H1 2004, foreign investments in Russia totaled USD 19 bn, up near 50% compared to 2003, with FDI reaching USD 3.4 bn, up by 35% (FSSS, 2004-08-19)40. Over the last two years, much of the inflow has been directed to expanding or upgrading existing installations and less so to new companies (Bofit, 2004-40). Despite not having attracted the volumes of investments as other transition economies, Russia still has over 7 000 foreign-owned large or medium-sized companies generating about 3.5% of overall employment, and over 10% of industrial production.

FDI figures look very different indeed depending on source as the Ministry of Finance reported a USD 7 bn figure for 2003 while the worlds leading authority in this field, UNCTAD reported, USD 1 bn (MOEDT, 2004-05-10, UNCTAD – World Development Report, 2004-09-16). As mentioned in the introduction, it is a tricky field to record FDI flows and just some few deals can make a large difference to the total. Unarguably, Russia has attracted the by far lowest share of FDI of all the 15 former Soviet republics, and other transition economies, with a per capita inflow of just USD 52, to be compared to the same figure for Kazakhstan and Azerbaijan of USD 938 and USD 625 respectively. The FDI level in Russia has, over the last five years been in the range of 1 – 2% of GDP while in the smaller economies, e.g. the Baltic state, the same figure has instead been near 10% (Bofit, 2004-45). To a considerable extent, this can be explained by the fact that Russia has completely failed to set up production-sharing agreements that has been seen as attractive by foreign investors in the oil and mineral sectors. In the reorganization of the government that followed the presidential election in 2004, it is now the ministry of Industry, where the former ministry of energy is

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- 51 - now a department, which will be responsible for production-sharing agreements. To further facilitate investments in mineral extraction, energy as well as others resources, a new law on “subsurface mineral resources” has been passed during August 2004 (Duma, 2004-10-24). It now gives the federal level unrestricted authority to grant permissions to extract, having taken away the “two-key-principle” by which local authorities could veto extraction, believed to have been frequently used as a means of extortion against companies on the local level. If that was the negative side of the old law, the negative side of the new is that it gives no say to local residents. Extraction rights will also in the future be auctioned, but the provisions for this will be clearly regulated (Kommersant, 2004-08-06). The importance of the question is shown by the fact that Russia holds 50% of the world's diamonds, 30% of the natural gas, 25% of the nickel, near 20% of the tin, and near 10% of the oil reserves (ITAR-TASS, 2004-11-11). At the same time, the Minister of Natural Resources has voiced worries of an upcoming depletion of resources as not enough prospecting is being done. As a result, current oil and copper findings could be running out by 2015 (ibid.).

Foreign investors are also scared from many sectors in Russia that per-se includes long term investments. The main problem for any investor is whether he is willing to take on the new risks for an extended period of time. Few of the international financial institutions, like the WB or the EBRD, have made investments with a horizon of ten years or longer. Already ten years is a long time and forces investors to be absolutely confident that there are no legal risks, and additionally that investments made will be protected by the government (Raiffeisenbank 2004-06-15). In the wake of the Khodorkovsky/Yukos affair, officials have, on numerous occasions, hinted that the decisions made ten years ago related to, e.g., privatization, tax breaks, and production sharing agreements could be revised (for a description of the process see below). Suggestions sure to give any possible long term investor the chills when discussing future plans and especially so when the government in early 2004 withdrew the development rights for the Sakhalin-3 oil exploration project from the initial winners of the tender, Exxon, Chevron, and Rosneft (see also under Petroleum and Sakhalin). This again served as a reminder to the business community that they are constantly exposed to government interference.

Over the years, since the start of economic reforms, Russia has continuously privatized assets in the form of companies previously owned by the state. At times this has been highly controversial and has been the base for the wealth creation for many of what today are the richest in the country. In the listing of what is currently the largest private companies in Russia, several of the very biggest were created in the loan for shares deal, while increasingly frequently,

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- 52 - large companies are being build in retail, real estate, and service. The biggest private company is the oil major TNK-BP (with a turnover of USD 12 bn), followed by the aluminum company Rusal (USD 4.5 bn) with the steel company Yevrazholding at third (USD 2.9) (by Forbes Russia in MT, 2004-11-01). Privatization sales have indeed contributed with large sums to the state over the years, but it has typically been a few large and more spectacular sales, most often to abroad, that has brought in the largest sums (Bofit, 2004-34). The privatization plan for 2004 includes the selling out of over 2 200 (1 300 in 2005) fully owned enterprises and over 1 900 (600 in 2005) stakes in companies. The continued process is getting increasingly difficult as the list of available assets is getting shorter and not all administrative layers are really interested in privatization as it means loosing both control and revenues. The largest individual assets up for sale during 2004 are stakes in the Svyazinvest telephone company, which never took place. The largest deal during 2004 was the 7.6% state share in Russia’s largest oil company, LUKoil, which in September brought in USD 1.9 bn, from US ConocoPhillips. The second largest was the 18% state share in the Magnitogorsk (MMK) steel company, which was sold to a company owned by the management for USD 800 million in December. During 2004, a list of strategically important companies, which will not be privatized, has also been circulated. It includes no less than 514 wholly owned state institutions and 549 joint-stock companies (MOEDT, 2004-09-09). A listing where many defense, transport, energy, and mineral extraction related companies have been included. It has later been indicated, that this does not exclude these companies from privatization, but if so, it must first be agreed with the president.

In contrast to most other countries the Russian banking sectors share in the financing of investments that has remained very small since the 1998 crises. During 2003, banks supplied around 5% of the capital used for investments, while the companies themselves, out of their own pockets, supplied 55% of the invested funds. An alternative source has instead become loans from abroad and Russian companies, with the stock of loans being estimated to USD 119 bn to domestic banks and USD 50 bn to foreign banks (Bofit, 2004-10-15). In the long run these are alarming figures, as it will restrict the diversification of an economy, which is already alarmingly over dependent on the energy sector. Diversification is something of a key to not only maintain the growth level demanded to first fulfill the president’s desire of doubling the GDP by 2010, but also to broaden the economy.

During the years of the 21st century, Russia has relatively successfully managed to make offshore funds return. Some of the biggest flows come from banking centers of the world where not many question are asked, with few restrictive regulations as well as practically no tax on assets. FDIs from Cyprus,

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- 53 - Switzerland, Virgin Islands and Luxemburg together make up more than 30% of the total inflow to Russia over the 1994 – 2003 period. The biggest investors over the period are Germany, Cyprus, UK, and the US (RFE, 2004-09-01). During 2003, the most important investors were UK, Germany, Cyprus, and France, investing from 4.6 to 3.7 bn each, followed Luxemburg, Netherlands, Virgin Islands, the US, Switzerland and Japan as the countries investing above USD 1 bn during the year. Also, China has, over the last two years emerged as an important investor in Russia, with investments of near USD 1 bn for 2004 and with plans for a manifold increase in the near future (CW, 2004-09-18).

Capital outflows during 2003 amounted to USD 2.3 – USD 7 bn (depending on source), which, no matter the source, was clearly up on the previous year. Net capital outflow from Russia during 2004 could exceed USD12 bn according to the Economic Development and Trade Ministry, while private financial institutions set the level at approximately USD 17 bn (MOEDT, 2004-09-14)41. The most commonly quoted reasons for the increase is the new intensity in the Yukos process, the mini-banking crisis in August and the terrorist attacks, e.g. in Beslan. During the first nine months of 2004, Russian firms invested about USD 25 bn abroad, with the bulk going to practically the same countries as are the origins of inbound FDIs: US, Cyprus, UK, Netherlands, and the Virgin Islands as the most important (FSSS, 2004-12-01). This outflow is said to include a dimension of tax optimization by larger companies to set aside money, that is later, to some extent, are to be reinvested in the Russian market. However, many of the larger Russian companies that have emerged after the restructuring of the economy have by now adapted global strategies, with the intention of becoming true global competitors in their segments. The necessity for international growth is explained here by the fact that if they do not go into international territory to learn from competitors, other global players will come and outdo them in their local market. Examples of such Russian global expansion could be companies like Severstal, which has taken over ailing US Michigan-based steelmaker Rouge Industries in a USD 286 million deal. Later to be followed by Norilsk Nickel, which in late March 2004 made the biggest Russian foreign acquisition, so far, in a USD 1.2 billion purchase of a 20% share in the South African gold mining company, Gold Fields.

As briefly mentioned above, in October 2003, the CEO of the second largest Russian oil company Yukos, Khodorkovsky, was arrested in his private jet in Krasnoyarsk and has since been jailed. At the time Khodorkovsky was estimated to control assets in the range of USD 12 bn. He was seen as the leading figure of the group of the so-called Russian “oligarchs", group that saw much of their wealth originating from the controversial “loans for shares deal” in 1996. This was a dealt that served as a basis for the creation of this relatively small but highly

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- 54 - influential, group of newly rich entrepreneurs with holdings valued above USD 1 bn. A listing that can be considerably extended, if made to include people with assets spread in different lines of business the number of people with holdings above USD 100 millions will include well over 100 (Vedomosti 2004-04-15) 42. In the evaluation made by the World Bank’s Moscow office the share of the countries GDP produced by Russia’s 23 biggest companies, controlled by just 37 individuals, was estimated to be 30% of the national GDP (World Bank 2003) 43. Of these 37, only 15 appear on the listing made by Forbes Magazine over the richest Russians, indicating the difficulties in estimating wealth. However, these 37, and many many more, have undoubted become very rich, by any standards, during the years of economic transition in Russia. On average, these control about 80% of shares in their companies, which is a higher level of ownership than for other controlling owners in similar kinds of companies. Ownership often stands around 70% for companies owned by the state or foreign investors. Later research has shown that the transparency in companies regarding the ownership of privately owned shares in the companies, is generally very low. Seen in contrast to the shares owned by other companies or institutional investors, shares in larger Russian companies to an additional value of USD 114 bn are owned by individuals, but without the true owner being disclosed (Forbes, 2004-10-12).

The most frequent view on oligarchs among ordinary Russians is that they have unfairly seized assets. From another point of view, it could be argued that these assets have made their owners strong enough to resist any attempts from the state to re-nationalize. During a time when the future path of the country, towards a market economy, was put in doubt, these holding have forced through a restructuring in many sectors. In this way, having been active in creating a more competitive private sector, and as a result increasing the value of these companies. Still, it is necessary that the authorities continue to take drastic measures to enhance competition in many sectors that have remained near monopolies. Measures that probably will have to include the breaking-up of several of the oligarch's large conglomerates44. Several possible explanations to the jailing of the Yukos director Khodorkovsky has been presented from different sources, and if a true answer exists, it could well be a combination of these. The problem is seen by some as he did not only promote liberal politics (in the run-up to the Duma elections in 2003), but also promoted the building of a privately owned export pipeline, towards Murmansk, and had initiated the process of merging the two oil majors Yukos and Sibneft. In a next step, it has been widely assumed, the new company created by the merger would partly have been sold out to one of the US giants, with Exxon Mobile as the likely buyer. Creating a position where he would have become “untouchable” for the government (MT, Polit.RU, RJ, various issues).

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- 55 - The process that has been surrounding the Yukos oil company, following the numerous tax claims for back taxes from 2000 – 2002, totaling over USD 27 bn, finally led to the sale of its major production unit, Yuganskneftegas on December 19, 2004. Auctioned off in Moscow, between two bidders it was taken over by the previously unknown Baikal Finance Group, registered in the minor city of Tver, for USD 9.4 bn. Only three days later, on December 22, Russian state-owned oil company Rosneft announced that it has bought the Baikal Finance Group giving it control of over 77% percent of Yugansk. Rosneft is about to be merged with state-controlled gas monopoly Gazprom during 2005 and has presidential aide Igor Sechin as its head. The whole process surrounding the handling of Yukos can do a considerable damage to the image of Kremlin (if not so already) as it is becoming increasingly obvious that the handling has been coordinated from the top level. It is probably unheard of in the world that unknown people, for unknown purposes, with money of unknown origin, is allowed to acquire another company, by some said to be worth USD 20 bn (with control of over 10% of the national oil production). Comments by the president to the auction of Zugansk were, “in compliance with the Russian law”, and to the Rosneft takeover deal "perfectly normal. Critiques have focused on the collection of the claims for back-taxes were only an excuse to only indirectly transfer assets back under state control (MT, Polit.ru, RJ, Vedomosti, 2004-12-17 - - 12-28). These deals have effectively wiped out the Khodorkovsky / Yukos oil empire and the reply has been a legal battle over the sale that was initiated before the sales, setting Yukos under bankruptcy in a US court (Huston, Texas). According to US legislation, this would have meant freezing assets of the company, which was ignored by the Russian authorities when the auction of Yugansk went ahead as planned. The Yukos side has said that it will battle the decision in court and that Rosneft, through the deal, “is taking on a serious headache” (Interfax, 2004-12-22). The result of future court decision could well be that foreign Russian assets, belonging both Rosneft, its future owner Gazprom, or eventually also the state, will be frozen as Yukos is asking for USD 20 bn in compensation. With unhappy Yukos shareholders in a number of western countries, the court battle could come to both spread to other countries and drag on for years to come (Vedomosti, 2004-12-26). Information that has become public later indicates that the Rosneft take over of the Baikal Finance Group was partly financed by USD 6 bn of Chinese funds made available to Vneshtorgbank that granted the loan to Rosneft (CW, 2005-02-02). For the remaining parts of Yukos, the problems continued after the sale of Yugansk, as a new claim for large back-taxes were filed at its remaining large production unit, Samaraneftegaz, of near 30 bn (Kommersant, 2005-01-26).

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- 56 - Banking and monetary policies According to the CBR’s statistics for 2003, the Russian current-account surplus for the year was USD 36 bn, up from USD 29 bn in 2002, which corresponded to about 8% of the Russian GDP for the year. The surplus was generated by a surplus in goods export that grew to USD 60 bn, while the services balance was in deficit by USD 11 bn, of which a large share of which has its origin in a rapidly increasing Russian tourism abroad (CBR, 2004-04-14). Net errors and omissions items in the balance of payments reached USD 7 bn, more or less on level with 2002, which partly relates to (illegal) foreign currency exports. During 2004, the trend was a large outflow in the first three quarters of the year that reached USD 18 bn. This later turned into a strong inflow during Q4, which came to reduce the full year outflow to about USD 8 bn. During the year the previously large outflow of unrecorded capital largely ceased, which had, until then, somewhat offset foreign currency earnings that was registered as a current- account surplus. Low interest rates in the West also made large banks and business, that had achieved creditworthiness, to borrow and bring home cheap money. As a result, the Russian currency reserve increased by USD 26 bn, or near 40%, during 2003 to stand USD 87 bn by the end the year, to continue on a slow increase to USD 124 bn by the end of 2004. Private capital outflow has increased during 2004, partly off-setting the increasing incomes from oil revenues (Bloomberg, 2004-08-25 + 09-17, CBR, 2005-01-28).

A relatively new tendency is the appreciation of the Ruble relative to the USD, which came to +19% in real terms in 2003 (RIA, 2004-04-08). Something that has continued during 2004 when the Ruble reached a four-year high, surprisingly without any CBR attempts to support the Ruble. However, when the 28 Ruble to the USD barrier was broken in early December, the Central Bank again started to buy dollars to reduce the value (RJ, 2004-12-03). Already prior to this, the Russian Ruble has been revaluated by nearly 5% during the first half of 2004 against a basket of its main trading partners, by over 5% again the USD and by over 6% against the Euro. The effect to this is that, e.g., the Russian manufacturing industry that has seen a strong revival since the currency crash in August 1998, again see its competitiveness being eroded by a rising value of the Ruble. An increase in purchasing power of the Ruble makes foreign products cheaper for domestic consumers.

CBR has, for a long time, been expected to change the anchor of the Ruble from the USD to a basket of based mainly on the Euro and the USD. The balance of the currency in the CBR’s reserve is normally in proportion to the trade relations of a country and the Euro share has only been 10% while trade with the Euro area has been about 50%. Inflationary pressure is rising in Russia with the long- standing high oil price and mounting inflows of currency at the same time as

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- 57 - given credits from domestic banks have risen sharply. The governments’ target for inflation during 2004 was set to 10% and missed by near 2%, and in the 2005 budget draft, the target was set at 7.5 - 8.5%, but with a CPI, that during January 2005 alone increased by over 2%; that target is difficult to make creditable (Bloomberg, 2004-08-22). It becomes a very difficult balance, if not impossible, to avoid inflation in an economy where there is a large inflow due to the strong export, both foreign loans and domestic credits are increasing and on top of that, FDIs are increasing. Seen from these factors, the outflow of capital, legal or Il legal, could be seen as positive as it is in the current situation reduces the inflation pressure. To slow down inflation, the CBR could let the value of the Ruble rise by more than the 7% that has been stated, which would have a positive effect of not only increasing purchasing power, but also increasing imports. By 2006, if plans are not to be postponed again, the Russian currency is intended to come into circulation also on the money market of Belarus as a future union partner (Bofit, 2004-37). The Belarus economy is small, about 5% the size of the Russia, but there are also a number of political obstacles that must first be solved before a merger can be carried through.

For 2003 Russia attracted foreign capital inflows to a value of USD 29.7 bn, which was up over 50% on 2002, but with foreign loans making up USD 22.2 of that figure. FDIs were also up, near 70%, to USD 6.8 bn, while portfolio investments were down by 15% to USD 401 millions. The income balance deficit of USD 13 bn for 2003 was largely generated by foreign investors’ interest and dividends. Net outflow of capital for the year was about USD 2bn. The net outflow of FDIs was USD 3 bn and portfolio investments USD 5 bn. Total inflow came to USD 19 bn, giving a net inflow to Russia for the year of USD 6 bn from other investments, but mainly from borrowing abroad. Russian companies receiving export incomes in foreign currencies have, during transition years been forced to convert incomes to rubles. The share that must be exchanged has gradually been lowered and in its latest step was reduced from 25% in November to 10%, and to be eliminated from 2007 (Bofit, 2004-49).

Saving in general has been seen as a problem in Russia with a major shift having taken place in the capital market over the last few years, as an ever larger share of total savings are being kept in Ruble. Another shift has been the demand for US dollars, which has decreased at the same time as demand for Euros have increased. In late 2002, the value in the exchange market of the Euro surpassed the value of the Dollar when measured in Rubles, which only strengthened its attractiveness. The Euro will not replace the US Dollar, but only serve as an alternative. People once proud of having dollar-based salaries, while the Ruble was unstable, have instead ended up on the loosing side during later years. Still a short hick-up in this trend was seen during the mini-banking crises in 2004.

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- 58 - Much of the Rubles that were withdrawn from accounts, were again largely converted to US dollars/currency, which came to recreate a brief “dollarization” trend that lasted during a month of the summer.

Russia has, since the breaking up of the union seen the creation of near 1 300 mostly very small, banks. Still, the Russian bank sector is small and the combined common assets of all banks are not much larger than a mid-size international European bank. This large number of smaller banks makes the system difficult to fully control and when the Sodbusinessbank had its banking license withheld in mid May, a shiver was felt throughout the banking system. Two months later, during just two days, July 8 and 9, depositors withdraw USD 859 in savings, from first of all two banks rumored insecure, Gota Bank and Alfa Bank, and USD 2 bn above normal during the month. Additional foreign currency was also withdrawn that the CBR does not give statistics for (MT and CBR, 2004-07-22 & 08-10). This, called a “mini-crises” in the banking system, had a positive effect as it was shown that the challenged banks, with support from the CBR, could overcome the crisis with a combination of adjustments45. As a result of the summer crises the CBR has tried to speed up the work on a deposit insurance system among smaller bank. Customers in Russia’s two outstanding largest banks, state-owned Sberbank and Vnestorgbank already enjoys this deposit guarantee for assets up to 100 000 Rubles per individual (USD 3 500). During the mini-crises, Sberbank logically received billions of Rubles of new deposits 46. In all, as of July 6, there were 1 183 applications from banks and credit institution to join the deposits insurance system (Aton, 2004-07-16). Later in the year, the CBR has decided to cancel the license of a smaller number of banks, but has also added another 80 banks to the list of banks enjoying credit guarantee (CBR, 2004-10-27). Despite the instability, there is foreign interest to invest in the financial sector. One such merger was made in July 2004, when BNP Paribas, France’s no. 2 bank, became majority owner in the credit card/auto lending group Russky Standart Group, making it the largest financial take-over in Russia (Vedomosti, 2004-07-17). Further on, it became public that the International Moscow Bank (IMB) will become the first bank of size in Russia that will see a foreign majority ownership. Germany’s second largest bank, HVB Group, is to raise its stake in the bank from 43% to 53%. In the share offering made by IMB, which will more than triple its capital base to USD 320 million, Scandinavian Nordea bank will also hold 26%, with BCEN-Eurobank and EBRD controlling the remaining portion (Bloomberg, 2004-09-27).

Employment The "economically active" population in Russia has been estimated at 73 million of the total population (RIA-Novosti, 2004-08-19). Out of these, the number of employable should be about 72 million, which sets the latter group to fewer than

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- 59 - 50% of the population, a figure that is expected to remain stable for the coming three years (MOEDT, 2004-08-16). At the end of August 2004, Russia had 5.4 million unemployed setting the unemployment figure to 7%, which is about 600 000, fewer than at the same time one year before, with about 30% of these having registered as officially unemployed (Kommersant, 2004-09-22).

Wages in Russia during 2003 increased by an impressive 25% in nominal terms, and that rate has been maintained during the first nine months of 2004. The average monthly wage in Russia by the end of September 2004 was just under 7 000/month (USD 240) with industrial workers earning about 8 500 and average pension at 2 000. (Bofit, 2004-45). Oil extraction had the highest wages at near 25 000/month, 350% above average, followed by gas extraction at 300% above. Coal and ferrous metallurgy were just 45% above, while the lowest wages were paid in retail sale, health care and education, with the latter being paid about 5 000/month, setting wages at about 60 – 70% of the average. Still, as much as about 20% of companies’ wage bills are estimated to remain unaccounted for, at the same time as about 25% household incomes fall inside this category. Although, the survey data for 2000 – 2003 indicate that this share is slowly falling (Bofit, 2004-11-11).

During the first eight months of 2004, real incomes rose by 9%, which was apparently largely being consumed as retail turnover rose by 11% for the same period (MOEDT, 2004-09-20). One important result is that the importance of private consumption in the GDP is increasing, and has reached beyond 40%. The continuation of these income improvements will be important to make it possible to double the GDP, envisaged by the President, as it should dramatically reduce the number of people living on incomes under the poverty line. Currently near 30% of families live on incomes under the domestic poverty line of USD 70/month, with the figure from the World Bank setting the figure at about 20%47. The regional differences are considerable as the average salary in Moscow is given as 13 000 (USD 460), but still with educational and social workers earning less than half of that (Vedomosti, 2005-01-17). The government has furthermore decided to raise the Russian minimum monthly wage, more used as an index base than as an actual wage payment level, by 20% from 1 January 2005 to 720 (USD 25). At the same time, the average monthly basic pension will rise by 12 % to 2,467, and so will wages for all state employees (Prime-TASS, 2004-08-23).

However, the Putin plan to double the Russian GDP by 2010, that would require a yearly growth of 7.1% could look well on track, with the strong support by world oil prices during 2004. Perhaps even more so at the adjusted date, 2014, later set by the government (RFE, 2004-08-03). The minister of Economy, Gref,

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- 60 - has forecasted that by 2015 the per capita GDP should have reached USD 18 000 (Minfin, 2005-01-13). Still it must be doubted if the growth power in the economy can be generated without considerable privatisations and restructuring inside the oil and gas, transport, large state monopolies and oligarchs’ holdings. Additionally to this more general skepticism, not particularly innovative and voiced by many, the IMF has doubted that a sufficiently strong political will exists for this (IMF, 2004-06-28). Adjustments to the prognoses by the Ministry of Economy for the near future growth to 6.3% during 2005, 6.1% in 2006 and a slight rise to 6.5% for 2007 support such skepticism. Russia is still considered to be a “transition economy”, but with a persistently positive economic development, it could be time, within a few years, to omit the use of the word “transition” when talking about the Russian economy.

2.1.2. Russia - EU relations

The European geographical direction has historically been the most important for Russia and has remained so also during the years of transition. It if from here that three military invasions have come, but it is also in this direction that a large share of both former times and today’s Russian foreign trade has both is destination and its origin. The share held by the EU has constantly been on the increase, as a result of the gradual geographical expansion of the EU during transition years, with several Russian neighbors joining the organization. In 1995 Sweden, Finland and Austria were added to the members' list, and then ten more countries in 2004. Several countries that joint in 2004 had previously been members of the economic and military cooperation, being practically subordinate to the Soviet Union (COMECON and Warsaw Pact). As a consequence of the emergence of this expanding economic space, the importance of EU as both a political-, economic- and trade-partner to Russia has increased considerably48.

Over the first years of the 2000s the relation between Russia and the EU has been ever improving was anticipated to retain the tension that the inclusion of the central Europe group of EU members would give rise to. Instead, toughness from both sides, not seen for a long time, re-emerged in the negotiations, sending cold chills in the direction of the days when the old dividing line between east and west was so clear in Europe. Although nothing like a break in the relations between the two is, or was, at hand the two have established strong links as Europe depends on Russian oil and gas. At the same time, Russia, on May 1 2004, when the expansion took effect, lost a number of favorable trade and travel arrangements with the new EU members. That questions with no formal connection suddenly become inter-linked is probably a normal strategy

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- 61 - in diplomatic work. For the Russian side, opposition to a new Partnership and Co-operation Agreement (PCA) while the expansion took effect, replacing the one from 1997, was one of few issues that could be used to show opposition. That so many different issues were brought up in the negotiations is what is worrying here, as this indicates some kind of structural weakness in the interaction between the EU and Russia. A structural problem, or perhaps more precisely procedural, that should be dealt with jointly, not to undermine co- operation and to avoid the emergence of similar situations in the future. That could mean a new negotiation mechanism, but then it should be of a different kind that does tackle issues before nearly becoming “fait accompli”, like in this case. Russian EU policies have for so long, both inside and outside Russia, been criticized for not having been sufficiently co-coordinated among ministries and the presidential administration. This could be expected to change and to become more stringent in the future. Especially so seen to Prime Minister (since April 2004) Fradkov background as Russian representative in Brussels, he will most certainly have a clear opinion on what will have to be done (EU-Ru, 2004-06-12). For the time being, and for the foreseeable future, it is likely to be so that it is better for Russia to be engaged with the West than to be outside and isolated. The West should also keep its faith in Russia, even if all the expectations for the establishment of a full fledged democracy in Russia appears to be over for now. Hopefully, it is so that the two neighbours have come to a stage of their mutual relation where a higher degree of openness to debate could be accepted without causing any lasting harm to the relation.

One of the reasons behind the problems that arose along with the EU eastward expansion was the fact that many of the new EU members were important Russian trade partners. Russia saw that the continued free access for its export to these markets is important. The EU position, on the other hand, was that Russia, with no exceptions, should extend all the current EU-Russian agreements to the new members. One such example has been the EU quotas for the import of grain from Russia. Prior to expansion, Russia exported grain to all former Eastern European countries without any restrictions, while now these countries are subject to obey the regulations in the EU Common Agricultural Policy (CAP). It was stated from the Russian side that the losses that will occur as a result of the EU enlargement, under EU conditions, would amount to EUR 150 m annually. This was seen as an economic loss large enough to strain diplomatic relations for a considerable number of months. Russian demanded compensation, included terms like asking for visa-free travel to Europe for Russians, financial aid to the Kaliningrad region, lower customs tariffs, and higher quotas for the import of Russian goods. In a step of conciliation, EU officials have indicated a readiness to open separate talks on some issues.

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- 62 - The EU, on its side, used the situation around the acceptance of new members to increase the pressure on Russia. The EU not only demanded that Russia should delimit its borders with Estonia and Lithuania, but also wanted to see reforms in the energy sector, raised security standards in the sphere of transport and nuclear energy and a stop to the charging of unfair fees for airlines using Russian airspace.

The new PCA includes reductions of the overall tariff on Russian goods exported to the EU, which, based on the new agreement, will fall from 9% to 4%. The EU also agreed to increase steel quotas by 437 000 tons, in addition to the current quota of 1.3 million tons of flat and long steel products, that can be imported to the 15 old member states (Bloomberg, 2004-03-21). Metals continued to be a problem area as Russia wanted larger quotas and Brussels accused Moscow for having restricted the supply of scarp, being the world’s leading supplier, by way of imposing an export penalty. Indirectly the action should have been taken to protect domestic producers in Russia, as more scrap is needed in steel processes in Europe49. When signing the new agreement with Russia, the EU did not impose any restrictions for its import of energy, neither in the form of oil and oil products, nor in the form of gas and electricity. The two has also negotiated about Russia’s entry into the WTO, where Russia, later in the year, accepted the EU demand of raising domestic gas prices for industrial users by something like 40% by 2006 and a doubling by 2010. In return, EU became the first of its major trade partner to accept an agreement to support the Russian entry.

On the ratification of the Kyoto Protocol that was one of the most important EU demands, the Russian position has been ambivalent, as the Duma was not prepared to ratify the protocol. The president first indicated in the early summer of 2004 that Russia is moving in the direction of ratifying, but statements by ministers of the government on occasions supported and sometimes strongly opposed any ratification. To come into force, the Kyoto Protocol had to be ratified by no fewer than 55 countries, accounting for at least 55 percent of global emissions in 1990. With Russia emissions corresponding to 17% of the total, its acceptance tipped the balance. After the United States had rejected the treaty that minimum could only be reached with a Russian ratification. The treaty is controversial because of the high cost of implementation has to be carried by the developed nations that participated. Russian supporters say that the treaty, which allows countries to trade greenhouse gas emission allowances, would provide an opportunity to attract international investment to improve the energy efficiency and competitiveness of the nation's crumbling industries (UNFCCC, 2004-08-24). The Russian argument against ratification is often that other countries that have signed the protocol have not undertaken enough

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- 63 - restrictions and these are countries with strong economies and relatively large emissions. The Russian’s fear that they will become too restricted for the future if they go along with the regulations of the protocol. Finally the government on September 29 2004 decided to endorse the Kyoto Accord, as it was noted by Deputy Foreign Minister Yurii Fedotov, "The fate of the Kyoto Protocol depends on Russia. If we rejected ratification, we would be the ones to blame" (Itar-Tass, 2004-09- 29). The Protocol was clearly approved by the Duma and the Federation Council; with support of the pro presidential party United Russia against the opposition by the Liberal Democratic Party, the Communist Party, and Rodina. With the signing of the president on November 5, 2004, Russian documents are delivered to the United Nations, to make the treaty go into effect within 90 days. The target set for Russia is equivalent to the 1990 level, but due to the economic collapse of much of the former heavy industry, emission levels are currently some 30% below the 1990 level (Kremlin, 2004-10-26). Emission quotas that can be sold on to other countries in need, to a market value where these 30% are hoped to bring in somewhere between USD 15 – 40 bn.

Despite many optimistic statements about the positive development of EU- Russian friendship and strategic partnerships, relations between Moscow and Brussels came to be badly strained by the complicated issues surrounding the EUs eastward expansion. The positive sign is that the relations were good enough to absorb all the strain that the extension caused. Although the solutions to some of the problems proved hard to find, it was all settled at the negotiations table without going into any trade conflicts. Consequently, it was expected that at the summit held in November 2004, an agreement about deepening of partnership relations could be reached, but this was postponed and is instead expected to be signed at the next meeting in Moscow in May 2005 (FT, 2004-11- 26). That the meeting was held parallel to the “orange revolution” demonstrations over the elections in the Ukraine, where the two parties supported different sides, did not smoothen the matter. That Russia came to accept both the raising of gas prices and decided to ratify the Kyoto Protocol after pressure from the EU, although later, have restored some of the previous damage done.

2.1.3. Russian Far East

The Russian advance to the east started early, and more than 350 years ago, already in 1638, the first outposts on the Pacific coastline was established. Making Russia into a country with a Pacific coastline already some 200 years before the US and 150 years before Australia was even established.

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- 64 - This distant part, from Moscow’s perspective, has always seen its remoteness being emphasized also in its name. Being not only distant from the national centre, but it is also unfriendly climatically to human inhabitants and therefore sparsely populated. It covers a surface of 6.2 million km2 (two times India) and has also internally large distances between population centers, having over its 350 years, remained an economic burden for the country as a whole. The possibility for any real internal control from the centre did not arrive until the extension of the Trans Siberian Railway reached the Pacific in 1905 (on only Russian territory from 1915). At the same time as improved communications facilitate central control, it also facilitates contacts in-between subunits and the outside world. All countries have internal differences between regions and generally the bigger the country the more different the regions. That is also the case in Russia and these are circumstances that at times could increase the risk for internal tension. A constantly strong military presence in the Far East has never left it in doubt that Moscow has always intended to keep the control over the area, no matter the costs. As mentioned above, the region has been of strong military interest with e.g. Vladivostok becoming an open city as recently as 1991, from having been a military port closed to foreign visitors. To make it possible to hold a population also in the Far East, transports were subsidized, and today's citizens have to pay some 100% more than the average for Russia in only transport costs. Needed investments have long been avoided, as the Tran- Siberian railway was not fully electric until the last 500 km stretch, in the Primorsky Krai south of Khabarovsk, which was completed in 2002. The Far East was not a region that was favored as a place to move for ordinary people during Soviet years. Therefore, work here was often related to higher wages and advantages that were to compensate for the inconvenience. A system that slowly died out with the falling apart of the Soviet Union, and has left the Far East sliding down on the scale of well being among Russian regions. Generally, the Russian Far East is today worse off than the average Siberian and Central Russian regions in practically all indicators that measure social and economic standards. The Far East in 1986 had 7.6 million inhabitants, to be compared to the current level of 6.6 million. The past ten years has seen clearly higher mortality than nativity figures at the same time as a large share of the workforce has moved west. The region is still losing much of its young professionals who see better prospects in other regions, with 60% of the younger generation considering to move west (vladnews, 2003-11-05). The years from 1990 to approximately 1999 were marked as the years of deepest crises in the region, while the years since has seen a relative recovery, based on energy production. The Far East in 2003 held less than 5% of the national population and produced about 6% of the national GDP (FEBRAS, 2004-07-02). The population on this gigantic area currently corresponds to one bigger Chinese city, or 15% of the bordering Heilongjiang Province, that holds abour 40 million.

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- 65 - The criminalization surrounding the use and control of marine resources over the entire transition period has fed criminal structures in especially the economically important Primorsky Krai. The near chaotic governor election in Primorsky Krai in late 2003, won by Sergei Darkin, that despite all strange episodes was approved from Moscow could indicate that the central control is not as strong as anticipated. The same situation has for years surrounded all local elections of a new mayor and a local Duma in the gateway town to the east, Vladivostok, being the only really well known city in the Far East. The local elections of July 18, 2004, that made Vladimir Nikolaev mayor of the city, despite his criminal record, were similarly controversial50. Perhaps surprisingly, Nikolaev has, during his time in office, proven highly efficient. With good connections to the governor of the region he has, e.g., been able to reinitiate the work at that local Duma that had long been at a standstill due to a boycott from the opposition, and again made water and electricity freely available in the city (RRR, 2004-10-10).

Foreign trade in the FE was to a large degree concentrated to its three NEA neighbours in 2003 with China being the destination for 35% of exports and origin of 25% of imports, with the corresponding figures for Japan being 20% and 24% and in the case of Korea, 15% and 17%, respectively (Ecrin, 2004-10-01). Quoting the presidential envoy to the Far Eastern Federal District, Pulikovskii, industrial production in the Far East grew by 8% during H1 2004 (RosBalt, 2004- 08-03). In the region, Russians are the largest investors with Japan as the leading foreign investor with Korea being ahead of the US and China. With the oil projects on the island of Sakhalin being the by far largest of any projects in the Far East, buy-ins from any country are bound to lift investments from that country to the top of the ranking. If, e.g., the intentions discussed between Yakutia’s biggest company Alrosa and Sumitomo of Japan, for the possible development of both coal and oil resources, this would probably be large enough to make Japan stay on top of the investment ranking for several years to come. The only major project has been a 10 km2 cross-border free trade zone that will be created in the city of Suifenhe in Heilongjiang, and Pogranichny in Primorski Krai. Here, an estimated USD 1 bn will not only be invested in creating a trade-zone within four years, with general trading facilities, but also to cater for tourism and entertainment. In perspective, the building of a high- tech manufacturing park is being suggested (CBW, 2004-06-15).

During 2003, 1.4 million Russians visited China while only half as many Chinese visited Russia, or about 660 000. From the presented statistics, it can be estimated that the number of Chinese workers in Russia could be in the range of 150 000 to 200 000. A figure that can be compared to the 35 000 was the figure estimated by the Russian national census during 2002 (Statistics from the Chinese embassy and polit.ru, 2004-03-31).

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- 66 - In the talks about regional reorganization in Russia, it has been discussed if it would optional to create something like three or four units inside the Far East. If so, Sakhalin and Kamtjatka could be expected to form a future region, the costal oblasts a second with the inland oblasts forming a third. It could, from an economist point of view be argued that large parts of the Far East area, as well as many other parts of Siberia, should be left uninhabited to form larger and more productive centers. That is if the population should not even be made to move into western parts of the country instead, which would probably be even better from a macro economic perspective. The five main population centers of the Far East, made up from the seven Oblasts east of the Lake of Baikal, are Khabarovsk, Vladivostok, Yushny Sakhalinsk, Petropavlovsk-Kamchatky and Chita (see map).

2.2. Trade

The Russian trade surplus for 2003 was near USD 60 bn, compared to the 2002 surplus of USD 46 bn. Russia’s foreign trade rose by 25% during 2003 to 6.5 trillion (USD 211 bn). Exports increased by 26% during 2003 to a total value of 4.2 trillion (USD 135 bn), while imports rose by 24% to 2.3 trillion (USD 75 bn). Out of this, the share held by the CIS countries in exports accounted to about 14% while the share reached near 23% on the import side. For the first eight months of 2004 trade expanded by about 25% to USD 166 bn and year total are estimated to reach about USD 230 – 240 bn. The trade surplus have reached near USD 85 bn after ten months of the year and still looks sure to increase further and could well surpass 100 bn (MOEDT, 2004-11-10)51. Trade with the CIS came to USD 31 bn and other countries to USD 138 bn, with the CIS trade expanding most rapidly of the two, by 36% and 22% respectively. Since 1998, the year before the large increases in oil prices started, Russian export has nearly tripled, up from USD 74 bn while imports have doubled from the official figure of USD 60 for the year52. During later years, the import figures have been rising faster than the rise in domestic demand, indirectly indicating an increasing share for imported goods in the market.

During the first half of 2004, energy accounted for over 55% Russia's total exports, with oil making up some 52% of that. With high world market prices and rising production volumes, the oil sector is constantly increasing its share of the fuel and energy exports. It is also oil and oil products that are contributing the most in the increase of exports, having increased clearly faster than the average. According to Russian trade data for 2003, 68% of Russian exports were destined for Europe, 8% to the Americas, 7% to China, 2% to Japan and only 1% to South Korea while 9% goes to other Asian destinations53. That a change is

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- 67 - underway can be seen from the fact that the yearly increase in trade with countries in the Asian region are far from the one-digit-level and instead, growth is often in the range of 20% or more. As a further, but non binding, step in its improving its position in the Asian region, Russia, in late 2004, became the seventh non-member to sign the basic ASEAN, Treaty of Amity and Cooperation in Southeast Asia, with the aim of increasing its cooperation with this group of South East Asian countries (RFE, 2004-12-01).

Some 35% of Russian exports used to go to EU 15 and by the establishment of the EU 25 the share has reach just under 50% by the end of 2004, giving the broadened EU a controlling stake in Russia’s foreign trade. For 2003 it was two EU countries that were Russia’s largest trade partners, Germany taking 10% with the Netherlands second at 7%, also showing the largest increase of the larger partners, up by 65% during the period. For the EU, Russia does not have a similar importance as it is only the fifth-biggest trading partner for the union, with trade between the two worth near USD 100 bn. It is especially in the field of energy that the EU and Russia are important partners. Of the Russian oil export, 53% in 2003 was destined for the EU, representing 15 – 20% of EU oil consumption. Over 60% of Russian natural gas exports goes to the EU, making up 25% of total EU, natural gas consumption, as 25% of the enriched uranium. With the expansion of the EU, the geopolitical situation in Europe changed dramatically and the new EU 25 is important as a “power centre in the system of multipolar international relations”, according to the Russian Foreign Minister, Lavrov (RFE, 2004-12-28).

As understood, the trade pattern of Russia is very similar to that of any developing country with a strong dependence on energy products and other basic raw materials; in the range of 75% of the total. At the same time, these commodities have seen major price fluctuations over later years on international commodity markets. A the same time, foreign trade has become increasingly important for Russia with trade volumes rising from abut 20% of GDP in the early 1990s to about 40% in 2003. In perspective, Russia must widen its production base of goods and services to achieve a level of sustainable economic position. In doing so, a much wider range of goods will have to be traded and these are highly likely to fall under the WTO regulatory framework. According to Minister Gref nuclear reactors are Russia's most important industrial export product, bringing in USD 800 million, jet engines USD 600 million and ships USD 560 million. According to the minister, near USD 700 million in 2004 were given in export credits, and this will rise to USD 850 million in 2005 (RIA and Itar-Tass, 2004-07-21 – 07-23). The largest credit for 2003 was USD 400 million to China for the building of a nuclear plant at Tianwan (Bofit, 2004-31).

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- 68 - Arms export is one sector where Russia has been very successful as an exporter over the last few years with exports reaching near USD 4 bn in value. Armament is a high tech sector, as a large share of the export success is based on advanced aircrafts, warships, submarines and other advanced equipment. Only to neighboring China the value of exports since 2000 has been estimated to nearly USD 6 bn, with basic products as oil and wood making up much of the remaining export. Chinese exports to Russia are, to a large extent, low-tech, and made up of garment and food products. Trade between the two countries have also expanded rapidly and came to near USD 16 bn during 2003 and is came to just above USD 20 bn during 2004 (CW, 2004-09-18 & 05-01-07). A complication to the trade relation was the Russian 30% import tax that was levied on all Chinese products from April 2004. This resulted in a chaotic situation where cargo that had entered Russia, but had not been declared, could not be picked up from bonded storages (MT, 2004-04-25). A situation that has eased, but that probably has added on to the unregistered trade between the two that already for 2003 was estimated at USD 6 bn.

Russian foreign trade with Japan reached about USD 5 bn in 2003, about USD 1 bn bigger than trade with Korea. Which for both neighbours must be considered to be very low figures, compared to the economic size to the two Asian nations (METI, 2004-03-20). The Russian export of energy in the form of crude and coal is not only dominant, but the export includes many other basic products, like wood, fish and basic steel. On the import side it is first of all cars, car parts, and electronics that are imported from Japan and Korea.

2.2.1. WTO and (free) trade agreements

Russia applied for membership in GATT, the predecessor of what since 1995 is the WTO, already in June 1993. At the time hoping to become a member before the turn of the century. Negotiations proved slow from the beginning and the financial crises in 1998 practically brought it to a stop. After President Putin had declared WTO membership as a priority, negotiations were reactivated in late 2000. During these ten years, the Russian economy has changed considerably towards becoming a market economy, practically converting it into another country compared to the country that handed in the application in 1993. Many different dates for a possible Russian WTO entry has been set over the years, but real dates will, in the end, depend on the progress of the negotiations. It was previously hoped that negotiations should have been concluded in time for the WTO general assembly in Cancun in September 2003, but such expectations proved to be greatly overoptimistic. Negotiators have encountered numerous disagreements and despite the fact that the later stages of the negotiations have been reached, it can still take some time to conclude that final accord.

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- 69 - At the moment, Russia is the biggest of the world’s economies that is not a member of the WTO, which enhances the interest for both parties to make Russia a member. Russia is, at the same time, a very good example of many of the advantages and disadvantages in relation to a potential member. A membership of the WTO is partly intended to become a way to gain a general and international recognition for the efforts to establish a working market economic system. It will also provide for less non-discriminatory treatment against export products, and open up for the use of the WTO’s dispute settlement mechanism54. From the one side, a positive effect should be achieved though domestic quality and quantity improvements through increased competition. On the other hand, that is exactly what is being feared by many local producers, as that would put them out of business. The circles that oppose a possible membership, or demand much prolonged transition periods, often fear the increased exposure to foreign products. The Russian market still has a number of product segments and regions with severely restricted competition, which see few reasons for change and instead resist.

The problems focused upon in the Russian negotiations are, from one point of view, very similar to that of most countries. It is often agriculture subsidies and trade in agri-products that are major stumbling blocks. In the process of negotiating possible membership terms are currently another 25 countries and especially for other CIS countries the treatment of Russia will set a precedent. EU demands that Russia should raise domestic energy prices, is another question that has become an important issue to include in the discussions. Cars, airplanes, and textile products have proved to be problematic products as well. This question has been raised because EU sees below world level energy prices as an indirect subsidy to local production55. How gradual such an increase can be made in relation to world market prices is being discussed, while a price increase would indirectly lead to increased energy savings that would also benefit Russia. Still discussions have not reached questions like the possible discrimination according to WTO policies, when Russia supplies gas to CIS countries cheaper than for export outside of the CIS. Additionally, other more traditional trade issues like the customs code, levels of duties, and quotas are problem areas under discussion. The Russian promise to raise domestic prices, along with the Kyoto ratification, has so far been enough to gain EU support for a WTO membership.

Russia’s chief WTO negotiator in Geneva has, since 2003, been the Deputy Minister of Economic Development and Trade, Maxim Medvedkov, until replaced along with the entire Kasyanov cabinet in March 2004. In the new ministry, Medvedkov was set to head the Trade Negotiations Department, and has, as a result, continued to be responsible of the WTO application process. Negotiations have included discussions at both bilateral and multilateral

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- 70 - meetings, with the WTO Working Group on the Russian WTO entry as the official negotiation forum. The Working Group set up for Russia has attracted no less than 60 participating countries, with discussions related to goods trade attracting representatives from 50 of these. Parallel to this, there are ongoing bi- lateral negotiations with a number of countries, where some has been concluded, such as difficult issues in the custom system, industrial subsidies, Trade Related Intellectual Property RightS (TRIPS), services, and finally agriculture56.

In March 2004, Medvedkov stated that he hoped to finish the negotiations for a Russian accession to the WTO before the end of spring 2004. A prediction based on the 2003 negotiations with ten countries had been completed and for another fifteen to twenty, the final stages of the discussions had been reached (MT, 2004- 03-18). For the Working Group meeting, there are nine sections related to the third part of the working group report that were discussed: taxes, the collection of custom duties, free economic zones, and activities of state enterprises. More meetings for the multilateral working group on Russian customs code and agriculture were needed. EU leaders, at the Russia-EU summit in Rome in late 2003, expressed the intention that Russia should enter the WTO before the end of 2004 (RJ, 2004-02-26). In April 2004 though, the Minister of Economy Gref lowered the expectations and predicted the spring of 2005 as a more probable date of entry. In the second half of 2004 the most probable date of entry was put forward further by Gref to possibly 2006. Early 2006 was also voiced as a possible date for Russia to join the WTO by the EU trade commissioner, Lamy, when in Moscow (MT, 2004-09-18). After Russia had been given approval for a bilateral deal with the EU, it is now approaching one with other important nations as China, Japan, Korea, and the US.

In preparation of a possible membership 36 Russian laws have been changed or amended in the last four years, with only four remaining, to prepare laws for a WTO accession. But, according to Medvedkov, this is “a not so perfect practice of their application”(Interfax, 2004-07-09). Russia has long been accused to be slack on violations of intellectual property rights, which is especially being stressed by the US. Possibly as an answer to this criticism, in August 2004, came the first harsh court sentence for piracy with a 3 ½ year prison sentence for DVD copying by a court in Rostov Oblast (Interfax, 2004-08-18). If this is the beginning of a massive attack on the large-scale business of piracy, with this sentence as a precedent, remains to be seen57.

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- 71 - 2.2.2. Neighbor relations

Based on a comparison of GDP growth figures over the last few years, it is not difficult to predict that if current trends remain, there is an impending shift in Russian foreign trade that will take place during the coming ten years. The trend is clear that the "Confucian trio" of China, Japan, and South Korea will increase their importance to Russia considerably compared to countries in the west. This group, including other Asian nations like India, could make countries along Russia’s eastern borders compete in importance with its Western neighbours in the next couple of decades. This as a result of that the economies in the east are growing more rapidly and are generally being in a phase of development that favors trade with Russia. These eastern neighbours are mostly big importers, and can be expected to become even more important importers of many of the raw and semi-processed export items that are the backbone of the Russian export (Brunswick UBS, 2004-05-25). In the upcoming situation, there is a policy conflict for the three Asian governments in China, Japan, and South Korea in expanding imports of Russian oil, gas, metals, and other resources. The stumbling block here is often the inability of Moscow to make decisions between priorities vis-à-vis the three and at the same time balance in-between the interests of domestic lobbies in Moscow. After all, it is the oligarch-owned Russian corporations that are probably the ones best positioned to take advantage of the predicted expansion of demand in these markets. This development has also been realized at the highest level, as the statements by the President Putin at the APEC summit in Thailand in 2003 has clearly shown. He stressed here the importance of a good relations to the APEC community because it: “gives us new unique opportunities, including for the development of Siberia and the Far East,” adding, “we invite everyone to mutually beneficial and efficient cooperation, including on a multilateral basis”58. This invitation could also be seen as a way to also strengthen the internal control of the region, as these contacts will largely have to be conducted through Moscow. The process could also become supportive for Moscow in the way that the more prosperity that could be transferred, the less difficult the continued control will be.

China Despite having diplomatic relations with China since the 1949, this could not stop the two neighbours to get involved in an armed conflict in 1969 over a few sandbank islands in the bordering Amur River. What initially was a small conflict escalated to the brink to an all-out war. The conflict with China led to that a large part of the army, perhaps as many as one million soldiers at the time, came to be stationed in the region. A peace agreement with China was later reached and in 2001 a treaty of “neighborliness, peace and friendship” was signed,

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- 72 - to follow up on a strategic partnership established in 1996. Land claims for the two bigger disputed islands, Bolshoi Ussuri and Tarabarov, found just west of Khabarovsk, were postponed59. At the time it was decided that the issue should be settled by future negotiations, which is apparently exactly what has happened. Negotiations that has kept a low profile and just after President Putin had visited China in mid-October 2004, it was made public that an agreement had been signed that had ceded the Tarabarov Island and a part of Bolshoi Island to China. In exchange, there will be an increase in economic cooperation between the two (RFE, 2004-10-21). The existing partnership between the two neighbours is aimed at covering issues related to energy, migration, and military cooperation. Relations in the region had already improved greatly before the agreement and during summer months, there has even been visa-free boat trips to the Chinese market town of Fuyuan 30 km upstream the Amur from Khabarovsk. In the latter part of 2005 the near ultimate stage of cooperation will be reached, as coordinated military exercises will be held on Chinese territory.

Russia probably fears its own weakness in the Far East as much as the strength of its southern neighbor China, with whom it shares a 4 200 km. The approximately 6.6 million Russian population in the vast Far East area is to be compared to some 100 million living in the Chinese provinces bordering Russia. In the beginning of the 1990s the national Russian economy was practically on the same level with the Chinese, but since then the two has parted completely in this respect. Today, China is a country that is economically three and a half times as powerful as Russia. Ironically, this has led to that the Chinese army has renewed its equipment, to a large extent sourced from Russia, with more modern equipment than what has been made available to the Russian army. Now, the FDIs from China directed into Russia have reached USD 1 bn for 2004, bigger than the Russian FDIs in China that has reached under USD 800 million. As a result of the Putin visit to Beijing, China also promised investments in Russia in the range of USD 8 bn for the next few years (Bofit, 2004-43). Additionally, mutual trade between the two is now about USD 20 bn, and increasing rapidly, indicating that the relation between the two neighbours is getting ever more economical and improved.

The combined effect of a decreasing population in the Far East and the difficulty for many less educated Chinese to find a job locally has given rise to labor migration between the two. The inflow of Chinese workers to Russian border regions has, first of all, been due to low paying jobs in agriculture and construction. That is of both a legal and Il legal kind, largely doing the same kind of jobs that émigrés from Central Asia do in the European parts of Russia. How many the visiting workers actually are remains a disputed question, and has been set as low as just a few percent, to as many as 15% of the population in

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- 73 - Primorski Krai. With a generally shrinking Russian population in the Far East, and having a country with the opposite problem across the border, fears of a slow take-over could be understandable. Despite the fact that the only real conflict between the two has been over some small island, the large expanse of the Far East could well become the centre of a struggle over influence rather than aim for its own sovereignty. The Russian and Chinese regions that share borders here are all among the least developed of regions in the two countries. For all regions and both countries it would probably pay the best dividend if the development in this extended border region could be coordinated. However, the long term Russian fear of a Chinese “take over” in some form, is not likely to fade away anytime soon and this complicates the matter. Although the general sentiment in the Far East region could be that China will sooner or later take over the region, the border is there, and Russia is likely to spare no effort to keep it in place.

Japan Already on his inaugural press conference as Russian Foreign Minister, in March 2004, Sergey Lavrov advised Japan against insisting that the disputed islands of Kurils should be included in a potential bilateral peace treaty. "We will deal with it on the basis of the Constitution" (Lavrov quoted in JT, 2004-03-19). Thereby reminding Japan that Russia will address its territorial preservation and integrity as it has been stipulated under the Constitution. However, efforts will be stepped up to conclude a peace treaty, as "The relations with Japan are progressing" (ibid.). Progress has probably been made through diplomatic channels in the meantime and with the Russian agreement with China, perhaps paving the way, a new attitude for a future compromise could slowly be emerging. By November the same minister was quoted saying “We want to regularize our relation with Japan” while referring to the proposed peace settlement from 1956, which was never adopted, and includes the return of only the two southernmost islands (RFE, 2004-11-16). The Japanese stand, declared by Prime Minister Koizumi, is that Japan will reject any such proposal. Moscow finds it problematic to come to terms with the Japanese position, albeit a considerable activity on the economic field is still focused on the need to resolve the territorial issue around the Kurils. On the islands, Russian seismic research has established large findings of oil, over 350 mt, a number of other minerals deposits large enough for extraction, there are rich fishing grounds inside their territorial waters, and additionally, there are over 10 000 Russians living on these islands. Despite the problems concerning the Kurils, the relation between the two has improved considerably. The Self Defense Forces became the first navy ever to visit Kamtjatka in September 2000, and has also conducted a common navy exercise with Russia in late 2003 (JDA, 2004-06-13).

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- 74 - Korea The relation with Korea took a leap forward with President Roh’s visit to Russia in September 2004. It was then confirmed that there are currently no issues complicating the relations between the two and a declaration of “Mutual Trust and Comprehensive Partnership” was signed. At the same time it was decided to hold regular talks in the future (Kremlin, 2004-09-22). From an economic point of view, the two countries look very compatible with a high tech industry in a raw material-starved Korea, and the relation looks like it will develop positively. On the individual level, the interest among Russians seems to be bigger for Korea than the other way around as the flow of Russian visitors to Korea in 2003 came to 170 000, while only 40 000 Koreans came to Russia (CI, 2004-09-25).

A resolution of the North Korean conflict would not only solve a possible threat, although not in any form directed against Russia, but it would also open a new window of opportunities. The North Korean economy, and much of its infrastructure, has to a large extent been built by assistance from the Soviet Union. It is probably hoped that Russia will find major openings whenever it will be time to do the reconstruction work. The building of both railways, roads, and pipelines that will cross North Korean territory has long been discussed and in case of a peaceful resolution, or even reunification, large-scale construction projects can be expected to be launched relatively soon.

2.3. Energy

The energy sector has been in the centre of attention for the Russian state both for its strategic interest and for its huge importance as an income generator. Since the loan-for-shares deal in 1995, most of the larger companies in the oil sector has been privatized, but with the state often holding an influential post of shares in some. During the years since the world price level increased in late 1999, by coincidence well-timed with the appearance of Putin as Prime Minister, the generated incomes has stabilized the economic development. The importance put on the energy sector is demonstrated by the fact that all major state companies in this sector can be found on the list of companies that have been excluded from privatization60. The sector could probably have been both larger and more efficient if all the energy-resource-development licenses issued by authorities over the last ten years had come into use. The number or such licenses controlled by private companies, but not yet developed, by the Ministry of Natural Resources was set to 23% out of the 16 000 that were issued (Vedomosti, 2004-09-14).

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- 75 - In later years, some of the state energy holdings have been sold off at a good profit, like in the biggest of the oil companies, LUKoil, while the interest in the giant gas monopoly Gazprom has been reinforced. In Gazprom, the state has instead declared its interest in increasing its 38% share to become a majority owner. In mid-September 2004, the take over by Gazprom of the largest state owned oil company, Rosneft, was announced. Being paid for Rosneft in the form of Gazprom shares, the state will, after the merger, hold the desired 50% +1 share in Gazprom (RJ, 2004-09-15). Just a month after that news, another merger of the state owned oil company, handling several large international operations, Zarubezhneft, has been included in the merger into what will be called Gazpromneft (Nestro, 2004-10-20). The future, now even larger, Gazpromneft will not only control over 20% of the world’s gas reserves but also over 20% of Russian oil reserves and about 10% of production or about 35 mt. As the original Gazprom was also well inside the ten largest oil producers, considerable coordination advantages are probably to be found in the new organization61. At the same time, the company will be opening up to a much larger portion of its shares to be owned by outsiders, which is bound to leave its mark in a new and more market-minded approach to management, transparency and efficiency. All three are aspects for which the company has been receiving strong criticism from minority owners and other outsiders since it was created. Outside of fossil fuels, the Russian energy sector is a mosaic of different kinds of facilities on the gigantic landmass of the country. All over, the largest of the power generator is the United Electric System (UES), when it comes to electricity. However, the energy sector also includes a multitude of other companies that could be anything from oil companies extracting crude oil to hydropower generation, but also the extraction and burning of coal and gas.

As was discussed already in the part about the economy, the World Bank and the Russian Government have very different opinions on the importance of the oil and energy industry to the Russian economy. The reason for the underestimation of the importance of the energy industry in the country’s GDP, is explained by the lack of consolidated accounts inside the large oil companies. In the oil and gas sector, larger companies have established devoted production companies responsible for the extraction of crude and gas. In its next stage, the products, still low priced at this stage, are sold to trading companies inside the same company group. These trading companies are responsible for the refining and distribution/export of the products. From this point of view, it is natural that the production companies incur high costs and low profits while the trading companies have relative low costs, but makes a considerable profit from sales. As there are a large number of these trading companies, and the trading volumes are very large indeed, this shifts the balance of the entire economy into a stronger showing for the service sector62.

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- 76 - The dramatic increase in Russian energy earnings from export is not only a result of increased production, but also from the fact that the energy intensity has been falling sharply. The energy consumption per capita (i.e., energy intensity) in Russia has declined during transition years. Russia had an energy consumption of 6.1 toe in 1990 that had fallen to its lowest at 4.1 in 1997, and has then slowly risen to about 4.3. Compared to other large and northern countries this level is low, as Canada had an energy intensity of 8.2 toes and the US 8.4 toe in 2000. Nordic countries, like Norway, Sweden, and Finland showed a much lower consumption than the states of North America, 5.7, 5.4 and 6.4 toe respectively, which still made them clearly more energy intensive economies than Russia. The Russian energy intensity is that of a medium income country in Europe, but much higher than countries on its own GDP per capita level, and many times higher than e.g. China, that had a consumption of only 0.9 toe per capita in 2000 (WB, 2004-08-22). One of the main problems for Russia is its critically low level of energy efficiency. Also, the Industry and Energy Ministry has understood that this must be attended to, as during 2003 average domestic energy consumption was more than twice the world average and over three times that of the EU. There is a considerable potential for savings as the ministry estimates that between 40 – 50% of energy is wasted. About a third of the wasting falls on the fuel and energy industry, while the rest is shared in-between industry, utility companies and the housing sector. (MOEDT, 2004-12-14). The Duma has called on the ministry to annually report on the progress in energy consumption and the Russian adherence to the Kyoto Protocol.

On the energy front, Russia is exploiting ways to win advantages and on the eastern front, with Japan and China having been locked into a bidding war for Siberian oil. On the western front it is Europe with its dependency on gas deliveries from Gazprom and as a consumer of over half the oil export. In the south, among the CIS states, both Gazprom and UES are extending their ownership into the energy systems of neighboring countries. Such examples are large UES holdings in Georgia, Armenia, and Kazakhstan. UES has also shouldered the responsibility to finish the building of two large hydroelectric dams, initiated by the Soviet Union in the early 1980’s, in Kyrgyzstan that will come in production by 2007 (Kommersant, 2004-08-20). At the same time Gazprom has secured large interests in gas distribution and pipelines in Belarus, Ukraine and Lithuania.

Under the demand conditions of 2003 and 2004, coupled with a world oil price well above most expectations, and with clear tendencies of economic recovery in much of the developed world, global oil consumption and prices could be expected to stay high. From high world market prices, Russia benefit substantially already, and benefit even more from planned increases in output.

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- 77 - Russia has already reached a somewhat pivotal role in the global energy market, having stayed outside to the OPEC group of countries. In the near future it could become the power broker that can tip the balance between OPEC and the United States. In the years of the Soviet Union, it was the 14 000 nuclear missiles that were giving political weight, while in the future this weight could instead well be conducted by where Russia will allow its energy to be consumed.

2.3.1. Petroleum

The production of oil in the former Soviet Union started in the region around Baku, in what today is Azerbaijan. Already before WW II the focus of production had started to move towards the North East and the Southern Urals, but came to continue to move further to the North East into western Siberia. Today it is the Khanty-Mansi Autonomous Okrug, located around at the junction of the two rivers Ob and Irtysh, which is the Russian centre of production. Soviet time production reached its peak in 1987 with 570 mt, with nearly 90% being produced inside what today is the Russian Federation. Production then started to decline and Russian production reached a low of just over 300 mt in 1996. After the disintegration of the Soviet Union the oil export has become increasingly important with some 50 – 60% of Russian oil production being exported. In the long term planning, it has been foreseen that the Russia's annual production should increase from its 2003 level of 420 mt to approximately 500 mt by 2010, or about 6% per year. A major factor restricting the Russian production growth is market access, it is for this reason that the access to existing pipelines, and the building of new ones becomes so important. Although there are hundreds of companies producing and refining oil in Russia, the domination of a handful of companies is considerable. In 2003, the ten largest oil companies produced some 90% of the crude and together owned about 80% of available refining capacity.

Russian crude oil output reached 458 mt during 2004, up 9% from 420 mt in 2003, which was up 11% from 2002, with about half the production exported (Transneft, 2005-01-16). According to the energy ministry’s August forecast, Russia will produce 6–8 % more crude oil during 2004 than in 2003, a figure 2- 3% lower than what industry sources estimate. With the current rate of increase in production, Russia will be more or less at par with Saudi Arabia as the world’s biggest producer. During the January - September period 2004, Russia's oil output increased by just fewer than 10% to 341 mt, surpassing previous expectations, indicating a full year production of about 450 mt (FSSS, 2004-10- 02). Russian oil output growth is likely to slow in years to come, after having risen by more than 50 percent since 1999 until the end of 2004. Also outside

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- 78 - factors like the higher taxation and insecurities generated by the Yukos case will contribute to this. Among the companies, Yukos was the biggest producer during 2004 with 86 mt (64 mt for 2003) followed by LUKoil with 86 mt (62), TNK-BP with 70 mt (37), Surgutneftegaz with 59 mt (44), and with Sibneft being fifth in size producing 36 mt (31). The export share among these companies during H1 was between the 34% of Surgutneftegaz to the 47% level of TNK-BP (Aton, 2004-08-02).

Exports of crude oil in 2003 reached 225 mt, up 12 % from 2002, slightly more than the increase in production. Oil exports during the first nine months of 2004 rose by 14% to near 160 mt, which was a sharp increase as the figures were adjusted upwards by over 10% in October (Customs RU, 2004-11-23). Full year export shipments, according to Transneft’s planning, are to increase during the latter part of 2004 to reach a level of near 230 mt (Transneft, 2004-10-12). The urge to export is generated not only by the fact that there is a considerable difference in prices between the domestic market and foreign markets, but also from the fact that domestic oil consumption is expected to stay relatively flat in the near future. Of the crude export during 2003, 83% was exported to non-CIS countries at an average price of just under USD 25/bbl, as calculated from the customs statistics. For exports to CIS countries, the average price paid was significantly lower, around USD18/bbl (Reuters, 2004-09-14). During just the first six months of 2004 a total of USD 25 bn in revenues from export sales had been transferred to the foreign currency accounts of Russian oil companies. Being over 30% more than for the same period in 2003, with an average June 2004 price declared for export crude of USD 30/bbl, 20% higher than for the same month last year. When discussing oil prices, it must be remembered that the price for Ural’s crude is quoted at about USD 2.5 – 3 lower than world quotation for North Sea Brent oil, which in turn is lower than Texas Intermediate63. Attempts to sell Urals via international exchanges have so far been futile despite the large difference in production volume where 9 mbd of Urals stand against the 400 000 Brent produced (Interfax, 2004-02-28).

As shown by the production statistics the largest Russian oil companies when measured in production volume for 2004 were Yukos, LUKoil, TNK-BP, Surgutneftegas, Rosneft and Sibneft. This has since changed and the state has again become a major owner in the industry. Initially the state sold out a controlling majority in the oil companies to private investors in the loans for shares deal in 1995, but long kept a considerable share in the largest oil company, LUKoil. The state share of 7.6% in LUKoil was auctioned in September 2004, for just under USD 2 bn to US ConocoPhillips (LUKoil, 2004-09-18). Two months before the auction, the ConocoPhillips CEO met with Putin and after the deal, the company continued to increase its holding to above 10%, and has revealed its intention to raise its share to over 20%, which would also secure a

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- 79 - post on the board. Probably as a statement of “no risk” before this sale, and to show that it will not become a new Yukos case, LUKoil publicly declared its tax payments for H1 2004. The company had paid USD 3.4 billion, up by 24% due to increased extraction levies, which would correspond to over 4% of federal revenues for the period. This was from an oil output that rose by nearly 9% in the period to 42 mt (Reuters and LUKoil, 2004-09-09). The largest foreign investment in the oil sector, to date, is the 50% takeover by BP of the third largest oil producer TNK in 2003, at an announced value of over USD 6 bn. A company that together with Sibneft is a 50 - 50% owner each of the seventh largest oil company Slavneft. In its takeover deal with TNK, BP has included a paragraph that will make its share in the deal immune against future state claims; like what happened to Yukos. The large production volumes and what is still relatively low production costs, in combination with high world market prices, has converted the Russian oil sector into a highly profitable business. During 2003, the total revenue for the sector reached USD 70 bn, with USD 38 bn of that earned from exports, leaving a net profit of USD 25 bn, after having paid the same amount in different taxes (RJ, 2004-05-19). Profits during 2004 have probably been kept at least the same level, as world oil prices have risen further and with domestic prices having gone up by some 80% during the year.

In March 2004, the Russian Economic Development and Trade Minister, German Gref, stated that 2004 would be the last year of major export growth, as exports will surge about 14% during the year to 266 mt. In the following years, growth will be minimal, or around 2 % per year for several years to come. Although the industry indicates continued expansion, the research of IEA presented in its World Energy Outlook indicates the same slow growth trend as Minister Gref, by forecasting the year 2030 production level at 540 mty (IEA, 2004-10-26). Also investment figures support a slowdown in the sector as shown in the first nine months of the year when the aggregate had fallen by near 20% compared to the year before. With the increasing insecurity in this line of business along with the development in the Yukos case, and ever-larger tax intakes out of possible profits, all these have taken a toll on long-term investments (Ria-Novosti, 2004- 12-01). Not to over-tax the oil industry Minister Gref has mentioned the possibility of some reductions coming into force during 2005. Since 1995, Russia has been increasing its exports every year, while OPEC has, at times, been doing the opposite, where the main argument in later years has been the need to compensate, by higher oil prices, the effects of a depreciated dollar. If the prediction by Minister Gref will be converted into policy, it could indicate a policy that is moving it closer to the policies of OPEC, and indirectly, the Arab world. OPEC is at the same time an organization that is likely to come under increasing pressure over the next few years, as instability in the Middle East continues and some members, such as Venezuela and Nigeria, have been under strong pressure to break its ties with OPEC.

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- 80 - To make numerous Russian reserves in eastern Siberia, offshore Sakhalin and eastern Arctic come on stream in the future will take major foreign involvement. It is not unreasonable to expect that many potential investors can be found among energy and raw material-hungry neighbours in NEA. So far, Russian oil companies have concentrated on discoveries in the western Siberia basin and been exporting the output to Europe. Further to the east, Russia can afford to meet both neighbours’ demands for energy and raw material and at the same time help them to diversify supply away from the Middle East. To make this possible, Moscow could allow the construction of pipelines by private investors to the Asian markets, i.e., China and Japan. The law on Production Sharing Agreements (PSAs) has been updated as late as during 2003, with some controversial deals have been signed, e.g., for some of the Sakhalin projects. Here foreign oil companies have been allowed to take over the task of raising capital and developing new fields in the region, something that could be followed elsewhere in the country as well as in related sectors.

A final word of caution should also be included when it comes to oil and gas as the estimations that are presented by the companies could be compared to what happened with reserve figures by the international oil major, Shell, in 2003. Figures published by the company as “proven oil and gas reserves” showed to be overstated by as much as 20%, leading a number of lawsuits against the company, falling share prices and a forced resignation of the CEO. Also, the National Resource Ministry in Russia has been made aware of this problem and will, with the help of the FSB, start to monitor reserves and production volumes reported by oil companies (RFE, 2004-08-13). A surprise fully in line with the Shell revision mentioned above, but on the reverse, appeared only one month later. The most important production company inside the Yukos group, Yuganskneftegaz, that control 60% of deposits, declared that its reserve were five times larger than what had been stated previously, up by 1 bn ton (Kommersant, 2004-09-18). Declarations by Sibneft that it has made the largest finding in Russia in the last 15 years, in its Vankor field in the Krasnoyarsky Krai that could produce 15 mty, should perhaps be looked upon from this “Shell” perspective (Bloomberg, 2004-10-17). It is not only on the company level that oil figures are insecure, but also as experts are complaining that the whole OPEC group is exaggerating its output volumes. The reason for boosting, to get higher internal production quotas, could add-up to as much as 7.5% of total production for the group (Groppelong, 2004-08-07). If so, the exaggeration would correspond to approximately the production volume of Yukos.

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- 81 - Transport of petroleum The most important component in the transport system for crude and oil products in Russia today is the pipeline network. Parallel, and all through the history of Russian oil extraction, large volumes of crude and oil products have been shipped by railway over long distances.

During the years of transition, the pipeline network has remained a monopoly under the control of its fully state owned operator, Transneft. The pipeline system for transport of crude and oil products has a total length of about 47 000 km. A network that came to see its first expansion phase in the late 1950 and its second, with the international pipelines build to countries in Eastern Europe, in the 1960s and 1970s. Before the building of these large export pipelines to “brotherhood nations” in the former Eastern Europe, deliveries were upheld by a huge operation by way of rail shipments. As the importance of findings in western Siberia increased, the network also expanded eastward, and later on to the North East. It was not until the late 1990s that the building of new lines took off again with the building of the Baltic Pipeline System and continued expansion to connect new production areas in Siberia and Timan-Pechora. The only major pipeline on the territory of the Russian Federation that is not under full control of Transneft is the CPC line, connecting the gigantic Tengiz field in NW Kazakhstan with the Russian oil terminal in Novorossiysk. This line, although largely laid on Russian soil, is operated by a consortium lead by the field’s operator Chevron Texaco, but includes both the Russian state and several Russian oil companies among its owners.

The volumes transported through the pipeline network, which is separated for crude oil and oil products, ware about 310 mt of crude and 25 mt of refined products in 2003. In Transneft’s plans for 2004, crude exports will increase by about 15 %, or nearly 30 mt, to 230 mt, with the total transport volume in the system to reach some 460 mt (Reuters and Transneft, 2004-09-14). In the current situation, the capacity in the pipeline system is one of the serious factors that limit the expansion of exports. Alternatively, that spare capacity do exist but in parts of the network where production has been falling. At the same time, the building of new lines is becoming increasingly expensive in line with the rapidly rising steel prices. With Transneft having received constant criticism from many sources during 2004 for being the limiting factor in the Russian oil export, its CEO, somewhat surprisingly, was quoted to have said that “there is spare capacity in the system the oil companies have not been able to fill” (MT, 2004-10-17). As often, the situation is impossible for an outsider to assess, and the truth is probably to be found somewhere in between these opinions. At the same time, oil companies have constantly increased their own direct export by rail or by way of inland shipping and especially the number of oil rail tank wagons in use has been

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- 82 - increasing dramatically over the last few years. Today, an increasing volumes of crude and oil products are being railed from production areas to both refineries and export terminals. Still about 80% of exports flow though the Transneft pipeline network, or about 600 000 tons per day, at a price of about 10 – 12 Ruble per 100 km. This price will follow inflation and increase by 11% in 2005 (Bloomberg, 2004-12-08).

Apart from the mentioned pipelines in Europe and other CIS states, most of the Russian oil export is seaborne, although being loaded after having transited to ports in Estonia, Latvia, and the Ukraine. The biggest Russian export outlet for oil is the terminal in Novorossiysk where a volume in the range of 40 – 50 mty has been loaded for export in later years. Also in the Black Sea is the smaller export terminal at Tuapse that already in 1928 was the first in the Soviet Union connected with a pipeline. Still much of the increase in the export from Russia in later years has been loaded for export at terminals likes the new Baltic Sea terminal in Primorsk, some 150 km west of St Petersburg, on the northern shore of the Gulf of Finland. The terminal here, opened in late 2000, has seen unprecedented expansion, and was, by the end of 2004 handling at a rate of 50 mty. Another terminal is under construction at Primorsk and will be connected by an additional 1 050 km pipeline along the route of the previous, Primork- Kirishi-Yaroslavel, and then on to Kstovo. Transneft will invest 80% of the USD 870 million needed to ship about 8.5 mty initially, and with 25 mty as its designed capacity (Transneft, 2004-10-08). Only 20 km beyond Primorsk, on the eastern shore of the Gulf of Vyborg, is the next large export terminal being build by LUKoil. The terminal here is to handle exports of 5 mt of oil products from 2005, but relying on rail deliveries, something that has already proven problematic. The expansion of the terminal is constantly ongoing and it will have the capacity to handle 100 000 dwt tankers from 2005, and with capacity to be extended to 12 mty by 2007 (LUKoil, 2004-12-24). Transneft has suggested to the government that they would be better suited to handle both this terminal and a somewhat larger terminal under construction by Surgutneftegaz in Batareinaya Bay, on the south shore of the Gulf of Finland. Neither of the two oil companies has shown any appreciation for this “offer” from the state monopoly (RJ, 2004-06-02). In the near future there will also be a number of smaller new devoted terminals built in the Russian North West at Murmansk, Vitino, Severodvinsk, Vrandey and Indiga. In late 2002, a number of Russian oil companies presented grand plans of building their own large-scale oil pipelines, from fields in Western Siberian to Murmansk on the coast of the Barents Sea. To date, it has always been state pipeline operator Transneft that has been behind the building of oil transport capacity in Russia. Initially, the Murmansk pipeline was to be built jointly by several of the major oil companies. At a time when the feasibility study of the Murmansk project had barely been initiated, the

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- 83 - authorities crackdown on Yukos/Khodorkovsky, one of the largest participants in the project, commenced. As a result doubts followed about Yukos attempted merger with another of the project participants, Sibneft (which later had to be reversed). As a result of this, the prospects for the first major private pipeline dimmed considerably, although it is still wanted by the oil companies. The idea behind the Murmansk pipeline was the prospects of a sharp rise in exports to the US, and that the location of Murmansk would convenient as a year-around ice- free access to the Atlantic. The project idea has been taken over by Transneft and could still be realized. Planning for the USD 6 bn project is slowly ongoing with approval having been given by the local regions (Transneft, 2004-11-15). The other alternative in this direction is to ship oil to the North West and the Murmansk / Barents region. The grand pipeline plan by the major private oil companies to connect the Timan-Pechora area with Murmansk has been taken over by Transneft that still talks about the line in its medium term plans. On the Pacific coast, a number of the Sakhalin projects will come on steam during the coming years and are currently constructing export terminals. The first new export terminal, for Sakhalin-1, will be located in the Russian mainland, in De Kastri in Khabarovsky Krai, where the first test voyage was made with a 100 000 dwt tanker in 2002. Deliveries of the first of the ice-strengthened and purpose build tankers for Sovcomflot and Prisco, the companies that were awarded the transport contract, will take place in early 2006 (Sovcomflot, 2004-11-15). Also for the Sakhalin-2 project, a similar terminal will be built in the very south of the Sakhalin Island, at Kholmsk.

In the southern direction over the Black Sea, it has become a major problem for Russia that the outlets to the Mediterranean Sea, the Bosporus and Dardanelles straits are on the busiest waterways in the world. Over the last ten years, it has become an even more important route for the Russian and other former Soviet states, for the export of especially crude oil to world markets. In 1998, Turkey implemented new rules, e.g., banning tanker traffic at night through the strait, to increase safety. Only since 2001, traffic through the straits has risen by over 30%, reaching 135 mt during 2003 and is expected to increase by another 20% during 2004. According to Turkish maritime officials, a volume equaling four loaded 100 000 dwt tankers per day pass the strait during the year. The increasingly frequent delays for ships passing in the strait have, by the Turkish authorities, been blamed on the increased traffic. During only December 2003, delays at the Bosporus and Dardanelles nearly doubled shipping costs for about 1 million- barrels of crude cargoes.

Turkey, together with the US, has been the main actor in pushing for the building of the Baku – Ceyhan pipeline. A USD 2.6 billion pipeline for crude oil is being constructed that will connect the Caspian Sea region with the Turkish

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- 84 - oil terminal of Ceyhan. Together the two successfully lobbied international oil companies to connect this oil terminal, in the northeast corner of the Mediterranean Sea, which is also connected by pipeline to Iraq, with the Caspian region. This project could be seen as an attempt to reduce tanker traffic in the Bosporus, and alternatively, as a way to reduce Russian influence over oil transports in the Caspian Sea region. Work on the oil pipeline commenced in 2002, and on a gas pipeline in 2004, despite strong concerns from opponents and environmentalists that the route chosen was not economically viable. Fears that are increasingly likely to prove correct, as construction costs are souring. The construction co-coordinator, BP, have admitted that costs have increased to approximately USD 3.2 bn (Itar-Tass, 2004-12-21). Also costs for the gas pipeline has increased from its initial estimations of USD 3 bn to over USD 3.5 bn.

For the future, the capacity of Russian export capacity will have increased to over 430 mt according to Ministry of Energy. Out of this, some 60 mt will be transported by the Baltic Pipeline System towards the Baltic Sea, some 15 mt towards other terminals in the area, some 70 mt via the Caspian / Black Sea. The large change is to be found in the Murmansk area where a new pipeline is planned delivering 80 mt from Western Siberia – Timan – Pechora – Murmansk (Transneft, 2004-10-26). Somewhat surprisingly the plans does not include any export pipeline at all in the Asian parts of Russia, as what will be dealt with below.

The Russian pipeline project to China / Japan Noticeable in the description above is the lack of established connection to the world’s fastest growing market, neighboring China, where oil consumption is expected to increase by double-digit figures in the coming years. Although Russia wants to maximize the price received for the export of its strategic oil and gas resources, depending on the direction, the national strategic interest can be strongly influenced by what is pure economic interests. In Siberia, the two pipelines under discussion has been intended to lead oil from Angarsk, west of Irkutsk, to the Chinese oil refining centre in Daqing in the province of Manchuria. While the alternative pipeline proposed by Japanese interests would by-pass China and lead directly to an export terminal on the Pacific cost. Of the two alternatives, one offers a shorter line, but results in China as the sole buyer and difficulties to set prices, while the longer alternative opens up the possibilities to sell to a wider market.

The long discussion about the destination of the pipeline from Siberian oilfields eastward has been especially frustrating for China. On the Chinese side, construction work for the pipeline was started, but oil is currently being delivered by rail, in much smaller quantities than what the proposed pipeline

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- 85 - would be able to carry. After years of negotiations, the Chinese government has still no confirmation from Moscow that a pipeline for the export of crude to China will be built in the foreseeable future. From the Chinese side, the objective is to reduce its dependence on first of all, Middle East oil, but to what extent this means that China is prepared to pay a higher price for this “spreading of risk” remains to be seen.

By mid 2002 the prospects looked positive for the construction of a Russia-China oil pipeline. When the initial investment blueprint for the pipeline was presented, it included two possible routs, the somewhat shorter through Mongolia alternatively directly to China, but also two destinations, either Beijing or Daqing in Manchuria. The Russian side favored the 170 km shorter route through Mongolia while the Chinese side preferred to avoid Mongolia to lower the political risks. During Deputy Prime Minister Viktor Khristenko’s visit to Beijing in April 2002, the pipeline project was the main topic of discussion. Funding for the pipeline on the Russian side should originally come from the second biggest oil company, Yukos alone, while on the Chinese side it was the National Petroleum Corp (Chinaoil) that would fund the connection. Yukos, as the sole Russian partner, later came to be supported by Transneft, which put aside its earlier doubt and decided to participate in the project. Chinaoil was the contract partner when Yukos in 2003 signed a preliminary 25-year deal. The agreement indicated that 700 mt of crude should be delivered to China over 25 years, given an average of 28 mt/year, at a cost of USD 150 bn. How the financing should be solved was never made clear, although Yukos executives had indicated that the Russian side would contribute about USD 700 million and Chinaoil the remaining part. The pipeline's total length was given at 2 400 km, of which 1 400 km was in Russia. A slightly changed routing was presented that better took into account the environmental concerns about the potential risk of oil leaks, that might pollute Lake Baikal, as the new route passes further away from the lake. Constructions was originally planned to start in 2003 and the first oil should reach Daqing in 2005. Initially at a rate of 20 mty, and by 2009, deliveries should reach the 30-mty level, with oil pumped from fields in Sacha/Jakutia.

This development brought Japanese officials into action, and the former Prime Minister Yoshiro Mori, Foreign Minister Yoriko Kawaguchi and other officials arrived in Moscow to urge Russia to instead cooperate with Japan (RosBaltConsulting, 2004-03-22). Although such a venture would mean that a 60% longer, 4 200-km, pipeline from Angarsk to Nakhodka had to be built. In April 2003, the Russian government announced it would authorize the construction of a pipeline to Daqing, with a 20-mty capacity, and the intention to study a second 25-mty pipeline to Nakhodka. It later changed its mind, after

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- 86 - continued lobbying from Tokyo, to further investigate if it could be possible to build the Nakhodka leg first and the China pipeline later. A major insecurity with the Nakhodka alternative is that it is probably more difficult to set a fixed price for the oil arriving in Nakhodka. This is because the Japanese oil sector is private and the price paid at the end of the pipeline is therefore likely to be subject to full market exposure. For the Chinese alternative, prices could probably be expected to fluctuate less, but also become much less profitable in times of high demand/prices.

In late February 2004, the Russian government, through its then Minister of Energy, Yusufov, announced that the choice of direction for the Asian pipeline project has come to lean towards the project outline suggested by Japan. Turn of events that can be seen as surprising as Kremlin had long seem to priorities greater cooperation with China. President Vladimir Putin had stated that the level of relations between Russia and China was "higher than ever" and that bilateral economic relations were "below potential" (Kremlin, 2004-03-12). This was a statement that opposed what has been previously been made public by the state controlled pipeline operator Transneft. Transneft had argued that the resources in the oilfields taken into production in the region would not be large enough to justify an investment of this scale. A statement that, for good reasons, can be questioned as the construction of the pipeline between Kazakhstan and China (from Atasu to Alashankou) was initiated in the end of September 2004. A project that is based on smaller findings than in Siberia, nevertheless, this 1 000 km line is planned to deliver 10 mty to China from late December 2005 (RFE, 2004-09-29).

The China and the Japanese/Pacific alternatives carry two distinct price tags. The much shorter Chinese alternative is estimated to cost in the range of USD 3 bn while the Japanese/Pacific coast alternative is expected to cost in the range of USD 16 – 18 bn. For both alternatives, the final cost is dependent on the capacity of the pipeline discussed. In the case of the Pacific alternative, anything from 20 mty to 80 mty of capacity has been mentioned by different actors, while the Japanese credits has constantly been referred to as USD 7 bn. During the visit of President Putin to Beijing in 2004 the Chinese pipeline offer was extended to even finance the pipeline to China. To complicate matters, the building of the pipeline towards China had its initial backing from Yukos that controlled the nearby oil resources through its subsidiary Yuganskneftegaz. Since then, the tax- debt campaign against Khodorkovsky/Yukos and the forced sale of its most important production subsidiary Yugansk, it is now the state through Rosneft that controls Yugansk. The sale of the most important reserves for the pipeline projects made it possible to finally take decision to scrap the Chinese alternative. Instead, the most far-reaching promise to supply oil to China by railway has

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- 87 - come to be made by Rosneft, now controlling the original finding that Yukos based its original Chinese contracts on. For the next five years, Rosneft has committed deliveries of 4mt of oil for 2005 and with deliveries to reach 8 mt by 2010 (Rosneft, 2005-01-10). These deliveries are expected to repay the USD 6 bn loan from the Chinese side given to Rosneft in the takeover of the findings.

Construction costs for the pipeline are huge, but at the same time as demand goes up, so does normally the prices for transport/shipping. However, the price of transport is in this case also strongly related to the availability of transport capacity (i.e. suitable ships), but could swing 100% inside days, but also remain relatively stable. Average price for the transport of crude oil from Persian Gulf to Singapore in July of 2003 stood at Worldscale 52 and in the same month in 2004 at 165, and by the end of October, it had reached 247. Corresponding to a shipping price of USD 0.5/bbl in 2003, but at USD 1.6/bbl in 2004 for the Persian Gulf to Singapore leg, with contracts by October 2004 having been agreed at a shipping price of USD 2.6 bbl from the Persian Gulf to Japan (SSG, 2004-10-21)64. These are money paid for transport costs that alternatively could have been invested in a pipeline project to deliver oil from elsewhere. If the proposed pipeline from central Siberia to Nakhodka would carry about 80 mty, at an investment cost of about USD 18 bn (over 20 years), then that would correspond to USD 1.6/bbl65. There would still be some additional costs though to operate the line and to forward the oil to potential consumers.

State controlled Transneft is one of the most important players, being the government’s right arm, as it simply waits for the government to pronounce its decision on the route. To merge the two projects could appear logical, but until the government makes its final decision, nobody can say what route will be chosen. What perhaps could be seen as a compromise, presented by Transneft and the Russian Railways, is to initially only connect findings to loading terminals along the BAM railway, leading north of the Lake Baikal to Chita, and to ship the oil by this under-utilized railway line. Such a project could be operated inside two years, while a pipeline to the Pacific would take up to seven years to build (Kommersant, 2004-05-27). In the Far East, Khabarovsk Krai has also started its own battle to change the final destination of the pipeline to the Tatarskiy Bay, near the ports of Vanino and Sovgavan (RRR, 2004-09-20). This would make the pipeline go straight to the east to reach the Pacific Sea from Khabarovsk, and not south into Primorski Krai and Nakhodka. The two alternatives are about 450 and 800 km long, respectively, with the longer to Nakhodka over relatively flat land while the shorter to Vanino passes a mountain ridge with 2000-meter peaks. A decision on the pipeline projects had first been expected in the late spring of 2004, then during the summer, but only to be postponed until the end of the year or early 2005.

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- 88 - It is time that Moscow come to address the fundamental questions, of how and which of the oilfields of eastern Siberia should come to be ready for production, and how soon. If not, it was expected that some indication of the decision would emerge during the visit of the Chinese Premier Wen Jiabao to Moscow in early October 2004, or during the return visit of Putin to Beijing only weeks later. Instead the President has stated that the decision will be based on "Russia's national interests". The Minister of Economy, Gref, has been more outspoken, having indicated that the problem is whether to build a connection to Daqing, after a pipeline to Nakhodka is completed (MT, 2004-10-18). This inability to decide also sets the Japanese lobby off against the Chinese, and makes this question of economic policy towards its neighbours become a crossroad at which the Russian government has long proven unable to choose direction. However, on the last day of 2004, Prime Minister Fradkov signed a directive of the construction of a USD 18 bn and 4 200 km pipeline in the direction the Pacific under the responsibility of Transneft (Rosbisconsulting, 2004-12-30). The line will, in this proposal, pass about 150 km north of Lake Bajkal, indicating both an awareness of environmental concerns and the possible use of the BAM railway for shipments during initial stages of construction.

The Sakhalin oil and gas projects The origin of the oil that will be shipped in the previously discussed pipelines to China and/or the Pacific coast will be pumped from mainly east Siberian fields. The only major oil and gas fields in the Far East where any major investments have been seen so far is on and around the island of Sakhalin. The first prospecting here started as a joint Russian – Japanese initiative from 1975 with geological prospecting and a large seismological survey of the continental shelf east of Sakhalin. Exploration covers the eastern shore of the northern 2/3 of the island, generally in a water depth of 25 to 150 meters. Already, the first test wells drilled was successful as both gas and oil were first found in 1977 (Rosneft, 2004- 07-04). Initially, the construction of a pipeline to Japan was promoted for both gas and oil from the island, as the distance across the Le Perousse strait to Hokkaido is not more than 70 km. However, the idea has slowly faded away, despite having found initial support by the Japanese government. As co- ordination between the different projects seem to have been minimal, any such plans have been postponed for the time being. Since then, a number of supply deals have been signed between Japanese consumers with the different projects, including transport contracts by ship, which put it in doubt if a viable economic ground for a pipeline can be found. The drawback on the east coast of Sakhalin is that there is currently no technique to run year-around production and prospecting off the east of the island, due to the severe winter and the stormy conditions. It is not until the foundations for the fixed production platforms have been installed and reached the production stage, billions of dollars more will have to be invested in the Sakhalin projects; from 1 to 6.

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- 89 - The Sakhalin-1 project and its three off shore reserves in the northern part of the island are estimated to hold over 300 mt of oil and 485 bncm of natural gas. Overall, the project could be the largest investment project in Russia, being valued at USD 12 bn, of which about USD 2 bn has been spent (Sakhalin1, 2004- 10-12). The first oil from the project is expected to reach the market during 2005 and produce at about 12 mty at the production stage. The oil will be transported from the drilling platforms, by a 220 km pipeline, across the island and on to Khabarovsk Krai territory. A new devoted deep water single point mooring facility has been built in De-Kastri, where 100 000 dwt crude carriers will be loaded from a similar size tank storage. The transport contract for the shipping of the oil from the terminal has been awarded to Sovcomflot and Primorsk Shipping that will build new ice class tankers for this. Also, Valdivostok-based Far Eastern Shipping Company has contracted two larger icebreakers for ten years to the terminal from 2005. Gas production from the S-1 project has only been said to supply customers in Khabarovsk Krai from some time in late 2005. Two contracts with local buyers have been signed. In the development of the Sakhalin-1 project, the leading operator, Exxon Mobil, has been faced with numerous problems and delays in the development of the field. Among these the larger subcontractors had problems to fulfill contracts, and contracts already awarded had to be split further to fulfill the building of the first terminal (Bloomberg, 2004-09-17). Exxon Mobile and Sodeco (of Japan) holds 30% each, while Rosneft and Oil & Natural Gas Corp. (of India) each have a 20% holding in the Sakhalin-1 project.

The Sakhalin-2 project was the first of the project with the development rights granted in 1991, prospecting started in 1994 and with the first oil to be delivered in 1999. Sakhalin-2, or Sakhalin Energy Investment Company (SEIC), led by Royal Dutch Shell (55%), with Mitsui (25%) and Mitsubishi (20%) of Japan as partners, is so far the most successful of the oil projects off the coast of Sakhalin 1999 (Sakhalinenergy, 2004-08-11). Production from the project has reached about 1.5 mty and has gone up by about 10% over 2003. New large-scale findings will come into production from 2007 and a number of deals have been signed for delivery of gas to several Japanese energy majors for about 4 mt of LNG per year. Contracts signed for gas correspond to about 35% of the estimated production capacity of 9.6 mt that has been estimated. Sakhalin-2 has awarded the transport contract, valued at USD 350 million, to Japanese, Nippon Yusen (NYK – Line), that will supply the LNG shipping capacity needed (MT, 2004-09-09). A two-year construction project for the two southbound 860 km, and USD 2.5 bn, oil and gas pipelines initiated in early 2004, but since been partly postponed. The two pipelines are intended to deliver products to a liquefaction plant and an oil terminal on the southern gulf of the island, near Kholmsk, from the two production areas off the coast in the northeast. This

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- 90 - construction project has come under heavy environmental criticism, as the pipelines will cross over, and not under, 29 major rivers and will be built underground, not on pillar support, in an area of strong seismic activity66. Additionally, with connecting offshore lines from the three production platforms crossing, what probably is the only summer breeding ground in the world for grey whales (WWF, 2004-08-12).

Additionally Russia is said to be about to sign a 20-year agreement with South Korea to provide 5.3 million tons of natural-gas condensate from the Sakhalin gas fields annually. The likely supplier in the deal is the Sakhalin-2 consortium, which is currently constructing a plant on Sakhalin for the production of liquefied natural gas. The proposed deal, which is believed to be worth USD 830 million per year, will include a subcontract under which Russia will purchase condensed-gas tankers from South Korea shipbuilders to transport the fuel from Sakhalin to South Korea (Izvestiya, 2004-08-10). In line with this deal Korgas, the Korean national gas company, has been invited for discussions of joining the project as a future minority owner (Kommersant, 2004-09-23). Also the biggest oil refiner in Asia, China Petroleum and Chemical Corp., is reported to be interested to join the Sakhalin-2 project, as the first Chinese buyer of liquefied natural gas from the Sakhalin projects (Bloomberg, 2004-08-17).

The tender from 1993 for the rights to the Sakhalin-3 project, which was then won by a consortium led by Exxon Mobil (33%), Chevron Texaco (33%) and Rosneft (33%), was annulled by the Russian Government in March 2004. The official reason given was that exploration had not been initiated, by the two partners, as was specified in the contract. Sakhalin-3 holds very large reserves, but these are spread out over four fields along some 250 km of the coast. Total reserves here have been estimated to over 800 mt of oil and 1.4 tncm of gas (Rosneft, 2004-07-04). A new auction of the development rights is expected to be hold during 2005.

The project license for Sakhalin-4 was won by Rosneft, in cooperation with BP, now TNK-BP. It is only expected to contain about 100 bncm of gas, but due to the geological structure of its reservoirs, it will be jointly developed with the Sakhalin-5 project (Rosneft, 2004-07-04).

The development of the gigantic Sakhalin-5 project has, from as late as in April 2004, come a step closer to its initiation. All initial costs up until production start will be financed by the 49% partner TNK-BP alone, but in a JV with its 51% partner Rosneft. Of the two, it is Rosneft that holds the so important drilling rights for the project67. As the initial agreement to develop the filed between the two companies, signed in 2001, was due to expire in 2004, some kind of

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- 91 - continuation was not unexpected. It can also be expected that other foreign companies had been looking for a stake if BP had not finally stroke a deal. BP had probably wanted an even split of initial costs, but Rosneft will not contribute until the first oil has been produced. As in all raw material exploration projects, estimations of the total Sakhalin-5 development costs depend on the final size of the project and how soon the production stage should be reached. Development costs needed to reach production at the field have been estimated to anything between USD 2.5 to USD 5 bn. Explorative drilling commenced in 2004, and at the end of the drilling season, Rosneft declared that, what it called “significant amounts of oil and gas” had been found off-shore in the first attempt (Rosneft, 2004-10-06). In perspective, the Sakhalin-5 is expected to reach an output level of crude and oil-condensate of 600 mt, and to hold a total of 500 bncm of natural gas. Currently, 2010 estimated as the most probable year for the first deliveries. By its assignment here, BP is increasing its already strong commitment in Russia, where now one in five BP barrels are being produced (BP, 2004-06-12; Reuters, 2004-03-09).

The license to the Sakhalin-6 project, holding one large field, is held by TNK, but now part of TNK-BP. The drilling of two exploration wells for that project is scheduled to take place during 2005.

Out of the three projects that have reached the production stage, or near the production stage, Sakhalin 1 and 2 are conducted under the PSA legislation while the Sakhalin 5 is working under normal Russian tax legislation (Itar-Tass, 2004-10-07). Under PSA agreements, profits are divided between the project partners and the government after the costs that in advance has been approved among partners and the government has been covered.

Early on much criticism of these projects was focused on the sensitivity of the environment in the region to degradation from the oil spills and effects on indigenous population groups. Not much discussion has been seen concerning where terminals are being constructed or where pipelines have been laid, apart from against the Sakhalin-2 pipeline. The first major disaster struck in September 2004, with what still must be considered as a small spill, seen to the volumes handled by the different projects. It came to be caused by a dredger, carried onto the coastal rocks by a typhoon, spilling 200 tons of fuel-oil (Vladnews, 2004-09- 14).

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- 92 - 2.3.2. Gas

Similar as for oil, the production of natural gas has, over the years since WW II, come to move from the first fields in central Russia towards the North East. As in the case of oil, the new gas findings were first found in the southern Urals and then further to the North East. In the years just after the war only a few percent of the Soviet gas was produced east of the Ural Mountains with nearly 60% was produced in what was to become CIS states. The Siberian share was still one digit by 1975, but had reached over 35% by 1985. In the same period, the average transport distance of the gas more than doubled to over 2 500 km, which was also due to new pipelines connecting the Urals from far away Uzbekistan and Turkmenistan. The trend that the findings will be located even further away from consumers has continued, and will continue, as the next generation of large fields will be developed on the Tajmyr peninsula, in the very north of Siberia. The go-ahead signal for the development of the giant Yuzhno-Russkoye in the area has been given and it expected to come into production by 2007 (Gazprom, 2004-11-15). As near half of both heating and electricity has natural gas as its energy source, over 50% of Russian primary energy consumption constitutes of natural gas, with the same figure coming to about 25% in both the EU and the US.

During early transition years of the 1990s, the consumption of natural gas in Russia declined considerably less than other forms of energy sources during the same period. This tendency had increased the importance of gas in domestic energy use, at the same time as exports of gas fell less than for oil during this period. In 2004, total production increased by less than 1% to 545 bncm at the same time as oil production was up by 9% to reach 12 mt for the year (Gazprom, 2005-01-25). Plans for 2005 are expansive and include a production volume of near 550 bncm. Exports outside the CIS are expected to reach 145 bncm and investments in pipeline construction will be tripled, to near USD 2 bn (Gazprom, 2004-11-10 - - 11-24).

The production of natural gas in Russia has, since the break up of the Soviet Union, remained a near monopoly under the state-owned company Gazprom. Gazprom controls most parts of the near 160 000 km of gas pipelines available in Russia, and especially so the large diameter interregional and export pipelines. Additionally, it is not only the world’s leading supplier, controlling near 90% of the domestic production, but is also supplying 25% of Europe’s gas needs. The importance of the company is somewhat shown by the size of its staff that already before its recent mergers, was over 300 000. Also, the earnings of Gazprom are impressive at over USD 19 bn for exports outside the CIS, up by 16% over 2003, from exports of 140 bncm (+6%) and an additional 52 bncm to

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- 93 - CIS countries (Gazprom, 2005-01-25). International gas deliveries have a long tradition and were initiated with the building of a pipeline to Finland in 1974, and for which current delivery contract of 5 bncm extends to 2025 (Fortum, 2004- 09-29). However, total earnings are slowly falling as a result of higher costs, as input prices are up by over 20% during 2004, at the same time as gas prices are set by the state and can only be raised by way of government decisions. Gazprom has demanded the government to allow prices to go up by 23% for 2005 if it should not be forced to reduce investments considerably and to make a loss on domestic sales as extraction tax is due to increase. Over 80% of revenues during H1 2004 earned from exports, where average prices are 2.6 times higher than domestically (Gazprom, 2004-08-15).

Gazprom has long been listed on the Russian stock exchange, but with only a minority of shares available to foreign and a larger part to domestic investors. The dual trading system has received much criticism as it has been suspected that foreign investors own considerably more than the allowed 15% of the company. With the merger of Gazprom and Rosneft, which will take effect in 2005, the 50% -1 share, that is not owned by the state, will be available for free trade68. Gazprom also produces oil and its 2003 volume of oil and gas condensate places among the six largest oil producers in the country. During the merger discussions, it was also made public that Gazprom has acquired over 10% of the electricity utility UES, further increasing its weight in the energy market.

Despite its size, Gazprom is also in need of foreign partners for continued expansion and American Chevron Texaco has agreed with Gazprom on a “gas- sector cooperation” deal (Gazprom, 2004-09-22). The development of the giant Shtokmanovskoe offshore gas fields containing an estimated 3.5 tcm and 30 mt of gas condensate, but located 380 meter under the Barents Sea (RosBaltConsulting, 2004-09-22). In an attempt to start building a customer base for LNG in the US, Gazprom will in 2005 start swapping gas delivered in Europe for LNG delivered in the US. To be replaced by LNG that will be shipped from Gazprom’s own fields inside a few years time. When the approximately USD 10 bn needed has been invested in the Shtokman field, it will be well positioned for deliveries to the quickly expanding US LNG market (Bloomberg, 2004-09-25). The rights to develop the field are held by Rosneft (due to merger with Gazprom) and Gazprom. To support its export plans, Gazprom will also build an LNG export terminal west of St Petersburg, together with Petro-Canada (SeaNews, 2004-10-11). This project is bound to connect to the planned laying of an export pipeline under the Baltic Sea, from the Gulf of Finland to Germany. A possible future connection to Finland and Sweden from this pipeline is under study. This North European Gas Pipeline (NEGP) under study by Gazprom and

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- 94 - its German importer Wingas, could carry 20 – 30 bncm/year, with its 3 000 km route chosen in international waters to avoid the kind of transit problem like what has been seen in Belarus and the Ukraine (Gazprom, 2004-10-10)69.

At the same time, the development of the offshore Shtokman and the northern Yamal Peninsula fields are indications of a trend where the cheap-to-develop fields are slowly getting depleted and the new large fields are proving increasingly expensive to develop. The latest survey made public on 90% of the resource base of Gazprom, including proven and probable gas reserves at end of 2003 have come to 16.8 tcm proved reserves, plus another 1.9 tcm probable, down 1% on 2002 (Reuters, 2004-07-22). Also, the approximately 10% slice of Russian gas that is not being controlled by Gazprom has been attracting international attention, with the French oil major Total buying 25% of the second in size gas producer, Novatek, at USD 1 bn (RFE, 2004-10-05).

Only in the Siberian part of Russia, the gas reserves have been estimated to about 45 tcm, of which 33 tcm in Eastern Siberia and 12 tcm in the Far East. This accounts for about 20% of Russia’s initial overall natural resources (Gazprom, 2004-09-21). One of the biggest fields in the region is the Kovykta field, located some 400 km to the north west of Irkutsk. It is estimated to contain more than 2 tcm of gas reserves, and was long seen as the field that would supply the gas for a pipeline to Asia. It is the company Russia Petroleum who holds the production rights to the Kovykta fields, to 63% controlled by TNK-BP, with other owners being the industrial group Interros and the local administration. In early 2003, Russia Petroleum signed a preliminary agreement with consumers in China and South Korea to supply gas from the field, beginning in 2008, with deliveries reaching 30 bncm per year within two years. When Gazprom was made state coordinator for all Russian international gas projects later in the same year, BP offered Gazprom a stake in the field, but Gazprom wanted 50% of the venture and not only the 37% offered by Interros and local authorities. Negotiations have continued and a preliminary, but not public, agreement is said to have been reached (Bloomberg, 2004-08-23). In early March 2004 TNK-BP agreed with Irkutsk authorities to supply major consumers in the region with 300 mcm of gas beginning from 2006, and rising deliveries to 2.2 bncm by 2009. Total investment in the Kovykta field from 2004 until 2009 will amount to approximately USD 650 million for this local project, where the implementation will not depend on possible terms of international projects (TNK-BP, 2004-08-10). Additionally, TNK-BP has also signed an agreement with two domestic companies to extract helium that is also contained in the gas field, at a USD 40 million plant that will be build at the site for that purpose (TNK-BP, 2004-05-26).

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- 95 - Gazprom has been chosen by the government to co-ordinate gas export from the Far East, but has not shown any enthusiasm for export plans in the direction of Asia. Focus for the company has been on the sale of gas locally and in Europe; with CEO Miller having stated that Kovykta gas should go west and that Sakhalin is the most important finding in the Far East (Bloomberg, 2004-10-05). Gazprom has become a partner in Sakhalin-1 project and has indicated an interest also to participate in Sakhalin-2. One of the major problems in the Russian negotiations with the EU and WTO is that the state-controlled domestic gas prices have been kept at about 20% of the about USD 140/1000m3 that EU companies pay Russia (DG-TREN, 2004-07-20). In the bi-lateral preparatory WTO negotiations between the two, Russia has promised to raise prices for gas for business users. Export value of gas during 2003 came to USD 16.5 bn for a volume of 141 bncm sold, with 2004 expected to become an even more profitable, as volumes are expected to reach 150 bncm and prices will increase by approximately 15%. Contracts already signed up to 2008 will set export volumes to no lower than 147 bncm (PetroleumNews, 2004-09-19).

2.3.3. Coal

In early Soviet Union years and up to the 1950s, the burning of coal was the backbone of the energy sector. The importance of coal peaked at some 60% of energy supply, but has since fallen to well under 20% by 2004. Despite a continued increase in production of coal until the 1980s its economic importance continuously declined, due to the even more rapid raise during this time in oil production and oil use. The use of coal is no longer as wide spread as it used to be, but power stations and the steel industry remains the most important users of coal.

During Soviet years, the extraction of coal was one of the most heavily state subsidized undertakings. Incomes from the sale of coal made up less then half the cost, with that state contributing what was needed in different forms of subsidies. Already before the break-up of the union, more than half of especially smaller mines were deemed unprofitable, often with production volumes as low as 500 000 – 600 000 ton per year. In this sector, nearly half of the mines were lost to other countries of the CIS, while in the oil and gas sector, only a minor share in number were located outside of Russian territory. At that time, only one in five of the mines had a technical standard comparable to the west and many of the shafts of underground mines were of such poor standards that they were right out dangerous. Based on this, the sector was left in a very complicated situation already at the start of the transition years and the production volume inside Russia fell by over 50% during the 1990s (IEA 2004-10-10). Reforms have

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- 96 - made progress, although slow and irregular, which in this case has led not only to the closure of a large number of mines, but also wide spread privatization. The international support from e.g. the World Bank has been strong, focusing on assistance in the social transformation for the employees becoming unemployed in the process (WB-Ru, 2004-07-07). Still, protests against closures and wage arrears by miners have been many, and sometimes also violent. The situation in the sector has reached a more stabilized stage in later years. The privatization process has more or less been completed in the coal sector, where private ownership has increased from something like 40% in 1998 to about 95% by the end of 2003.

In later years, the volume mined has been in the range of 250 mty but has in later years slowly increased to reach about 280 mt for 2004 (MOIE, 2004-12-29). In 2003 Russia exported 36 mt, or 7% of world exports of thermal coal, having increased to 37 mt during 2004, but with cooking coal export increasing rapidly to near the same volume, or 32 mt (FSSS, 2004-10-10, and Bloomberg, 2004-12- 24). On the export side, it is distance that is causing two major problems for the industry. First; about 80 – 90% of the Russian coal volume is being mined in the Kuzbass region, in and around Kemerovo, and from there it is often 4 000 km to the ports. As a result up to 30% or more of the final price quoted for the export thermal coal could refer to transport costs (Coaltrans, 2004-10-18). Second, rail cars, that can load 60 tons, often combined in a 70 car or 3 500 ton trains, can hardly be expected to do more than 15 trips to a port per year. Despite such problems, export remains an attractive economic alternative, but the lack of rail cars for transport is bound to limit the export potential for years to come (SUEK, 2004-10-20). Problems are also the handling at the ports. As has happened before during winters, trains get stuck on the lines when unloading capacity is not sufficient and the coal is frozen. In late November 2004 this happened again with about 150 coal trains waiting to be unloaded at ports in St Petersburg and Murmansk, with as many more under way (Bloomberg, 2004-11-25). However, far from the full export volume is destined for the ports as some of the export is also bound for CIS destinations.

Despite having the largest reserves in the world, Russia has not yet seen any of the world’s four coal majors, BHP Billiton, Anglo, Rio Tinto, and Xstrata/Glencore having invested in any of the Russian mines. In Russia, it has instead been the large metallurgical companies and important financial industrial groups who have business interests in different industrial sectors, and especially metals and steel, that have shown an interest in coal mining. Today, the Russian coal market has essentially become divided among three main players: the Siberian Coal Energetic Company (SUEK), EvrazHolding, and Severstal; the last two being principally steel companies.

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- 97 - 2.3.4. Electricity

The majority state-owned Unified Energy Systems (UES) is not only Russia’s biggest producer of electric power, but it also controls the national electric power grid. The distribution network under the control of UES reaches a total length of about 60 000 km of major lines. The UES, in the same way as Gazprom, especially dominates the interregional high voltage lines and the export lines. All together the UES controls about 440 electric power stations with a production capacity of 197 GW, with 20% of this coming from nuclear power (UES, 2004-10-09). Alternative energy sources find little room in Russia, and the only three thermal plants inside UES (and Russia) can all be found on Kamtjatka, with a combined capacity of 70 MW. During 2003 UES produced 790 TWh, out of a national consumption of 860 TWh. During the first nine months of 2004, consumption increased just over 2% to 650 TWh, out of which UES supplied about 70%. Most of the increase was generated by the UES hydropower plants, which boosted their output by 15% during the period, as a result of above average water flows in the rivers (Bloomberg, 2004-10-05). For the future, increasing demand will force UES and others, to increase capacity more rapid than the 400 MW installed during 2004 and the 1 300 during 2003 that was installed by the UES (Prime-Tass, 2004-11-05).

Spread over the country, there is also a large number of, mostly regional/oblast, vertically integrated power generators / distributors. To a varying degree, also these are often being indirectly controlled by the UES. UES is currently one of the most highly valued companies on the stock exchange with a long awaited political reform of the power distribution system, which is likely to influence much of its future value. The biggest producers outside of UES are Mosenergo (in Moscow and on the stock exchange) and Irkutskenergo (in Irkutsk and state- controlled) which have installed generation capacities of about 15 000 and 14 000 MW respectively70. Regional energy companies, which are often under the control of the different oblasts, have been used to support large local industries through subsidized price policies. As for many other sectors in the country, a major problem during transition years has been non-payments from its customers. Non-payments have been a long running problem for the electricity suppliers, which worsened after the crises in 1998. With the state, through the military, as one of the largest debtors and one that in numerous cases cannot be denied deliveries for security reasons. Since, the debts and non-payments problems are slowly approaching acceptable levels. However, the results of the lost incomes have; and been that severely cash starved power generators have, for many years now, been forced to refrain from much needed maintenance work and other investments. Consequently the quality of the grid has deteriorated to alarming levels, including a long backlog in the upgrading of equipment.

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- 98 - In the NEA direction, the Russian electricity giant UES has signed a partnership deal with Chinese Datang to open for joint national and international projects of infrastructure development (RJ, 2004-09-01). Increased economic activity in China has made electric consumption rise sharply, and so has the Russian electrical power exports to China, which is expected to reach about 235 million kWh in 2004.

2.3.5. Nuclear

Russian nuclear power is the fifth most important energy source on the domestic market after natural gas, oil, coal, and hydropower. In 2004, Russia had nine nuclear-fuelled power producing stations with a total of 29 reactors in operation71. During 2003, Russian nuclear power stations increased their generation by 6.3% to 149 TWh, or about 11% of total production of electricity in Russia. A production level that is 16% above estimated maximum in Soviet years, with much of the 2003 improvement achieved from a 4.5% increase in capacity utilization. A rate of production increase around 5% per year is foreseen in the coming 15 years, as the share of electric production from nuclear plants should rise to near 20% by 2020 (Minatom, 2004-04-02, IAE 2004-04-02)72.

Seven of the nine nuclear power stations are located west of the Ural Mountains. There are two dominating designs of these reactors with 13 being VVER’s (pressurized water reactors) while 13 are of RBMK design (graphite-moderated reactors). Of the RBMK reactors, four can be found in Sosnovy Bor, 80 km west of St Petersburg, where all reactors are of the most unsafe type. The first two reactors here were brought into operation already in 1973 and 1975 respectively and reached the end of their technical lifetime in 2003 and 2005. But this has not happened, on top of this, the three research reactors at the same site, aimed for training of submarine crews, are also in operation. Used fuel elements from RBMK reactors can, to date, not be upgraded, in contrast to elements from the pressurized water reactors, at the same time as no Russian centralized long-term storage facility has been built. In the case of Sosnovy Bor all old fuel cells from its reactors are stored under doubtful circumstances less than 50 meters from the Baltic Sea (Bellona 2004-05-10). RBMK reactors are the type that “must be shut down” and any investments in safety, like in Sosnovy Bor and the Lithuanian Ignalina reactor, shall only be seen as temporary (IAEA, 2004-05-15)73. The low local confidence in the security measures surrounding domestic nuclear power was shown by the panic caused in Saratov, from what proved to be just rumors, of an accident at the largest power producer in Russia, the nearby Balakovo nuclear power station (RJ, 2004-11-05 - 11). Even President Putin has called for increased safety at nuclear power plants, although his chief concern was related

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- 99 - to the risk of terrorist attacks. Stating that there are currently some 70 million tons of solid nuclear waste in Russia. Additionally there are considerable problems in both decommissioning reactors, especially from the Navy, but also in cleaning up areas contaminated by military and civil nuclear activities (Ria- Novosti, 2004-12-16).

The Soviet Union, and later Russia, used to have an additional 13 nuclear reactors to produce weapons grade plutonium oxide, of which three are still in operation while all 14 in the US has been closed. Large US investments, USD 688 millions in 2003, have so far managed to close ten of the Russian ones, with two of the remaining located in Seversk and one in Zheleznogorsk (ibid.)74. These three still produce 1 500 kg of plutonium per year as a by-product, but first of all electricity for surrounding areas, for which there currently is no replacement, and because of that the plants cannot be closed75. It has been planned to build new thermal power stations to replace these, but that will not be ready for the scheduled closing of the stations in 2006. The conflicting interests are, at the same time, openly obvious as the former ministry, Minatom, has two new reactors on the drawing board, BREST and BN-800, that are plutonium based (Minatom, 2004-05-10). Development has continued, in co-operation with German Siemens, to develop a fourth generation of pressurized reactors. For the smaller of the two, the intention is to use a submarine type of reactor to generate energy at a floating station in far away areas, e.g., along the Arctic coastline. In 2003 the Duma approved the continued construction of a full-scale model at the submarine shipyard in Severodvinsk, west of Arkhangelsk. This kind of reactor has also been offered for export to both India and Indonesia during 2003.

Reactors based on Russian technology have been constructed in nine other countries, with the much-criticized ongoing construction of a new reactor in Iran as the most recent one. These countries are Finland (2 reactors), Hungary (4), Slovakia (4), Czech Republic (4), Bulgaria (6), Slovenia (1), and Armenia (1) that all house the considerably less dangerous VVER reactors76. Of the three RBM “Chernobyl type” reactors in use outside Russia, two can be found in Lithuania while one of the 15 Soviet design Ukrainian reactors is of this design77. The reactors at the Lithuanian plant are due to close in 2005 and 2009, respectively, after the EU has promised about USD 600 million in compensation (Le Monde, 2004-04-15). This sum could serve as an indication of the extra costs involved for the closure ten years ahead of estimated lifetime, in a country that is to 70% dependent on electricity from this one plant.

Russia is also one of the major producers, and most active exporters in the world of uranium to fuel nuclear power plants. New contracts for the delivery of fuel have recently been signed with Hungary, India, Slovakia and the Ukraine, with

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- 100 - exports having increased by 25% during 2003. The overall value of the exports of fuel and equipment from Russia in this sector increased by 15% to USD 3 bn during the same year.

Another much debated aspect surrounding nuclear activities has been the Russian potential as a future recipient of radioactive waste from abroad. Suggestions for this have not only been met by outrage from regions in Russia where transports would have to pass through, but also from environmental circles in possible exporting nations. The two possibilities on offer for waste treatment are reprocessing or final storage at one of the two mentioned Siberian facilities of Seversk and Zheleznogorsk, respectively (IAEA, 2004-05-15). This is not an alternative without interest in certain circles in the EU, where nuclear currently accounts for about 1/3 of electricity supply with four of the new EU members operating outdated and dangerous Soviet made nuclear reactors (DG- Tren 2004-05-24). It is not very difficult to find encouraging statements for such an export from respected circles “There are a lot of places to put waste in Russia” (D. Taylor, Head of Science Magazine, 2004-05-10). The building of new plants inside the EU has even been restarted, as at the end of 2003 the French state owned EDF-company won a contract to build the first new nuclear reactor for over a decade, of EPR type, planned in Finland78. By far France is the biggest user and has 58 nuclear reactors operating in 19 nuclear power plants that in 2003 produced 78% of the country’s electricity (“Euroatom” at Cordis, 2004-05- 17). Of the countries with active nuclear power stations in the world, it is only Sweden, Finland, France, Germany and the US that has come anywhere close to start building a deep repository for high-level nuclear waste (LBL and SKB, 2004-05-15). Minatom has indicated its intention to build a similar facility in the vicinity of Krasnoyarsk, but has so far not given any further details on the advancement of the project.

2.4. Transport

One of the greater challenges facing manufacturers, as well as importers and exporters, of products in Russia is moving these products over long distances to and from ports, but also to get products distributed to potential consumers. There are still problems facing transporters on all levels, from the lack of supply to problems with the quality of the existing infrastructure. Despite that much has been invested at all levels of the sector in later years, still many basic problems remains. This is due to years of neglect in maintenance and investment during Soviet years, and long into transition years, which has generally left infrastructure in a very poor starting position for its build-up.

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- 101 - Transport statistics for 2003 show that there was a general growth in volumes, lead by aviation that increased by 11% for the year. It was only municipal transport that showed negative figures, -4%, which is consistent with the trend of an increasing number of private cars and bus companies. On the cargo side, the railways increased their freight volume by +10%(Mintrans, 2004-05-03). Still further growth of transport volumes, in line with continued economic growth figures, will become increasingly difficult to cope with as aging infrastructure and an ever increasing transport lack of modern transport means will restrict capacity.

Much of the problem in the transport sector can be derived from the fact that the price of the transport service (it could also refer to a product) during Soviet years were never allowed to reflect the true cost of supplying the service. Under pricing was an epidemic inside the transport sector, compensated for by direct or indirect subsidies. Setting prices lower than the true cost give rise to over- consumption and wasteful usage of a service, simply because the user is paying less than what he should. Another result of the constant subsidies given is that the efficient use of resources is not being promoted, because the operator knows that eventual losses will be compensated for. That the transport components share of the final price of Russian product is often 50%-100% larger than for comparable products in developed countries were normally some 10% of the price reflects transport costs. This large difference cannot only be explained by the large size of the country here, but it also indicates a considerable degree of general inefficiency built into the system, indicating a problem that affects all sub-sectors of transport, although for different reasons. The general lack of understanding that also transport services should be paid for, first of all by its customers, was demonstrated all too well in Russia during the summer of 2004. In the heated debate concerning the abolition of free traveling on local transport for large groups of the populations (and some other services), it was never discussed where the money would come from to pay for the service. As the American saying goes “There is no such thing as a free lunch”, there is no such thing as a free transport service. It deserves to be repeated, free travels/transport leads to over consumption and misuse by some, while it is of no value what so ever for those who are out of reach for the service79.

A long-term plan, presented by the Ministry of Transport, for a new transport strategy was signed by President Putin in the fall of 2004. It is hoped that the introduction of the plan will lead to that the available transport infrastructure will be fully reorganized and considerably upgraded by 2025. The plan foresees that Russia, by then, should have created what the Soviet system verbally aimed for, but never achieved: “a unified transport system”. A far-reaching overhaul of the national transport system will need annual investments of RUS 600 bn (over

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- 102 - USD 20 bn) and with just one-fifth of this coming from the federal budget (Interfax, 2004-03-03). Prime Minister Fradkov has stressed that there is a need for more private capital in the transport sector and hopes to see 60% of investments in all kinds of transport infrastructure coming from private sources by 2013.

2.4.1. Railway

The Russian Railways (RZD) is the worlds largest, with a network of 87 000 km, which corresponds to around 10% of the world total, out of which about 42 000 km has been electrified. The RZD has inherited an organization from the Soviet railways, which was based on 32 local railway districts, out of which 17 are still operational inside Russia. The railways used to be organized under a special Railway Ministry that was said to be one of the most influential during Soviet years. Since the restructuring of ministerial structures after the presidential elections in March 2004, it has now been converted into a department under the Ministry of Transportation (RZD, 2004-08-10). The reforms inside the RZD, despite the fact that much remains to be done to create real competition, are nevertheless seen as impressive by European Ministers of Transport; especially when it comes to investments and increasing productivity, where the RZD has made a difference in its little over a year of existence. Impressively quickly, it has turned the corner from an inefficient state monopoly into a holding with an international credit rating, presenting its results under international accounting standards (ECMT, 2004-10-26).

RZD has so far proven a profitable company and looks to earn about 8 bn for the year and hoping to double that during 2005 (RZD, 2004-10-29). Faced with massive needs for new equipment and modernization that the government will not supply over the state budget, the RZD has been forced to borrow from the open market. Without the changes mentioned above, and the positive view taken by foreign institutions to the changes incurred, such lending would not have been possible. As a result, the RZD has been offered, and accepted, access to a gigantic loan from Temi, made up of a group of large European railway equipment manufacturers and banks. A loan has been set up with an upper limit of Euro 25 bn (USD 29 bn). Given over ten years, at an interest rate of 3%, it will open up for the possibility to partly pay back in the form of barter goods. The loan will enable RZD to upgrade and build a number of new lines, e.g. in north- central Siberia on the permafrost stricken Yamal peninsula, as requested by Gazprom. Seen to RZD’s generally low evaluation among investment agencies, the size of the loan seems highly speculative (Bloomberg and MT, 2004-09-20). RZD is also working on alternative credit facilities and will issue Eurobonds to

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- 103 - attract money for other long-term investments. An initial issue will be for USD 400 million, scheduled for late 2004, and a second issue will follow during 2005 for about double that amount (Bloomberg, 2004-09-09).

Freight When measured in transport work the Russian Railways handled 1 510 bn tonkm during 2002, which was the third largest volume in the world, behind 2 290 bn tonkm carried in the US and the 2 044 bn tonkm carried in China (RZD, 2005-01-25). During 2004, the Russian Railways carried a volume of 1.220 mt, which was near 6% more than the volumes in 2003. The transport work during 2004 amounted to near 1 700-bn tonkm, which was 8% up compared to 2003 (ibid.)

To maintain volumes, the RZD intends to spend 1.2 trillion on new rail routes and 600 bn on its rolling stocks by 2010. About 1.5 trillion from the company and an additional 10% from the government on what was called “non-commercial project”, like upgrading rail routes in Chechnya. RZD ships 40 percent of Russia's cargoes, but currently has more than half of its locomotives and rail cars reaching the end of their standard working life by 2010 (RZD, 2004-06-14).

In a meeting with his Chinese counterpart in September 2004, the head of the RZD, Fadeyev, promised to greatly increase the transport capacity to China. Currently, the volume railed between the two neighbours reached 30 mty and this is expected to have doubled by 2010. On just the 400 km from Siberian city of Chita to the Chinese border an estimated USD 480 million will be spend in upgrading and double tracking during 2004 and 2005 (Vedomosti, 2004-09-24). Nearly the same amount will be spent on upgrades of the two other connections to China as RZD see it as a strong future market and that capacity elsewhere is being underused due to these restrictions. With also container handling by railway between the two having doubled during 2004, surpassing a yearly volume of 100 000 TEU, capacity must also be extended to be able to handle a continued expansion (RZD, 2004-11-26). Of the three crossings between the two neighbors, the one south of Ulan-Ude, connecting through Mongolia, is the one most in use, followed by the one south of Chita, connecting just east of Mongolia, while the third one is located just north of Vladivostok. Shipments along the whole TSR has never surpassed the 150 000 TEU per year volume despite its huge potential.

The oil shipments to China have come in the center of the debate as large Russian promises for oil shipments by rail have been done, that are to be handled by the RZD. During the visit of the Chinese Premier Wen Jiabao to Moscow in 2004, it was stated that 10 mt will be railed during 2005 and 15 mt by

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- 104 - 2006 (MT, 2004-09-26). Also in the Far East direction, the RZD has stated that it can handle the shipment of as much as an additional 10 – 20 mty of oil by 2010. That is when it has carried through its 26 bn (USD 900 million) upgrading of lines in the region (Bloomberg, 2004-10-05). In the southern direction RZD has committed itself to invest USD 100 million in a new rail link to be build along the western shore of the Caspian Sea. Such a link, where construction will start in early 2005, will connect Kazvin in Russia with the Iranian city of Rasht, at the southern shore of the sea. 340 km of new tracks will be built for a line that is hoped to carry 6 – 8 mty within five years (RZD, 2004-05-20).

Passengers When measured in transport work, the transport of passengers on the Russian Railways was the fourth largest in the world in 2002 with 153 bn passengerkm, behind the 477 bn passengerkm transported in China, the 457 in India and 241 in Japan (RZD, 2004-08-10).

The near future planning of the RZD also includes the long discussed high- speed railway between Moscow and St. Petersburg. Evaluations of the need for infrastructure improvements are underway, which will include the elimination of all single level crossings on the 750 km line, before a contract that is to be signed with Siemens AG. In the current plans the first high-speed train will be running on the line by late 2007 (RZD, 2004-12-23).

During the first seven months of 2004, the passenger volume on the Russian Railways grew by 5% to just under 100 million passengers, indicating a full year volume of 175 million. On long distant lines the volume increased by just over 6%, while the passenger volume on suburban lines, fell by near 2% (Russian Railways, 2004-08-04). Passengers on international lines to neighboring countries for H1 2004, on the other hand, increased at twice the rate, or 12%. Examples of destinations with increased volumes were the Ukraine, +15%(near 5 million), Uzbekistan grew by 33%, while passengers to the Belarus were down by 9% and to Estonia by 23%. In all, the railways carried 9.4 million international passengers during the period (RZD, 2004-09-08).

2.4.2. Road

The Russian motorway system includes slightly under 400 000 km of paved roads, from a total of about 950 000 km. The problem with this huge system is that it is still not enough, leading to a very low road density at the same time as the configuration of the network leads to high expenses for road transportation. The Russian road system in 2004 corresponds to just over 5 km per 1 000 inhabitants, while the same figure in the US and France are 13 and 15 km, respectively (SIKA, 2004-06-10).

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- 105 - Road transportation in Russia is an increasingly problematic sector as car ownership has increased by about 7 – 10% per year in later years. As a result, traffic density has doubled in less than ten years while the construction of new roads has slowly declined and by 2004 it is far from keeping up with the rate of degradation of roads. Partly as a result of poor road conditions, with roads being under-repaired and with many incomplete construction projects, the number of accidents the roads have increased sharply, and the death toll is approaching 100 per day80. The reason behind this situation is both a lack of financing and the way the allocated funds have been put to use; often not in competition and most often without transparency, how funds are being used. In recent years allocations have gone down, in relation to GDP, from around 3% in 2000 to 1.5% in 2003, with a figure around 3-4% being the standard in the west (Duma, 2004- 06-10).

The government launched a road-building program in late 2004 that will increase the funding for road building to previous levels. At the same time, privatisations in the construction sector and new working methods are hoped to improve the productivity of road building as well as that of maintenance projects (Ru-Gov, 2004-10-15). Allowing for private investments in the building of roads has also been suggested, but the generally low-income levels and low car ownership to international standards limits the road sections that could be of interest to investors to only a small fraction of the road net. Investments in road building would also be a very long-term investment for any investor, with currently unforeseeable legal risks and more questions than answers in the future.

To attract international interests concessions for road building must be very clearly defined and this has not yet been formulated in the legislation. It must clearly stipulate the period of both construction and guarantees for road usage, to give investors a fair chance to see a return on their money before the contract expires. One way used elsewhere is to sell established state toll roads to private investors, with the rents from such projects being channeled into the building of new state toll roads. Another alternative is to give a concession to investors who invest in road construction along with the government that includes land near the road that would compensate the investor for the costs. This alternative is probably only possible where there is a considerable demand for services from motorists, like gas, food, shopping, and entertainment. As referred above, by Prime Minister Fradkov, a motorway Moscow – St Petersburg – Helsinki could be a suitable pilot project for this kind of private - state joint partnership (Kommersant, 2004-10-07). This project of 735 km of motorway valued at over USD 6 bn was presented already some months earlier by the Federal Road Agency, for a construction start during 2004 or possibly 2005. No partnership

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- 106 - was indicated at the time and the estimated costs, for a road of relatively limited demand, would largely consume the totality of what is currently available in the road funds (SeaNews, 2004-05-26). Just weeks later, a somewhat surprising Chinese investors’ group was presented, with an interest in the private 50% of this five year and USD 6 bn project (Kommersant, 2004-10-07 & MT, 2004-10-19).

The largest road investment in Russia in later years has been directed to the Far East in an attempt to, in the near future, make it possible to make the 10 000 km drive from the Pacific coast to the Baltic Sea, all year around. This is a project that already started in 1978, but came to a standstill in the 1980s, saw a restart it in the 1990s, but rampant corruption made it come to a halt again until 2002. The construction effort was again restarted and when President Putin inaugurated a large new trunk of road in March 2004, the ceremony also carried a strong symbolic meaning. It showed the intentions of the central government of holding together the vast country. Funding for this project has increased considerably, and at times has corresponded to near 25% of available investment resources. It has been estimated that spendings on the Trans Russia Road Project have reached USD 1.3 bn since the project began in 1978 (RRR, 2004-08-31). Much construction work has been assigned to the military, but as among other constructors, a considerable share of the money assigned for the project has been filtered away from its original purpose. A stable supporter in the road sector has been the EBRD, that has lent a total of USD 520 millions to two projects in the Russian road sector, for the St Petersburg ring road and this Trans Russia Road Project. The money has been made available on 15-year loan terms, with USD 130 millions in September 2003 and another USD 160 in July of 2004, despite the bank having had its project inspector killed in the Amur Oblast (EBRD, 2004-07- 04). When there will be a ready road, in a few years time, the Trans Russia Road will be no less than a new window to the currently expanding Chinese market. Its use can particularly be expected to improve business conditions for small- and medium-size industries, in the service sector as well a trading of both inputs and products for local and external markets.

Motor Industry: The volume of domestically produced cars in the Soviet Union and Russia has never been comparable to countries in the West, and neither has car ownership. In the years after the break-up of the Soviet Union, the industry first grew in importance with car ownership becoming only a question of money. However, already after a few years, it fell back again, after being hard hit by a continued increase in imports of new and second hand cars; from Europe in western Russia and from Japan in the Far East. In response to the pressure from domestic producers custom tariffs on imported cars have been changing regularly and has been lifted to near 100% of the original car value.

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- 107 - Ownership in Russia is on the rise from the late Soviet time level of around 50 /1000 inhabitants to around 80/1000 in 1998 to near 200/1000 in 200381. The differences are considerable regionally as Moscow is said to have well over 250 while, e.g., the Far East is set around 150/1000. From industry sources it is projected that the car ownership level should have reached about 8 out of ten families by 2015, from under 3 currently.

Production in Russia stood at 1.1 million cars in 2003 and is not expected to increase dramatically, with 1.2 million being produced by 2010 (MOETD, 2004- 08-04). During the first nine months of 2004, the domestic vehicle production has increased by 13%, over the year before, to 924 000 units. The volume of cars increased by 14%, to 735 000, or 80% of the total, with 140 000 being trucks and the remaining being a mix of other vehicles. The biggest producer of cars, AvtoVAZ, with its main brand name being LADA, is in the second half of 2004 producing at a yearly rate of 720 000 units (AvtoVAZ, 2004-09-14). Several of the domestic car manufacturers have attracted investments from international manufacturers and are currently producing not only their own brand as well as cars based on foreign design, but also foreign brands. Such examples are GAZ (Gorky Automotive Works, Volga model – in Nizhny Novgorod) has attracted capital from Italian Fiat, AvtoVAZ (Volga Automotive Works, Lada model - in Togliatti) has lined up with both GM and Korean Ssangyong to set up production facilities for SUVs, and UAZ (Ulyanovsk Automotive Works, jeep models in Ulyanovsk) is lining up with Nissan. A number of foreign producers have opened assembly lines in Russia under different arrangements, like BMW, Ford, GM, Hyundai, KIA, Opel, and Renault. These now produce or assemble imported, more or less completely knocked down (CKD) cars. An increasing percentage of the parts used for these foreign brands have been replaced by locally produced parts. The reason for this is twofold, prices are considerably lower for local parts and import taxes for parts are high. Sales of these are expanding rapidly and the Russian production of foreign brands reached beyond 140 000 during 2004, which was 140% up on 2003. With its current rate of increase, full year sales are estimated at around 145 000 well surpassing 10% of the total after having stood at 1% in 2002 (RJ, 2004-08-04). Although production of locally produced foreign cars expanded rapidly during 2004, it has still not reached more than 40% of foreign car imports, that was up by 80% during 2004 to 350 000 units. For 2005, it is expected that the increase will continue at a somewhat slower pace, or about 40% for the year, lifting the total above 500 000 (Vedomosti, 2005-01-18).

Joining forces with foreign producers has proved problematic, especially in the early years of transition, and many of the partnerships have been rumored for years before they came about. A new dimension of central control in this sector

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- 108 - was introduced by the Federal Antimonopoly Service in the spring of 2004. It ruled that a clause in the agreement between AvtoVAZ and GM that regulated the production volume of the Chevrolet Niva and the old Niva model is Il legal and must be removed. The production of the old four-wheel-drive Niva model has been held back during the beginning of the year, to allow for larger sales of the more expensive Chevrolet Niva. This is an unusual twist to conventional market economic thinking, as AvtoVAZ is both main supplier of parts for the Chevrolet Niva model and JV-partner (Itar-Tass, 2004-05-26). Having sold its own make model for over 25 years it cannot be seen as unreasonable that the company deliberately reduces production.

Of the producers from the NEA region, Daewoo was an early mover to venture into Uzbekistan in 1993, and has much regretted this, while the production unit set up in Kaliningrad from 1999 has been more successful. KIA is already producing in Russia and has seen sales rise sharply and is upgrading plans to produce 55 000 units by 2006. Both Toyota and Nissan are planning to start production in Russia, initially based on CKD that will be shipped, with a gradual increase of sourcing from local parts’ suppliers. This is the result of who both companies have seen yearly sales volumes develop positively, and saw sales jumping by near 50% and 70%, respectively, during 2004. Six of the seven top selling foreign brands for 2004 were from Korea and Japan, with Hyundai leading the list with sales of 51 000 during the year, up by 230% from 15 000 in 2003, and only 6 000 in 2002. Toyota came second, selling 44 000 (+40%), followed by Ford, selling 40 000 (+90%)82. Of these three both Hyundai and Ford assembles cars in Russia while Toyota and other NEA producers have been considering joining-up with a local producer. At least Toyota will build a factory of their own, which will be the first Japanese car factory build in Russia, at an estimated cost of USD 90 bn (Nihon Keizai, 2004-08-16). What for years have been among the most important export flow from Korea and Japan has not been new cars, but instead second hand cars. A trade so important that it is one of the issues that it is said to have held up Russia’s bilateral agreements in preparation for the WTO with Japan and Korea. From Japan alone approximately 150 000 cars and additional some ten’s of thousands has yearly been Il legally exported to Russia in later years (JT, 2004-06-03).

Russia’s main truck maker, GAZ, is in the second half of 2004, producing at a yearly rate of about 100 000 units (Itar-Tass, 2004-10-05). While GAZ mainly produces smaller distribution vans, also the most important heavy truck maker, Kamaz, with an over 30% share of heavy truck sales, i.e., >12 tons, increased production by 30% during H1 to near 14 000 (Kamaz, 2004-08-12). Also, a number of large foreign truck manufacturers have entered the Russian market, where both Scania and Volvo are currently assembling CKD units and are intending to increasingly source its parts locally.

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- 109 - 2.4.3. Water transport

Shipping At the time of the falling apart of the Soviet Union, ownership of high sea ships and shipping companies came to be split up among the new states. The city of registration for the different shipping companies came to serve as the base for the reorganization. The process came to result in some odd outcomes, as both the Ukraine and Latvia came to inherit large tanker fleets, as a result of the shipping lines that had formally been registered in Odessa and Ventspils, while neither country produces any oil for export. The same occurred also for the inland shipping where it was practically only Azerbaijan that, after the reorganization, had ships in the Caspian Sea. This was because the Caspian Shipping Company had been registered in Baku.

Although the shipping sector saw these kinds of outcomes from the split-up of Soviet time assets, ships are still both movable and sellable objects if they cannot be made use of, while ports are strongly bound to their geographical location. Ports are, in all respects, important as a vital point in the transport chain to handle international trade. Also in this line of business, the emergence of new borders came to produce a number of unforeseen situations. The centralized planning system of the Soviet Union had not foreseen that the cargo-generating areas in central Russia would ever be separated, by national borders, from the ports where the cargo were to be loaded. The ports in Odessa and Ventspils are again good examples as their oil terminals were both to experience the complications of relying on long distance sources for the cargo volumes they handled, and that later came to be greatly reduced.

During the 1990s the Russian Government long discussed the need for a fleet revival program, as the average age of ships in Russian fleet in the mid 1990s had reached well above 20 years. Newer ships, controlled by Russian companies, fly foreign flags to avoid the hefty state taxes. Much of the reason being that a ship build abroad and “imported” to Russia would have taxes corresponding to about 25% of its value levied. In 1992, about 800 merchant ships were registered under Russian flag, with a total of 10.6 million dwt. By mid-2004 the register had 200 ships with a total of 2.7 million dwt, with none of the 34 bigger ships built during the last five years flying a Russian flag (MinTrp, 2004-11-15). Since the turn of the century a fleet renewal program has been initiated, with the largest Russian based shipping company, with fully state owned Sovcomflot, as its main beneficiary. Sovcomflot has since 2000 through 2004 tripled its tanker fleet, to 45 ships, and during 2003 it carried 16% of the Russian oil export, or 10 mt out of 64 mt, to overseas markets. As a result the share of Russian foreign trade has been on a continuous decline. The continued orders placed for new ships by

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- 110 - especially the two major Russian shipping companies, in first of all Korea, but also in Japan and Russia, indicates that this expansion is far from over (Sovkomflot, 2004-08-15)83. Despite being state owned, the Moscow based Sovcomflot has during the last year started to register ships in Cyprus and Malta, and seen a sudden change in CEO to the former Minister of Transport, Sergey Frank (SSG, 2004-10-13). The second biggest shipping company, Novoship, on the other hand, was already the biggest Shipping Company in the Soviet Union under the same name. It was recreated after the break-up of the union, and has come to register most of its ships abroad. It has also set up an operational unit in London, which has taken over an increasing share of the duties from its former centre in Novorossiysk (Novoship, 2004-08-15). A new policy at Novoship, among others, could be under way, as after years of debate the ministry of transport has issued a proposal of a second, parallel, Russian ships register that would avoid the tax problem mentioned above (MinTrp, 2004-11-15). A register that in some year’s time is hoped to attract some 750 ships to a total of 17 million dwt and to a value of USD 13 bn.

Inland waterways The Russian inland waterway system links the Black Sea with the Caspian Sea through Volga and Don, but can also be navigated north to reach both the Baltic Sea as well as the White Sea. Practically all major Russian rivers are navigable, but most larger rivers are floating north – south, and not west – east, as would have served the existing transport needs better. In the beginning of the 1990s Russia had about 100 000 km of navigable waterways, but how much out of that figure that can be used today is difficult to assess, but probably something in the range of 60 000 km. So far, the long awaited opening for internationally flagged vessels to use the inland waterways has still to happen. What limits the use of the vast waterway system, and its development, is the many years of general degradation, due to low levels of maintenance and non-fulfillment of the constant need for dredging.

Ports During Soviet years, the location for the big ports was chosen to fit the existing transport needs and infrastructure at the time. The cargo handling, that the ports were built for, was the type of cargo traded by the Soviet Union and not the kind of cargo, and the kind of cargo handling, that is a part of the 21st century. During recent years, Russia has been very active in constructing export outlets for its expanding oil production, attempting to meet a growing demand for transport and export capacity from oil producers. This ongoing construction effort has led to the building of new oil pipelines and export terminals, which geographically has focused on finding as favorable as possible locations, but restricted to the limited shoreline available inside Russia. An integrated part of the Russian transport strategy over the last few years has been to actively support its

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- 111 - domestic port sector through lower transport tariffs on the railways. When the destination has been a foreign port for an export consignment, sent by a Russian producer, the tariff has been considerably higher than to a domestic port. Of the handling in Russian ports, all commodities and a large share of other cargoes arrive by rail to the ports. Simultaneously, domestic ports had been expanding their handling capacity rapidly, in practically all cargo categories during these years. From 2005 this policy will be reversed. Rail prices for domestic cargoes will increase by 12%, and a strike among port workers against the decision has not made the railways change their decision (SSG, 2004-12-20).

With so much of the Russian export destined for the European market, it came natural to locate a new large port on the Baltic Sea in the Gulf of Finland. The Russian government has given priority to increase the capacity of the Primorsk terminal, which is to become at least as important for Russia’s oil export as the terminal in Novorossiysk at the Black Sea. With access to only a short western coastline, the locations to choose from were few and the drawback of the Primorsk location is heavy ice conditions for many months of the year and it is located on the border of a nature reserve. The need for new port capacity for oil was enhanced when the Russian pipeline operator Transneft, in late 2002, decided to stop using the existing 30 mty Latvian terminal in Ventspils. Growth has also been exceptional at Primorsk and from having loaded its first ship during the last days of 2001, it has by the autumn of 2004, ahead of schedule, reached a capacity of 40 mty (Shipgaz, 2004-09-23). The continued expansion at the Primorsk terminal stops no short of a capacity of 60 mty by the end of 2005, and with also other terminals under construction, the Gulf of Finland is clearly becoming increasingly important to the Russian oil export.

Oil is, despite the enormous distances involved, not only being railed to ports in the Barents region, but also by ship along the Arctic coastline for reloading. Exports in the Barents Sea area are expected to triple from the 2.5 mt that was exported during 2003, to 6 mt in 2004 and up to 8 - 10 mty already during 2005. In late 2003, the VLCC tanker Belokamenka was anchored in Murmansk, on a 15-year charter, to serve as reloading storage for smaller tankers loading in Arkhangelsk or Vitino. The advantage is that the area from Murmansk and westward and is all-year ice-free conditions.

In the Far East, Russia has a long coastline on the Pacific Sea, but relatively few major ports. Out of what is possibly ten different alternatives, it is the three southernmost ones, Vladivostok, Vostochny, and Nakhodka that are the most important. Outside these, the Vanino / Sovjetskaja Gavan port and the new oil export terminal, from the new Sakhalin oil fields in De-Kastri, are the other with a larger share of international shipments. These ports are all highly dependent of

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- 112 - export cargos, often to some 70 – 80% of their turnover and a large share of this being deliveries from their mother companies. Ports in Petrosavodsk Kamtjatskij, Yushno Sakhalinsk and Magadan are important, but only so for domestic goods flows. In the four commercial ports in the region, the type of cargoes handled has widened with steel and containers as new and increasingly important products. Currently, a major share of the Russian coal export transits the Far East and the large coal terminal in Vostochny, where an export of 15 mty has been handled in later years. The main problem for the ports in the Far East are that they are located thousands of kilometers away from their main markets in central Siberia, and nearly two weeks away from Moscow by regular freight train – or over 9 000 km. This has not stopped large financial (coal- or steel- based) groups, generating large export volumes, from buying up controlling stakes in the largest ports in the Far East. Kuzbassrazrezugaol in Vostochny, NMK in Vladivostok, Evrazkholding in Nakhodka (both the commercial port and the fishing port); near the Korean border Universe Holding controls the port in Zaburino and the MDM Financial Group in the Poset port (RRR and Vladnews, various dates)84. The last two of these ports have been under discussions for a long-term lease from the Chinese side, as alternative port locations for Manchurian industry and mines are few, but the idea has been opposed by both the other ports and the regional authority. With the formal decision taken about a pipeline to the Far East the market will change dramatically. Inside the next five years, Nakhodka is to become the by far largest port, at the same time enhancing the strategic and economic importance of the whole region.

In later years, Russia has also made use of some oil terminals outside its borders to handle its exports, like the Lithuanian port of Klaipeda and it neighbor off- shore terminal of Butinge, but also the Polish port of Gdansk. This use of foreign ports has been selective though, as the pipeline to the Latvian port of Ventspils has been taken out of use, while oil shipments by rail to both Ventspils an to Tallinn in Estonia have continued to expand. Practically the same pattern has been observed in the Ukrainian port of Odessa that previously served as big transit port served by pipeline.

The administration of ports in Russia was reorganized in 2003, in line with the reorganization of the Ministry of Transport and is now run under the Rosmorport organization. It was formed to separate surveillance and safety from the commercial aspects of the port operation, which now is administered by the 25 affiliates that Rosmorport have located in different ports. Currently, different fees for domestic users, or visiting ships in the ports, are paid to different operators under Rosmorport (SSG, 2004-10-04). The minister of Energy, Khristenko, has revealed plans to increase loading capacity over the medium-

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- 113 - term to 433 mt by 2010, with the pipeline capacity to have reached about 300 mt. By 2015, there should be a pipeline to both Murmansk and the Pacific Sea, initially with a capacity around 30 mt and should have reached some 80 mty by 2020 (RJ, 2004-11-26).

2.4.4. Aviation

For a country of the size of Russia, air transportation is of major importance. Large parts of the country have limited possibilities for land transport with air transport taking something well over 50% of long-range passenger transportation. At the stage of the break-up of the Soviet Union, the capacity of the aviation sector was at a comparable level with both the EU and the US. What has happened since was first of all the break-up of the monopoly Aeroflot into a lot of different companies. Out of these, few proved stable enough to survive the initial stages, as they were seldom very profitable. This led to a situation with a generally very low replacement level of an aging fleet of airplanes that already were of an old design. Sadly enough the result was numerous crashes involving Russian airlines, which further eroded the airline industry’ already battered confidence among passengers. The few airlines that survived the hard years, and that have come out of the stagnation as reliable carriers, most often fly a fleet with a number of rented foreign-made planes. Out of over 200 carriers the three largest are Aeroflot (carrying 7.2 million passengers (5.9 in 2003), Siberia 3.9 (3.2) and Pulkovo with 2.8 (3.1) (Aeroflot, Siberia, Pulkovo, 2004-06-10 & 2005-01-18). The Russian airfreight market is still small, but quickly expanding. The two dominating devoted airlines are Volga-Dnepr and East Line (Volga-Dnepr, East Line, 2004-09-09). Among the conventional airlines, Aeroflot dominates with an expected volume of 140 000 tons in 2004, which would be up by 30% in 2003. About 40% of the 2004 volume was flown by its devoted four freight DC 10s (Aeroflot, 2004-11-29).

By decree, the President has initiated a merger between two of the biggest airlines, Pulkovo and Rossia that will take effect in the middle of 2005 (MT, 2004- 09-03). The merger will not include the airport in St Petersburg with the same name, Pulkovo, and neither the part of the Rossia Airline that fly the president and the government. Together, the two will control a fleet of nearly 90 aircrafts, with Pulkovo contributing 45 and Rossia with about 40, nearly challenging Aeroflot’s fleet size of 110. However, 30 planes will remain by Kremlin and as the two merge, it will be under the name of Rossia, despite being only ¼ the size of Pulkovo in passengers (MT, 2005-01-27). It is still Aeroflot that dominates the international market, carrying about 40% of all passengers while the domestic share has fallen to about 10%(Aeroflot, 2004-06-10). The Russian state still owns 51% in Aeroflot, a share that is scheduled for privatization during 2005.

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- 114 - During the previous political system, aviation was also heavily subsidized, which led to a high level of over usage as prices were set far below actual costs. In later years, when prices have had to cover costs somewhat more accurately, this has hit those far-off regions the hardest that are practically without alternative means of transportation. Other related problem areas in the aviation sector has been infrastructure at airports and runways as well as that for air traffic control.

During Soviet years, the importance paid to maintaining air connections among cities demanded an aviation industry of a considerable size. Based on the construction of military aircrafts, a civil aircraft industry was also developed in the 1950 and onwards that included well-recognized brands like Tupolev, Ilyushin, and Antonov. In line with the brutal fall in profitability in aviation, airplane manufacturing also came to a near standstill after the break-up of the Soviet Union. As in so many other industry sectors problems became worse by the simple fact that different branches of the same sector were now located in different countries and not only were they facing the difficulties of conflicting national interests, but also non payments for previous deliveries and currency problems coupled with large scale inflation. As the sector had been producing technically outdated products, it soon proved practically impossible to try to find an export market. After years of struggles, large scale downsizing, state mergers of the industry and a number of JV with large foreign manufacturers new planes are reentering the market with the brand names Tupolev, Ilyushin and Antonov still in production. Tupolev/Ilyushin aircrafts are still being produced in different civil aircraft versions for 100 – 200 passengers, while the Antonov company, now a Ukrainian one, has its focus on freight planes (Tupolev; Antonov, 2004-09-10).

2.5. Other

2.5.1. Iron and steel

During Soviet years, the expansion of steelmaking had a strong symbolic meaning, all from the early years of the revolution and the first economic five- year plans where iron and steel were the most important of the industrial sectors. Soviet steel production was, for decades, also the only to challenge US volumes and to ultimately surpass it for the first time in the beginning of the 1970s. The Soviet Union, and later the CIS, then remained the world’s largest producers until after the break-up of the union when surpassed by Japan in 1993, but with production continuing decline until 1998. During Soviet years, about 60% of production came from producers in what today is Russia. Total

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- 115 - crude steel production for the three biggest producers in the former CIS, Russia, the Ukraine, and Kazakhstan in 2003 was 63 mt, 37 mt, and 5 mt respectively. Russian consumption during later years has been relatively stable around 20 mty, while production again started to increase about five years ago including 2004 (IISL, 2004-12-12). Average production costs for basic steel products in Russia are estimated not only to be by far the lowest among all major producer countries, but also among the lowest in the world; some 25% below Korea that have the second lowest (combined from IISI and WSD, various dates).

There are not only large and small-scale producers of steel in Russia, but also a number of in-house steel mills at some of the largest machine building and engineering companies. The ten biggest producers account for a very dominant share of rolled steel, but are less dominant in “flat” and “long” products85. Russia is also one of the relatively few countries that are fully self-sufficient in raw materials for its steel industry including coal and other metals. Since the beginning of transition the Russian steel industry has, based largely on price competitiveness, sharply increased its export to western markets, although the Russian steel exports have been met with strong resistance in many foreign markets with the setting of quotas and the introduction of other import restraints. As Russia is not a member of the WTO, this has been possible and had to be dealt with bilaterally in each individual case. Much of the export is directed towards Asia with the EU market and the US to follow in importance with rolled and flat products being the most important on the export side.

Russia’s biggest producer, EvrazHolding, produced near 14 mt of crude steel in 2003, with the MMK Group, producing about 11 mt, Severstal just under 10 mt, and with the number four producer, NLMK about 7 mt (EvrazHolding, MMK, Severstal, NLMK, various dates).

However, during the last three years, Russian consumption has increased faster than world demand, up by 14% in relation to 7% per year, with prices in the domestic market increasing by some 20% during H1 2004 (Metal Bulletin, 2004- 08-12). Exports of steel products have increased in volume during the period, but even more so in value that has jumped by 70% to USD 6.7 bn from near 11 mt of products exported during the same period (Interfax, 2004-09-08). Russian producer, like most producers around the world, are profiting greatly from increasing demand and prices, with all the major producers having increased their profits many-folds over the last three years (Bloomberg, 2004-09-15). As an example, Severstal, Russia’s number three producer, had net profits from 2002 of USD 180 million, USD 590 in 2003 and with expectations of a profit of well beyond USD 1 bn in 2004, with the other majors posting earning in the same category (Severstal, 2004-10-29). These numbers have helped the industry to

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- 116 - reduce financing costs further through greatly improved credit ratings from international institutes. Also the operation has improved greatly over the years, which the inclusion of Severstal as number two, rising from number five in just one year, on the listing of the world’s best steel companies for 2003 indicate (WSD, 2004-06-21).

Inside the industry, the increasing wealth has fuelled speculations that the future will include large-scale international expansion. Initiated by the Severstal acquisition of the US steel maker, Rouge Industries, for USD 286 million during early 2004. The Russian steel industry has a strong competitive edge in low costs and strong demand from an economy showing strong growth figures. It also attracts a considerable foreign interest as the state being set to privatize its 24% share in the MMK Company during 2005. The future in the sector is somewhat contradictory, as Yevraz has stated to cut production due to slightly falling prices and demand, after having stated increases just months before. At the same time, the company is investing USD 60 millions in Novokuznetsk to increase production from 0.9 to 1.5 mt (Bloomberg, 2004-06-15). Examples indicate that any deeper understanding is not really possible without a deeper knowledge of the industry in question and relatively detailed information about prices and production86.

Other big mineral extractors, and metal producers, are Norilsk Nickel near monopolist for both nickel and cobalt while producing over 50% of the copper. It is also world leader in the production of the rare earth, and high value, metals like palladium and platinum. Norilsk Nickel is another company in the mining sector that is expanding internationally by its takeover of a 20% share in South African Gold Fields Ltd. for USD 1.2 bn in March 2004 (Norilsk, 2004-07-01). A deal that has been discussed to be as much as way to secure foreign assets for its owners as it is a conventional FDI. Polimetall is another of Russia's largest miners of gold, 6.6 ton, up by 60% over 2003, and 537 tons of silver (+47%), placing them among the world's top-ten (Canadianminingjournal, 2004-08-31 & Itar Tass, 2005-01-20).

With energy costs making up 30 – 40% of the final price of aluminum, it is not surprising that Russia is a world power in the refining of aluminum. That is despite the fact that Russian smelters so far have had to import most of the raw material in the form or alumina (aluminum oxide) used in the production. As energy consumption in the electrolytic process is so large, the location of the two biggest smelters in the country, at Krasnoyarsk and Bratsk, with the latter being the largest smelter in the world are not surprising. Both are to be found near two of Russia’s biggest water power stations, which well offset the fact that they are found 5 000 km away from the nearest port. Just these two units turned out

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- 117 - about 1 mt in 2003. During the year, RUSAL produced about 2.6 mt out of the Russian production of just over 3.5 mt (RUSAL, 2004-08-01). As the domestic consumption is less than 10% of the production volume, 90% is being exported, making Russia the world’s leading exporter, only being behind China in production volume (Canadianminingjournal, 2004-09-23). Restructuring in this line of business has been dramatic and the now dominating industrial group, RUSAL, produces 75% of the national production and 10% of the world’s primary aluminum. With aluminum being a sensitive industry, Rusal’s attempt to sell off two of its less productive units, in Samara and Belaya Kalitva to the world’s largest producer, Alcoa, has long been awaited official approval.

The second largest among Russian aluminum producer is Siberian Ural Aluminium (SUAL) with an output of about 900 000 tons for 2003 with over 80% of this exported (SUAL, 2004-08-01). SUAL also holds Russia’s largest bauxite finding, from which only 1 million tons were extracted during 2003 at a smaller bauxite mine in Sredny-Timan in the Republic of Komi, and shipped to the nearby alumina refinery, out of near 4 mt extracted in total. To multiply the mining volume, SUAL has been trying to attract the interest of numerous overseas aluminum producers and miners for a joint investment project in the range of USD 2 bn, but with little success so far (SUAL, 2004-08-17). On the other hand, SUAL has had success in expanding in the local in taking over Russia’s smallest smelter in Volkhov and the Pikalyovo alumina refinery from Metallurg (Reuters, 2004-10-05).

In titanium mining the worlds largest mining company, BHP Billiton, has been named by LUKoil as possible partner in developing Europe’s largest titanium finding, at Yaregskaya oil and titanium field in the Komi republic. A combined field that is estimated to hold about 640 mt of ore, but also 31 mt of oil. It was only after a similar offer to Russia’s only titanium producers, Verkhnaya Salda Metallurgical Production Association, had been turned down that Billiton was invited. A partner is needed to build a processing mill and to market the output (Vedomosti, 2004-10-28).

For the first time ever, Russia during 2004 released official figures concerning its output, exports, and imports of diamonds, and the numbers are not as huge as has sometimes been rumored in the past. During 2003, the production value of diamonds reached USD 1.7 bn (33 million carts), and after a slight increase during H1 2004, the value reached USD 948 million (18 million carats) (RJ, 2004- 12- 23). During 2003, the export of rough industrial diamonds corresponded to about half the total value.

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- 118 - At times when prices are high, mining could not only be a highly profitable business, but it is also a considerable pollutant and is seldom a welcomed newcomer in not well-established exploration areas. It is also a line of business that, in its search for new findings, is eager to overcome administrative hurdles. An example of this in the NEA region could be the large-scale corruption scandal that erupted inside mineral resource extraction in the Khabarovsk Krai. The head of the Department of Natural Resources and Environment Preservation in the Krai was in the beginning of 2004, arrested on charges of extortion and the taking of bribes. This has led to cancellations by some 60 awarded contracts for mineral exploration in the Krai has, after having been re- examined in Moscow (Interfax, 2004-02-22).

2.5.2. Forest

Despite being the country that holds the by far largest forest reserves of the world, the Russian forest industry remains greatly underdeveloped. The margin for improvements is high as the industry has, especially since the break-up of the Soviet Union, concentrated on supplying raw materials to neighboring markets and on producing basic products for the domestic market. It has lacked investments and has not been able to make use of its potential for value-added production for sales domestically or internationally. During Soviet years, attempts were made to upgrade production in the sector by considerable investments, which included bringing in foreign equipment on a large scale. Investments were mainly directed towards large paper and pulp plants, with several of these intended to export parts of the production. However, forest- related activities remains an industry, which will offer substantial long-term investment opportunities for many years to come. The abundance of natural resources available, being international cost competitive, with increasing domestic demand, will for a long time provide a good base to transform the sector. The geographical spread of the sector can make it become an important growth sector in the economy, especially in northern and peripheral areas with few other mineral resources.

The sector has, over the transition years, been one of the least centrally controlled and also one where corruption, e.g. to obtain felling permissions, has been wide spread. This has also left its mark on production statistics that can be assumed to be even less reliable here than in nearly any other sector. Since the sharp devaluation of the Ruble in 1998, made Russian wood production, as well as all other products, has even more price competitive than before. Exports have largely been on the increase since then. The control over the Russian forest has, during transition, been legally based at the regional level,

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- 119 - and to improve cohesion, a new forest code was adapted during the spring of 2004. The new code is expected to generate much greater federal control of Russian forest resources. Minister Gref hopes that this will increase foreign investments in the sector as well as reducing the export of logs and instead promote the production of processed forest products, as a way to use available resources more efficiently. The government also wants to improve the timber- processing sector and by increasing taxation on the export of unprocessed products, it hopes to support the value-added side of production (MOEDT, 2004-03-10). The new code will make it possible to sign extended lease terms for forest up to 49 years. Currently, the maximum is five years, and it is hoped that the longer term of lease will make investors put at longer-term perspective on their ownership. Rights will first of all be sold (that is, for lease) at actions, which critics fear, will lead to that only rich foreign companies will win tenders; as what happened with fishing rights when a similar reform was made. Therefore, there is a growing concern in forest-rich regions, like Karelia, that foreign owners that win tenders will not accept any social responsibility for exposed smaller communities in forest regions (Karelia, 2004-10-15). At the same time it is not very likely that many foreign bids will be given at auctions if the most important in the bid is how much money that will be set aside for local infrastructure and initiatives in the social sphere.

Alongside energy and marine products Russian forest products are an important export products from especially the Far East to countries in NEA. It is also a product category that carries a considerable potential, as the surrounding markets are all large consumers with a limited domestic supply. Timber and other forms of processed products are important transport generators in each step of its elaboration with the export reaching over 10 mt in 2004. Russia holds about 22% of the world’s standing timber and is increasingly serving as a growing source of low-cost timber and wood fiber source for other parts of the world.

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- 120 - 3. Japan

3.1. Introduction to Japan87

From about 1950 on to the first oil crises in 1973 the Japanese economy was subject to a lasting positive trend, with an average GDP growth of 9.7% to show for it. The years that followed did not prove as predictable, as strings of good years were mixed with lows, but still maintaining an average GDP growth of 3.7% over the next 20 years. However, by the late 1970s and during the 1980s Japan was monitored as something like the model of economic achievement by countries in the west. Something that was to change with the stagnation period that set in around 1990. As a result Japan has instead come to be looked upon as an example of near constant stagnation over the last 15 years. Since 1992 Japan has only registered GDP growth of above 2% during 1996 and 2000, but actually only one negative year, 1998. Although the GDP growth figures during the 21st century cannot be compared with previous decades development, things have indeed changed for the better. Japan’s economic growth figures for 2003 became the best in 13 years, indicating an export-led recovery growth of 6.4% and the most promising economic recovery since the big downturn in the early 1990s. For 2003, Japan outstripped growth in the US and by a large margin that of the EU. At the same time Japan's currant-account and its trade surpluses have grown steadily since late 2003 until the end of 2004.

3.1.1. The Japanese Economy

The positive development of the Japanese economy since the beginning of 2004 has been better than expected and the annual growth of GDP for the fiscal year is, by the Bank of Japan (BOJ), expected to reach 3 – 3.5%88. This is based on the continued strong growth in exports to China and the United States, and hopes that the positive effects should come to spread into the national economy (BOJ, 2004-04-29). During 2004 the positive economic trend has proved stable enough to make also international institutions like the IMF upgrade predictions for the full year, and substantially so, from 3.4% to 4.5% (Kyodo, 2004-08-12). Not only was the forecast for 2004 the highest given in ten years, but also the forecast for 2005 was upgraded from 1.9% to 2.4%, as the economic problems seemed have eased. The clearly lower figures for 2005 comes from the fact that trade with especially China is expected to slowdown to a less booming level which will also moderate the Japanese export expansion. The Japanese economy has in real terms continued to expand during most of 2004, but at a falling rate as the first quarter GDP was up 1.4%, second 0.3% and with only a 0.2% growth during the

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- 121 - third quarter (METI, 2004-12-08). In the autumn of 2004, a new method to calculate the GDP was introduced, said to better reflect the effects of inflation and deflation. Instead the economic progress during the three quarters in real terms came out as 0.3%, –0.6%, 0.1% respectively (PMOJ, 2004-12-24).

During 2004, the government has constantly kept issuing positive assessments of the economy, but has also stayed cautiously about the effects on the economy from the upward trend in raw material prices. With companies having seen the positive effects of the positive economy, clear indications are still to be seen from that this has spread into the private sector. So far, neither the economic upturn nor the interaction between these two sectors of the economy has been as strong as could have been expected. Companies have generally been able to increase profits resulting in slightly higher share prices since the year before. At the same time, both investments and wholesale prizes increased, while unemployment has slowly started to fall, to a six-year low of 4.7%, which are all factors that should indicate an expanding economy. The 1.3% rise in wholesale prices was the first in over six years, but consumer prices still fell by 0.1% during 2004 (PMOJ, 2005-01-28). By mid 2004 it was expected that the pace of industrial production growth would gradually slow down, with exports to remain steady (METI, 2004-07-29). Seen to the full year figure, that is exactly what came to happen. The production increase for the year came to 5.5%, while during Q4 the rise in industrial production came to a very modest 0.8% (PMOJ, 2005-01-28). Despite several seemingly positive signs of a strong GDP development, the positive trend has slowed and deflation had by early 2005 not been fully overcome.

Given the recent upward trend in world commodity prices, it can be expected that also consumer prices will go up, but prices of intermediary products have remained stable, which can also indicate a fall in profits for business. Such effects of the rising prices have been absorbed in the business sector is shown by the fact that average wholesale prices in Japan did not rise during one single month from June 2000 until the next rise was registered in April 2004 (BOJ, 2004- 05-13). During 2004, it is prices for energy, metals and coal that lift the average having gone up by about 10 - 15%, while electronic products, phones, instruments and machinery have all seen falling prices during the year. Since 1995, with exception for 1997 – 1998, deflation has been a constant phenomenon in the Japanese economy. One of the most important long term goals of the government has been to break the long term deflationary pressure on the economy and rising wholesale prices could be a sign that this is about to soon happen. Possibly so, but the positive effects of the GDP growth still has not spread enough to have benefited the small- and medium-sized companies and regional economies. The first to profit from the positive development has been

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- 122 - the large conglomerates and the ones focused on exports, which has come to focus the improvements to the Inland Sea region. This very same region, along the inland sea, has shouldered much of the hardship during the long years of economic slowdown.

Confidence for a stable recovery is not only underpinned by strong demand from export markets, like China, but also strong domestic sales of digital electronic products. With a third straight quarter of sales gains, ending in June 2004, this became the longest streak since a seven-quarter increase that ended in September 2001. Household spending in Japan has been on a slow upward trend during 2004, with families spending a monthly average of 306 000 (USD 2 800). In the Japanese GDP, the household spending figure is of utmost importance as it makes up some 55% of the total (MOIAC, 2004-09-04). The upward trend has remained, but with a stagnating industrial production and with flat exports, and has resulted in a falling business confidence also among large manufacturer (BOJ, 2004-12-17). As a result major business leaders are expecting 2005 to become a year similar in development to 2004, which is a tendency that can probably be attributed to a record price for oil and the increasing value of the Yen (Kyodo, 2005-01-03).

There is apparently a widespread skepticism between the rather convincing macroeconomic data (in its first version) presented by the government and how the general public and the retail business see the situation. Increased sales of a product does not necessarily mean increased revenues if prices are falling, or have been lowered, as sales are equal to unit price times the number of units sold. Currently it is also frequently so that if products increase in capacity by 50%, which currently happens at a rapid pace for mobile telephones, computers and cameras, while prices remains unchanged, the figures become distorted. This is, at least theoretically, a 50% cut in the price of the product. In the different sectors of the economy, it is increasing unlikely, with ever-shorter business and production cycles, that all companies will face the same development, although the sector at large is developing well. During 2004, the price of both laptop and desktop computers in Japan fell by near 30% and in the Tokyo area prices in December dropped for the 63rd consecutive month, down by 0.5%, indicating a continuation of the trend of falling prices (JT, 2005-01-29). The state also has to take side in the development and decide where to use its resources, if it should invest in supporting the currency value or if the available resources should go to infrastructure projects. Factors outside the domestic market have also come to more directly and increasingly affect the development rapidly, with oil prices being a good example. Out of the final price of a product, the price for the raw materials being used is becoming an ever-smaller part, and Japanese manufacturers have so far been able to absorb these costs without

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- 123 - razing final prices. Another insecurity for the future is the interest rates that have been kept on a historically low level over the last few years. If, for the near future, interest rates remain low, then it is not unlikely that the current deflation could continue well into 2005.

When an economy, like in Japan over the last few years, is faced with falling prices an important factor in the discussion is the GDP deflator. It is an indicator that is derived from price fluctuations during the period, and has, in the case of Japan been on the negative side since 1998. It is used to recalculate the nominal GDP to real GDP, increasing the value in an economy facing deflation and reducing it for an economy facing inflation.

In the same way as the economy in Japan has showed low, or negative growth, the stock market has also developed poorly, but has nevertheless shown an increase of 10% over its August 2003 index. Apart from general pessimism, other culprits behind the slow stock development over later years is due to that corporate pension funds have been selling to dismantle cross holdings in the financial sector. At the same time private funds have to sell shares to be able to return to the state the assets from the pension funds they have managed on behalf of the government (JT, 2004-05-01). However, the relatively modest improvement in stock values over the last year is surprising as company pre-tax profits for fiscal 2003, on the first section of the stock exchange reached the highest level ever. Profits surpassed 20 trillion (USD 180 bn) and broke the 2000 record of 18 trillion (TSE, 2004-04-20). As in 2000, its large domestic sales of digital equipment that is said to not only have lifted profits, but also increased export along with cuts in costs and staff at many companies have boosted profits.

In the state budget for 2005, worth 82 trillion, the government has made an “utmost effort to cut costs” by marginally reducing other outlays and while seeing debt servicing costs increase (PMOJ, 2004-12-20). To make up for falling revenues, there will be a rolling back of a tax-break given in 1999 to lift consumption and a rise in the VAT, from its present 5%, has also been discussed to increase the 44 trillion-tax intake. Still, there will be a shortfall of near 34 trillion that will be financed by new bonds, which is over 40% of the budget. In the Prime Minister’s long-term plan, tax intake will cover expenditure, except for debt servicing by the early part of next decade. It can only be hoped that the country will not again enter into a stage of deflation. However, Japan cannot be to overoptimistic either about its economy, as it perhaps was in the late 1980’s. In the medium term there are important reforms to the state that should be carried through. Reforms that have been initiated are on the pension system and to local governance. Additionally, the privatization plan prescribed, among

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- 124 - other objects, includes the controversial privatization of the state Post beginning from 2007. The Post is seen as important due the fact that it will make it possible to dissolve huge postal funds worth 350 trillion (USD 3.4 trillion) from both public and private sources. Seen in the light of an aging population and a shrinking working population, a reform to the social welfare system, already absorbing 25% of the deficit state budget, is another increasingly urgent reform area.

Investments Domestic Investments The share held by the state in investments has fallen during later years, as a result of a deliberate government plan to create economic structures that are less dependent on state and public sector demand. At the same time domestic lending from banks to corporate customers has been on a continued decline for 83 months, from January 1998 to November 2004. Indicating that companies are first of all reducing their debts, at the same time as investments could have been even bigger (BOJ, 2004-12-08). Generally, Japanese companies are willing to invest, but something of a two tier system has developed where more companies are cash-rich after some good years while many are still burdened by debts (PMOJ, 2004-11-03). Japanese companies invest the correspondence of some 15% GDP in corporate plants and equipment in 2003, compared to about 10% in the US. The willingness to invest is underscored by the fact that during 2004, companies placed the largest orders for machine tools since 1990, up by 45% over 2003, to upgrade production facilities. In a situation with large investments and debts in a market where consumption is stagnant, companies have few other alternatives than to export.

Outbound Investments Already during the 1980s, Japanese manufacturing companies started to move out parts of its production to the “tiger economies” that were booming at the time. This had a relatively limited effect on the Japanese economy as a whole, and it possibly strengthened the economy, as the domestic market remained well protected from imports at the time. Still, it has been Europe that has remained the most important destination for Japanese overseas FDIs over the last ten years, being on a level of twice the amounts invested in other Asian economies. The second most important geographical area is North America that some years has nearly received investments on par with Europe (WebJapan, 2005-01-31)

During fiscal 2003 the Central Bank’s currency interventions absorbed much of the available funds that alternatively could have been used for investments abroad. At the same time, the low value of the Yen resulted in increased export.

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- 125 - In evaluations made by ministries it has been shown that domestic companies increasingly view China more as a market than just as a low cost production base (METI and MEXT, 2004-09-12). Although many Japanese firms have shifted much of their production bases to China and other low cost labor nations, they have at the same time proved reluctant to allow their latest technology to move out. Japanese companies have generally protected their advanced technology by keeping their development and production processes at their home base, in relative secrecy. What is more standard technology has been widely passed on to overseas facilities, but this is not the case for state-of-the-art technology, for this new Japanese production facilities have been build by many of the top electronic producers over the last few years (METI, 2004-08-12). The focus of production for these new installations has been high-tech products and automation, to compensate for labor costs.

Being the home country for a number of important outbound investors the transfer of profits and other payments have come to be of increasing importance to Japan. To a large extent, these changes were practically impossible to foresee some 20 years ago. As a result, Japan has taken the initiative to revise existing tax agreements with its Asian neighbours, with the hope that lower costs will increase business contacts. The proposal was introduced at the meeting of ministers of finance at the ASEAN +3 meeting in Korea in May 2004 (METI, JT & KT, 2004-05-12 – 13). It will probably take quite some time to first convince other countries of the necessity of new agreements, and then negotiate such deals. The plan is based on the new tax agreement, effective March 2004, with the US. It is hoped that the tax on dividends should not only be reduced to 5% in the country where the money was earned, but also to cut taxes on royalties paid abroad. Both these profit transfers and royalties are important income earners for Japan.

Banking and monetary policies In the 2000s, the Government under Koizumi has worked hard, and relatively successfully, to ease the burden of bad loans that has been restraining the Japanese banking sector. A policy that has been supported by the Central Bank that since March 2001 has kept the cost for borrowing money at almost zero, with the aim of overcoming stagnation and help the economy to take off. The BOJ has no intention to change its policy until clear signs exist that consumer prices have clearly started to pick-up, after its six continuous years of decline. With the last quarter of 2003 and the first of 2004 having displayed good growth figures, with the following two have been somewhat stagnant, but still not positive enough to indicate the arrival of a more sustainable growth. In Japan the consumer spendings is an important indicator that has been increasing steadily, although very slowly, but despite this prices are likely to remain stable, or even decline, largely as a result of productivity improvements (BOJ, 2004-09- 09).

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- 126 - For the full fiscal 2003, Japan’s current-account surplus reached a record of 17 trillion yen, which was a 29% increase and even surpassing the 1998 record increase of 13% (METI, 2004-05-17). The surplus is, first of all, a product of strong goods exports, with merchandise trade generating a surplus of 13 trillion, and a fall in the service deficit by about 60% to 1.5 trillion89. The capital side of the balance resulted in a surplus of almost 21 trillion, up from a deficit of 5 trillion in 2002. The difference was largely generated by currency interventions made by the Central Bank and has served as a base for the build-up of the currency reserve. During 2004, the surplus of the current account has continued to grow and by the end of September increased a further 13%, to above 19 trillion yen (ibid., 2004-11-10).

The Yen has seen a slow rise over the last years and has had its three-and-a-half- year high around 105, although it has been held back by considerable Bank of Japan interventions to keep down the value90. The Yen rate is a big blow to exporters as a stronger Yen makes their goods more expensive in world markets, which is confirmed by the employers union: "Our biggest worry is the Yen" (Nippon Keidanren, 2004-05-15). Despite China's strong economic growth in recent years, the value of the Yuan has decreased against the Yen by 8 – 10%, contrary to economic theories, over the past year from mid-2003. The values of all the major currencies, like the Yen, the Dollar and the Euro are flexible and determined by market transactions, although some monetary authorities have intervened in attempts to adjust the values set by the market. The Bank of Japan, in particular, has intervened stubbornly, and has relatively successfully offset a larger rise in the Yen value in relation to the US dollar, during 2003. As a result of the monetary interventions to maintain a stable value of its currency Japan's foreign-exchange reserves has been growing and had, by the end of October 2004, reached USD 840 bn; which is the highest level ever (MOF, 2004-12-07). The largest holding in the reserve is US Treasury Bills that have been bought up during the latest intervention period that lasted during the whole of 2003 through the first quarter of 2004. This line of action from the Japanese side has been a considerable contribution to the US burden of financing its current- account deficit. This is something that has been shouldered actively by several of the governments in Asia who have seen this as being the most secure, but not necessarily the best, investment. The need for these kinds of investments have, like in the case of Japan, Korea, Taiwan and others, come from a booming foreign-exchange reserve that has been accumulated as a result of trade surpluses and the currency market interventions. In the latter part of 2004 the value of the Yen has again started to rise and by early 2005, the exchange rate reached a five-year high of almost 101 Yen to the Dollar, with no intervention from the Bank of Japan (JT and Bloomberg, 2004-11-19 – 12-03). It could well be so that this trend continues further as the gigantic US current account deficit, as

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- 127 - well as an increasing trade deficit, and costs related to the Iraq war, have generated a downward pressure on the US dollar91. At the same time, China has not changed its currency policy, and maintains a voluntary peg to the US dollar, bringing profits to Japanese companies that have shifted their manufacturing base to China. That refers also to domestic companies that buy inputs from Chinese suppliers. Still, it is not necessarily so that shifts in the domestic currency rates, even between trade partners, will affect traders as prices can well be set in a neutral currency.

The currency policy adopted by the Bank of Japan, aiming to maintain a low value of the Yen has led to an increasing national debt. To maintain the low Yen has cost the Japanese Government a lot of money. The outstanding debt of the Japanese government totaled a record-high 670 trillion (USD 6 trillion) at the end of 2003. A total that includes government bonds, non-bond borrowing and short-term debt financing bills, a debt that now demands large interest payments. According the financial plan for fiscal 2004 the debt is expected to surpass 700 trillion during the year, reaching over 150% of GDP; highest among all OECD members (MOF, 2004-03-25 & OECD, 2005-01-20)92. The cost for servicing the debt for fiscal 2005 is, by the Ministry of Finance, expected to reach beyond 20 trillion, or about 20% of the state budget (BOJ, 2004-08-27).

Profitable companies and continued FDIs by Japanese companies have led to that the net value of foreign assets held by Japan, reaching 173 trillion (USD 1.6 trillion) at the end of 2003. Although the net value fell by 1.4% from 2002, it remains the highest in the world for the thirteenth consecutive year and more than three times the net assets held of the number two, Switzerland (BOJ, 2004- 04-21). The slight fall in value can be attributed to the increased Japanese debt, more stocks held by foreigners, which, additionally, have increased in value during the year at the same time as the appreciation of the Yen has eroded the value of foreign assets. Total overseas assets stood at 385 trillion (USD 3.5 trillion), which was up by over 5%, while the external debt increased by near 12% to 213 trillion (USD 1.9 trillion) during 2003 (BOJ, 2004-05-21).

Japan is not the most active nation in the discussions concerning the eventual establishment of an Asian currency, but an established cooperation forum already exist in the currency field between countries in East Asia. At the yearly meeting between Central Banks in East Asia and Oceania in 2004, it was decided to set up a fund that will invest in government bonds, nominated in local currencies. This was aimed as a follow up on a mutual fund of similar size, USD 1 bn, which invested in Asian government bonds issued in USD. The intention of the two funds is to keep available currency flows in the Asian market, instead of making money initially leave the region and then coming back in the form of

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- 128 - currency reserves at a higher cost (BOJ, 2004-05-02). A long term goal for such holdings, if they can grow many times larger, is to stabilize money flows in the region and hopefully reducing the risk of a new crises, similar to what happened in 1997 – 98. The same kind of initiatives, attempting to find ways of creating and expanding an Asian bond market, has also been taken inside the ASEAN + 3 framework (ASEAN, 2004-08-10).

One of the factors that have made the Japanese economic recession so difficult to overcome, has been the huge non-performing loans that have accumulated in the banking system at the outbreak of the crises. In one case, Resona Holdings, the state came in and nationalized the bank, injecting about USD 16 bn of new capital. Because of the accounting system used, transparency has been lacking and the actual size of non-performing loans for the different banks have been difficult, if not impossible to assess, with figures between 10 – 50% of GDP having been circulating (Economist, 2004-07-16). Through its Deposit Insurance Corporation, the state has been supportive in reducing this debt, and has since 1999, bought non-performing loans from private banks to a face value of near 4 trillions, at a cost of 340 billions (BOJ, 2005-01-06). Much as a result of this support from the banking sector has gradually been able to reduce the burden from the non-performing loans, from over 8% of the loan stock or 41 trillion, at its worst in March 2003, to the end of September 2004 figure of 5% or 23 trillion. As late as June 2004 the number four in size, UFJ, itself created by a merger of three banks in 2001, after continued deficits has been given a green light to merge with the number three in size, Mitsubishi-Tokyo, creating not only Japan’s biggest, but also the world’s biggest bank measured in assets, USD 1.7 trillion. By a margin surpassing the two what was previously bigger, Mizuho with USD 1.3 trillion and the number two Sumitomi-Mitsui with USD 0.9 trillion in assets. The merger will make the now state-owned bank Resona move down to fourth, in terms of size. The sector at least looks sure to have emerged from some years where many banks had problems to survive, into a stage where practically all banks during H1 2004 were profitable again (Zenginkyo, 2004-12- 27).

Employment The Japanese workforce, of people registered as workers by companies, is approximately 43 million, with an additional 4 million being readily available on the labor market, out of a population of 128 million.

Recovery from the long economic deflation period has been considerably slower when it comes to employment and consumption in the household sector, than what is indicated by the GDP growth figures. Unemployment has been going down from its peak at 5.5% to a mid-2004 level of 4.6% and ending the year at

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- 129 - 4.4%, which is a very positive sign. Despite the fact that 2.7 million were registered as unemployed, it is still the lowest figure in six years (MHLW, 2005- 01-28). Male unemployment stood at 4.6% and female at 4.2%, with the number of people forced into unemployment due to bankruptcy or restructuring fell by 15%. A problem inside the trend of increasing employment is that most of the new jobs registered are not only less qualified and low paid, but are often also part-time jobs. During Q1 2004, as many as 15.5 million were non-regular workers, i.e., employed on short-term contracts, employed by temporary staff agencies or on part-time. In all, this group makes up 31% of the workforce and 53% of female employment (ibid., 2004-07-30). These workers often work near full time but get considerably less benefits than full time employees. In a labor market where wage increases have been marginal in later years, but with bonuses in the 1 – 2.5 million range being given at larger companies, it becomes increasingly important to find a fixed position by a company.

According to official statistics, unemployment for the youngest aged group, 15 – 25, averaged 8.3% in December 2004 (9% in 2003), but clearly lower for the 25 – 34 group, which had 5% (6%). Also during 2004, over 2 million younger employees, up by near 4% during the year, in the 15 – 34 age bracket, were getting along on part-time jobs only. Additionally, among the unemployed in the wider age bracket, 520 000 were estimated who were neither trying to find work, nor receiving higher education during the year (MHLW, 2004-09-09). Especially the latter group, which indicates that there is a need for a strict awareness to enhance this groups capabilities and enthusiasm for the future. If not so, this category runs the risk of slowly turning into a considerable societal problem. A positive figure by the end of 2004 was that there were 94 jobs on offer per 100 job seekers, up from the 2003 value of 83 (ibid., 2005-01-28).

In an effort to contribute to reducing costs, the government froze wages for civil servants, and slightly started to cut wages and/or bonuses in 1997. With differences now having been reduced among state wages and the private sector no reductions will be made during 2004. A recommendation that is expected to be followed through also by local governments. Still, yearly income for a state administrative worker, including bonuses, stood at 6.3 million (USD 57 000; bonuses are generally 2 - 4 months salary) at the end of 2003 (PMOJ, 2004-08-06). Average monthly earnings for Japanese employees, by the end of July 2004, stood at 392 000 (USD 43 000/year), with regular workers earning an average of 280 000 (USD 30 000/year). An average worker’s household during 2004 spent 530 000, indicating an increase of 1% over 2003. Domestic spending is an important factor in the Japanese GDP, but still the available share of incomes is lower in Japan than in other G5 economies; about 60% and 70%, respectively (MOF, 2004-07-02). The average number of hours per month worked by

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- 130 - employees at the end of July totaled 155 hours, a decrease by 0.6% over the year before. Non scheduled extra hours worked inside manufacturing totaled 16 hours per month, which was a 2% increase (MHLW, 2004-09-15 & 2005-01-28).

The consumer confidence index in Japan, that among other factors also includes the respondents, confidence in employment that stood at its highest in over 13 years, since July 1991, in August 2004. This indicates that consumers feel confident for the near future both in employment and when it comes to prices and openings for own spending (PMOJ, 2004-09-13). This confidence that resulted in a 1.5% increase in household spending during 2004, combined with record corporate earnings, and increased employment, should lead to a positive circle (MHLW, 2005-01-28). Although this development has still to really take off as the GDP late in the year showed a clear fall in growth.

The entry of foreign workers in Japan is regulated by a policy adopted in 1999 that allows for workers with professional skills to apply for jobs, but with strong restrictions for unqualified workers. This has led to that estimations set the number of Il legal foreign workers in Japan to some 200 000 (JT, 2004-08-23). Most of these work in construction, agriculture, forestry and fishing, i.e., doing relatively unqualified work. There are training schedules in place for workers that has introduced some 60 000 foreigners since it was started up in 1990. There are still fears that the work permit system is exploited by many companies to obtain low-cost labor this way, and not the high skilled workers originally intended (MHLW, 2004-06-16). In 2003 the share of foreign workers in the Japanese market was just 1%, compared to the US and Germany where foreigners constitute 10% and 8%, respectively (JT, 2004-08-23).

Seen from the outside, Japan would probably find use for foreign workers as it is has an aging population. A record 25 million Japanese were aged over 65, or just over 20% of the population in September 2004 (PMOJ, 2004-09-19). The group over 65 is 17% of all men and 22% of all female. But worse is to come as it is estimated that the share over 65 will continue to grow and to have passed 25% inside the next 10 years, with the share having grow practically uninterrupted since 1950. At the same time the youngest age group is getting smaller as the nativity rate in Japan in 2003 was below 1.3/woman (WebJapan, 2005-01-31).

Other related issues in brief According to a Government White Paper on the Economy for 2004, the positive effects of the globalization process have not been taken full advantage of by Japan and its business society. So far Japan has only acted as a receiver and has not been “going out”, which will demand increased state transparency, and that in turn will demand structural reforms. The opening up for more foreign

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- 131 - workers is not only one such field, but also deregulation and tax reforms needs to be carried through (PMOJ, 2004-07-17). These reforms that could lead to increased FDI, reducing labor shortages and reduced price differences in relation to neighbor countries. The most important change in later years for Japan is the shift in focus away from its trade dependence on the US to a number of Asian countries. Positive is also Japan’s current position with signs showing that the deflation period could be near over and an expansion of private demand, backed by banks that have largely come out of their crises and with employment in an upward trend.

Problematic for the long-term internationalization effort in a globalizing world is the restricted ability to use the English language among Japanese in general, especially among students. This is despite the fact that students generally have been learning English during 6 - 8 years, out of the 12 when reaching their high school exam. A skill that is on a level also below its main Asian competitors, with both Korean and Chinese students showing better scores than their Japanese counterparts when tested. Most alarming of all is probably that the self- confidence among all categories of Japanese students, good as well as bad, were the lowest of the three (Berlitz, 2004-04-13). Having partly understood the emergency in the situation the Ministry of Education has since late 2003 introduced a large-scale four-year “Japanese with English Abilities” project. Improvement of the quality of teachers is high on the agenda, but one of the long-term goals is also to make it possible for about 10 000 high school students per year to study abroad (MEXT, 2004-04-15). Nothing of the kind has been initiated or planned at the university level.

In the continued process of internationalization the Tokyo Stock Exchange has approved the first Chinese firm to make a public offering, the Xinhua Finance Ltd. The company is the financial arm of the state news agency in China and is providing financial information and credit ratings related to companies on the mainland (TSE, 2004-09-16). Products that are increasingly in demand by other Japanese companies seen in the light of the increasing importance of the Chinese market.

It is important for the future that South Korea, China and Japan have agreed to jointly develop the communication technologies needed for the fourth- generation (4G) cellular phones. An article that is an important trade item for the three parties and is expected to come into commercial use around 2010 (Nikkei Net, 2004-04-05) 93. 4G cell phones are expected to become 50 times faster than 3G phones in transmitting information, with transfer rates equal to what is today found in fiber-optic communication; in the range of 100 megabits per second. This should make possible a crystal-clear TV image on the display even when,

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- 132 - traveling on a fast-moving train. The number of mobile phone users in the three nations in 2004 accounts for about 30% of the world’s users, which could possibly make the protocol into a global standard. The three nations plan to hold regular working-level meetings to share information and encourage cooperation between business and research institutes. South Korea, China and Japan also plan to collaborate in adopting common communication technologies and to cooperate when the International Telecommunication Union (ITU) adopts an international frequency spectrum for fourth generation mobile phones in 2007 (ITU, 2004-05-10).

3.2. Trade

The history of the Japanese trade relations with the rest of the world can be traced back to the forced opening to trade by the US in 1854. During the 50 years that followed, the Meiji Restoration in 1868, Japan adapted a selected number of foreign social and technological innovations to its own ends. Japan was one of the few nations in the region that avoided colonization, and its government wanted to preserve national sovereignty. Being both poor and densely populated the country had a natural comparative advantage in labor-intensive manufacturing like textile products. The relation to its trade partners was often complicated, and during these years' Japanese exports were often met discriminatory trade restrictions imposed by trade partners fearing imports. As for economic policy during these years Japan economic liberalism was never fully accepted as the dominant ideology. At the time of the worldwide economic slump, which followed the conclusion of World War I, also Japan began raising its tariffs significantly. In the wake of the 1923 Great Kanto Earthquake, Japan raised tariffs further, and by well over 100% on many luxury items. Instead of reducing tariffs back to their earlier levels after the immediate crisis was over, Japan continued to raise its tariffs throughout the 1920s. With the installation of the Inukai Tsuyoshi cabinet in 1931, Japan moved further away from economic liberalism. In the years that followed policies were mainly aimed at controlling inflation, as the economic system in the West entered a time of crises. When Japan launched the Pacific War, during WWII, it included the aim of creating a Greater East Asia Co-Prosperity Sphere. After the war, when the country had been defeated and was practically in ruins, it was first run under occupation by US military forces. The US occupation authorities put into place a new set of economic institutions and implemented a new economic direction that were largely modeled after what had come to be called the "New Deal"94.

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- 133 - In the build up of its economy and trade in a post WW II world, Japan benefited greatly from the experience introduced by the US that, but the country continued to apply a conservative approach in economic affairs. During this period, what probably was the only real opening to establish economic liberalism was missed, as this period was to be followed first by the war in Korea and then by the development of the Cold War. This led not only to the deteriorating relation with China, but also to the Soviet Union that continued to move from bad to worse. Still, it was the relatively open international economic order in the area of foreign trade that proved to be the opportunity that was needed to create the basis for much of the Japanese wealth.

Japan not only came to fully explore its comparative advantages in production, but it also saw the advantages given by the introduction of GATT and its successor, the WTO. Two organizations that have been devoted not only to facilitate trade, but also to reduce tariffs and barriers in international trade. Benefits obtained from trade have undoubtedly contributed considerably to the fast income growth and rising living standards in post WWII Japan. This process in the 1950s was further supported by not only the US, but also the World Bank and the IMF, that directly contributed to the Japanese economic development. Among many much-needed infrastructural projects receiving support at the time was the construction of the famous Shinkansen (bullet-train) railway.

In later years, continued positive contributions from its foreign trade have been important for the economic stability, in a time of a stagnating domestic economy. Japan’s foreign trade for fiscal 2003 showed a positive trend with exports for the year increasing by 6% to 54 trillion (USD 480 bn), while imports grew at a slower rate, 4%, to 44 trillion (USD 363 bn), leaving a trade surplus of over 10 trillion (USD 118 bn). For the service trade, the deficit from 2002 of 3.7 trillion fell by over 60% to 1.5 trillion for 2003, which was much due to fear of SARS and international conflicts that reduced the desire to travel abroad (METI, 2004-05-17).

Meanwhile, Japan's export to the US continued its long and near constant decline, but still the Japanese trade surplus climbed by 7% to 604 bn (USD 5.5 bn) which was due to a sharper decline in imports than exports. The falling imports were the result of the ban on beef imports, caused by an outbreak of mad cow disease in the US. The continuous decline in exports is largely explained by the fact that Japanese automakers are assembling more products at their plants in the US as a result of the dollar's fall against the yen (MOF, 2004- 03-25). However, Japan’s most important export destination in 2003 was the United States valued at USD 115 bn, followed by China taking USD 57 bn worth of goods with Korea third, importing to a value of USD 35 bn (JETRO, 2004-02- 17).

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- 134 - During 2004, trade has continued to expand, reaching record high figures for both imports and exports over a six-month period. Total trade for the six months reached 51 trillion, with 29 trillion in exports and 22 trillion in imports, leaving a surplus of over 7 trillion, up 17% over the same period in 2003 (METI, 2004-11- 10). Exceptional figures in a year when in Yen terms export prices increased by 1.8% during the year while import prices increased by 7.4% (BOJ, 2005-01-14). The boom could be over as export figures showed signs of flattening out during the latter part of the year, but with expectations of renewed growth by the second half of 2005. Of the export products for the period, the three dominating and nearly equally important groups were electrical equipment, transport equipment and machinery. Each has contributed 7 – 6.1 trillion, respectively. As for destinations, the US is well ahead of China, 6.6 as to 3.8 trillions, but with the former decreasing by 0.3% and the latter increasing by 24%. At the rate of increase shown over the last year, China (excluding Hong Kong) could surpassed the US as Japan’s most important trade partner already in 2005, and for sure in 2006, and also as export destination by 200795.

Despite the surge in oil prices, ASEAN remains the biggest source for imports ahead of the US, the Middle East and the EU. The four being very balanced with a difference of just over 10% from the level of the ASEAN at 3.4 trillion to the EU at 3.1 trillion. Exports to Korea and Russia stood at 2.4 trillion and 0.2 trillion respectively, with imports from the two at 1.2 trillion and 0.3 trillion, respectively.

Generally speaking and among its neighbor nations, Japan’s spending in China the money it earns in Korea. Still Japan is improving its trade balance, from having had a USD 20 bn deficit vis-à-vis the other two, this has in only three years contracted to USD 1 bn deficit. This improvement can be traced back to the fact that Japanese companies have invested more in own factories in China, in difference from Korean companies that continue to trade with their mother company. Still Chinese and Hong Kong exports to Japan grew by 22% in 2004 to USD 80 bn, lifting the Chinese share of Japanese imports over 20%, while Korean goods constituted 4.7 %. Over the years since 1993 the share for China in the Japanese import has grown from 8.5% to 20% in 2004 while imports from Korea instead slipped 0.1%, to 4.7 %. The gap between the two exporters has widened sharply, especially over the last few years, as the difference was only 9% as recently as in 2000, having widened to near 14% by 2004.

The positive Japanese trend in relation to China has continued, despite the fact that the trade balance has for long been favorable for Beijing. The ever more tightly knit relation between the nations is also shown by the fact that Japan has emerged as China’s most important trade partner with China surpassing the US

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- 135 - in importance for Japan. Mutual trade with China, including Hong Kong, in 2004 came to a value of USD 213 bn (export at 86, import 127), US trade stood at USD 205 bn (137, 68) and trade with the EU at USD 152 bn (95, 62) (MOF, 2005-01-25). This can probably be seen as a result of the Japanese investments in China that have remained strong since many years. Japan has constantly been behind in the relation, but in February 2004 Japan posted a monthly surplus in its trade with China for the first time since March 1994. During the month, Japan’s exports reached 590 billion and imports 576 billion, leaving a surplus of 14 billion, showing the largest monthly increase in exports to China ever; +57% (METI, 2004-03-25). When the year was summed up it proved to be the only month with a surplus with China during the year. In the trade relation with the US and the EU every single month during the year generated a surplus of at least USD 2 bn (web-japan, 2005-01-31). Still China’s export to Japan includes a high degree of labor-intensive products, typical for a newly industrialized country. Although the export is being based on cheap agricultural products, clothes, and traditional computers, has still meant yearly deficits for Japan in the range of USD 20 – 33 bn during the years from 1996, with the record deficit dating back to 2001 (web- japan, 2005-01-31). Although China has increased the share of machinery and high-tech products in its export, it still has its base in lower-end products. There has been some attempts in Japan to restrict imports of Chinese agricultural products, with the arguments for such restrictions being based on what is an over usage of chemicals in China's farming sector.

July 2004 came out as a special month in the foreign trade history of Japan since the beginning of the current statistical series in 1947. Trade with Asia was the highest ever at 2.6 trillion, imports reached its second highest ever at 1.9 trillion yen, resulting in the third highest surplus ever at 750 billion. Trade with the rest of the world also reached the second highest ever, with 5.3 trillion in exports and 4.2 trillion in imports, leaving a surplus of 1.14 trillion. Of the export products, semiconductor-manufacturing equipment was leading with a 32% increase followed by steel that was up by 23%. On the import side, oil products were up by 53%, coal by 52% and crude oil by 23%. Trade surpluses for the month increased also for the most important market, the US and the third market, the EU, by 13% and 29%, respectively (JT, BOJ and MOT, various dates). Japan showed a worldwide trade surplus for 2004 of USD 120 bn, which was up by 18% over 2003 (MOF, 2005-01-25).

3.2.1. WTO and (free) trade agreements

After the US occupation ended in 1952, Japan applied to join the GATT. The application was initially opposed by a number of countries, but with strong US

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- 136 - support, Japan was granted provisional membership in 1953 and full membership in 1955. Once a member of the GATT, Japan became a member that relatively passively participated in the rounds of multilateral negotiations under GATT, including during the Tokyo Round of negotiations of the 1970s.

Due to poor settlement procedures under GATT, many trade conflicts that involved Japan still emerged during the 1960 and 1970 and had to be resolved bilaterally, often in a, for Japan, discriminatory fashion. In addition to GATT’s consistent forms of protection, such as antidumping measures, Japanese exports were also subject to innovative “gray-zone” measures. The trade relation between Japan and the US gave rise to a number of new expressions in the trade arena, later to be used in other bilateral trade relations over the world. First came the “orderly market arrangement” (OMAs) that was invented by Japan and the US in the 1950s and applied to textile trade. This was to be followed by the so-called “voluntary export restraints” (VERs), which the US and EU applied to Japanese steel and automobile exports in the 1980s96. In the 1990s, Japan and the US invented the use of “voluntary import expansions” (VIEs). The first of these two had the aim of restricting the penetration of Japanese products on the US market, while the VIEs supported the sale of US products in Japan.

With the establishment of the WTO in 1995 that included an improved dispute settlement mechanism, the settlement of international trade conflicts from the Japanese side took a new turn. This strengthened the possibility for fair settlement, and the ability to oppose discriminatory trade protection by partners. This was demonstrated in 1995 when Japan refused to agree to US market- opening demands, and threatened to open a case by the WTO. This case came to be settled out of court by the US. Since then, Japan has brought about one case per year to the WTO, with about half the cases involving the US and about half of these involve the automobile industry97.

While Japan, China and South Korea have followed the nondiscriminatory principles of the WTO, all have began to feel threatened in international negotiations by the fact that among the world's 100 largest economies, practically only Japan, Korea, China, Taiwan and Hong Kong are not a part of any regional cooperation framework. It is in the light of this situation that the eagerness in the region to conclude FTAs should be understood. A tendency that will appear repeatedly in the following chapters. Before any such negotiation process can start, both the process itself, as well as the results, are being analyzed to assess the possible impacts on competing industries in the participating countries. Tee analysis should preferably indicate a positive outcome of an agreement for both parties.

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- 137 - FTAs - Free Trade Agreements The moment that really set-off the idea among all major trading nations to try to sign bilateral trade agreements was the collapse of trade negotiations at the WTO summit in Cancun, Mexico, in 2003. At such negotiations Japan is looked upon as one of the “Group of 10” WTO members that have remained the most protective of the large food-importers that clearly contributed to the breakdown. Although numerous FTAs had already been signed in the world at the time, they had mostly been focusing on neighboring countries, as in the case of NAFTA. It was the US that started the trend in signing agreements with individual countries far away when no international agreement could be reached under the WTO in Cancun. In the case of Japan its first FTA had already been signed with Singapore in January 2002. Which was an agreement that could be concluded without having to touch upon the thorny issue of agricultural products in the negotiations. Japan’s second FTA, with Mexico, had been negotiated with the intention to be signed already during the visit of the Mexican President Vincente Fox to Tokyo in October 2003. That proved impossible and it instead took some 20 months of, sometimes bitter, negotiations to reach an agreement with Mexico. The main reason for the prolonged negotiations was the continued Japanese resistance in opening up its trade in agricultural products. The signing stage of an agreement was finally reached by the end of March 2004. Mexico is a country of symbolic importance in relation to Japan, as Mexico was the first country that, already in 1888, allowed Japan to sign a treaty of amity and trade. At the time, this was Japan's first ever reciprocal and equal treatment pact with a foreign country (Secretaria de Economia, 2004-03-11).

In an attempt to prepare for the future, the government has outlined a basic plan to promote free-trade agreements, with Asian partners to be given priority. This could be seen as a beginning of a long-term attempt to help build an East Asian trade community, based on the ASEAN+3 process, and with Australia, New Zealand and India that Japan would like to include in such a process (PMOJ, 2004-12-21). The plan includes a set of 12 criteria that will be used to choose potential FTA partners. The establishment of FTAs would help strengthen Japan's economic power and solve political and diplomatic issues. The latest countries included on the list of possible FTA partners, with negotiations to be initiated during 2005, are Chile and India with preliminary agreements planned and prepared for signing in 2005 and 2006, respectively. The economic benefits to Japan of most kinds of FTAs in the region are probably less economic than psychological. What could be seen as more important from a Japanese perspective would be the political weight that such a regional trade arrangement would give in the Asian region, but also to the region as a whole.

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- 138 - In discussions in economic circles the possibility of a future tri-lateral FTA that would then include Japan – China – Korea is often mentioned. Korean sources have estimated the outcome of such a tri-lateral FTA and have set the advantage of such an arrangement to be the greatest for Japan. The benefits to be shared for the group would come to near USD 120 bn, out of which Japan could count on approximately 60%, China 40% and Korea 10%, or near USD 72 bn in favor of Japan. In GDP terms, such an FTA would bring near 6% to China, about 1.7% to Korea, but only 0.6% to Japan (KITE, 2004-09-13). An FTA among the three would bring not only economic benefits, but also political ones as a counterweight big enough to the EU and NAFTA. Korea, China and Japan would be a strong combination, especially in the global manufacturing industry to gain international status that matches their combined economic strength. The pressure in Japan to take serious steps in this direction is also mounting from business circles and top business leaders organizations with the same kind of process taking place also in China and Korea. The most influential lobby group in Japan, The Japan Business Federation, is strongly in favor of further swift steps on the road towards increased free trade, to promote mutual trade and integration (Nippon Keidaren, 2004-10-21). The purpose is to promote the conclusion of free-trade agreements as soon as possible, as Japan needs economic pacts with other Asian nations, including FTAs, to secure its future prosperity. Although the process is full of stumbling blocks Japan has become increasingly eager to conclude FTAs, and especially so if a future FTAs could be negotiated that includes Korea, or preferably, even China.

China Discussions on a future FTA between Japan and China are ongoing although it has not reached a stage of official contacts on the matter. However, it could be expected to take place in a few years time, and if nothing exceptional will change the agenda, then could be expected to be about to be implemented inside 10 to 15 years. To make China a reliable negotiation partner, it should first convince the world that it can comply with the regulations it accepted in the WTO agreement, where compliance is still to be applied with nearly 100 items in the WTO agreement (JT, 2004-11-13).

Small, and medium sized, industries in Japan are not only finding exports of high-grade products to China an ever-larger growth sector, but also more basic products find a market in China. Examples of such are synthetic fibers produced in Japan that are used to make European designer label clothing in China, fish and crab from Japanese vessels are brought in to China, but also products like cedar and cypress for housing interiors have seen increased export. Japan's export to China and Hong Kong reached close to 10 trillion during 2003, and is approaching the United States as the most important Japanese export destination.

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- 139 - Korea This passage could serve as yet another example of how difficult it is not only to organize a possible FTA, but also that relations among countries can change for the better. It is not many years ago since a discussion about a possible FTA between Japan and Korea would not even be a matter to discuss. Only a few years ago, a Japan-South Korea FTA would have proved to be too problematic, if not impossible, politically. Generally South Korea has higher protection levels for its domestic market than Japan, 7.9% and 2.9%, respectively, and has also pursued a policy of actively discouraging imports from Japan. An "import diversification program" that had to be adapted in June 1999, as a part of the IMF conditions for a standby support package granted in late 1997, during the Asian crises. When import restrictions were abolished in 1999, imports from Japan surged in a number of products groups. A future FTA is likely to further increase Korea's trade deficit with Japan. However, Korea is expected to enjoy a surplus in services and its overall trade balance would improve. To make sure that the Korean deficit will decrease in the long run, an FTA must open-up for dynamic effects and facilitate for investments. The promotion of Japanese investments in Korea could somewhat offset negative trade effects at the same time as enhanced productivity could help lift the Korean GDP. The process of establishing an FTA with Japan is, of course, of interest to many of the neighboring countries in Asia. However, negotiations started with its first meeting of delegations in Seoul in December 2003, and have since taken place approximately every two months (JT, 2004-05-12).

Although Japan and Korea are major players in world trade, the effect of a FTA will have an almost negligible effect on world trade and the benefits are there for Korea and Japan to share. Steps in the right direction are the taxation treaty with Korea that came into effect in late 1999, and the negotiations for investment and mutual recognition agreements that started already before the FTA came on the table. In order to maximize the benefits of a possible FTA, various bilateral cooperation agreements needs to be expanded. For example, the Japan-Korea Industrial Technology Cooperation Foundation and Korea-Japan Industry Cooperation Foundation have been achieving results steadfastly in terms of fostering industrial technology among small businesses, developing human resources, and enhancing productivity. Cooperation is particularly needed in the areas where both Japan and Korea are internationally competitive. In such sectors, the two severely compete with each other, but this is also fields where inefficient over capacities exist. An FTA would also be beneficial in sectors where intra industry trade is underdeveloped. To realize such cooperation, one suggested way could be the establishment of a Korea-Japan Industrial and Technological Cooperation Council, comprised of private businesses. The positive effects from increased bilateral trade will be seen through the abolition

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- 140 - of tariff and non-tariff measures, leading to falling prices in the two markets (KIEP, 2004-10-10). Regarding the ongoing FTA talks between the two countries, the Japanese Minister of Finance, Tanigaki, has warned against premature expectations, indicating that rather than immediate results, both nations should look for long-term benefits (CI, 2004-05-20).

The US As briefly mentioned above the latest official complaints that has been brought up against the US in cooperation with a wide range of nations, among them Korea and the EU was against the US “Byrd Act”. This Act approves transfers of incomes from anti-dumping fees levied in the US, and paid by the foreign exporters, on to the industries mostly affected by the under-priced import. In this way the foreign exporter gets punished twice, first by the dumping duty and the by the fact that local producers get unsanctioned economic support. That was also the view of the arbitrators at the WTO when the result of their investigation was presented which gave Japan the right to retaliate to a value of USD 80 million per year (WTO, 2004-11-25). From this date on the group of countries that have filed the complaint can retaliate in the form of import duties on US products, of up to 72% of the amount being transferred to US firms under the Byrd Act. That is up until the date when this issue has officially been settled among the parties involved. To retaliate against what is Japan’s most important trade partner, so also for many of the other countries that complained, is a highly sensitive matter. How the possibility to do so will be used, is likely to vary widely among the countries that won the appeal.

Any action that will be taken to retaliate will diminish the Japanese hopes of possibly start a round of near future FTA negotiations with the US. Something that the US Trade Representative has set out as impossible as long as Japan keeps it agricultural market practically closed for US products. Over the years, this has especially referred to rice, but also to beef imports, due to outbreaks for mad cow disease in the US (USTR, 2004-09-21).

Asia Japan has agreed to start serious FTA negotiations with the ASEAN group of ten countries in April 2005. The mutual aim is to reach a full free trade status with six of the more advanced economies in the group by 2012. Negotiations with the full group has practically not advanced at all, as Japan is already, since 2004, in discussion bilaterally for an FTA with Malaysia and Thailand, having already concluded one with Singapore and has signed an outline with the Philippines. Talks with the ASEAN group will focus on more or less the same difficult questions again as with Mexico. Tokyo demands lower duties on auto parts and electronics, while Thailand wants access to the Japanese labor and agricultural markets, while the most disputed question with the Philippines was Japanese

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- 141 - steel export (JT, 2004-11-21). In the case of Malaysia, negotiations were started in late 2003 and the major stumbling blocks here are the Japanese export of auto- parts and Malaysian exports of commodities like plywood, but with rice being excluded from the negotiations (Kyodo, 2004-11-04). Of agricultural products, rice remains in the centre of attention, with Thai requests for non-tariff access in its negotiations with Japan, something that was rejected by Prime Minister Koizumi by saying: “What is impossible is impossible, even if a lot of time is spent on it” (JT, 2004-10-13).

The FTA with Mexico As mentioned above Singapore became the first country to conclude a FTA with Japan, while the second with Mexico had to cover practically all kinds of products, and especially agriculture. At the same time Mexico holds an important position as a member of NAFTA, along with the US and Canada, and as a place where Japanese industry can enter the North American market. This is further enhanced by ideas on future negotiations on that side of the Pacific for a Free Trade Area of the Americas (FTAA). A future FTAA that could come to include countries in both North and South America, extending the possible market to a total population of 800 million generating a GDP of USD 10 trillion.

With its second FTA in hand signed with Mexico in September 2004, expected to take effect in May 2005, Japan gained much experience in the field of organizing such a complex negotiation process. Looked upon superficially, Japan has the technology while Mexico has the agricultural power and low cost labor, which makes the two economies seem perfectly complementary. Ironically, it has been these sectors that made negotiations last for almost two years, with the most interesting part of the deal with Mexico being the treatment of the sensitive agricultural products. To make the deal with Mexico possible, Japan had to make large concessions in the negotiations and no country before Mexico had been given such preferential tariff treatment.

The agreement with Mexico will give Japan more access for car and steelmakers and lower prices for imported farm products. Just the achievement to conclude an agreement indicates that groups, both in favor and against, have had to adjust their positions to make an agreement possible. For the Mexican side it has been estimated that the FTA will bring FDIs of USD 1.2 bn/year over the coming years. Over the ten years following the introduction of the agreement the 20 – 30% tariffs levied on motorcycles, photocopiers, games and computers from Japan, will have to be lifted along with the lifting of import quotas for a number of other articles. During 2003 Japan imported food products from Mexico to a value of around 3.8 trillion yen, which make up more that half of total imports from Mexico. There will now be an 80 000 tons of tariff-free quota of pork, and

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- 142 - an annual low tariff quota for 6 500 tons of orange juice, 4 000 tons of fresh oranges, 6 000 tons of beef and 8 500 tons of poultry (Secretaria de Economia, 2004-03-11). Quotas should be increased after a transitional period, but the tariffs will not be set until will into the transitional periods set for different articles. The delay indicates the fear that any sizable step might antagonize Japanese farm groups, which are already ahead of ongoing trade talks with other Asian nations. The symbolics in lowering trade barriers in the agri-sector are so strong, that any step taken becomes minimal. At the same time, tariffs on about 380 less sensitive Mexican agricultural products will be fully eliminated. The sensitivity to farmers' interests from the government’s side is strong, and there is a long road ahead before Japan's agricultural market is opened.

The agreement that will go into effect in 2005 and will boost the Mexican exports to Japan which reached USD 1.8 billion in 2003. Japan is still a very small partner compared to the US, Mexico's largest trading partner, which accounted for 85% of Mexican exports and 75% of Mexican imports in 2002 (ibid.).

3.2.2. Neighbor relations

Japan’s influence on institutions in the global economic scene has always been, and still is, smaller than one would expect from a country being the world's second largest economy. Japan’s possibility to influence issues are not only limited by the dominance of the US and its unwillingness to risk a rupture with them, but also by the historic legacy of suspicion and distrust from neighbours in Asia. The neighbor relations in the region are a sensitive matter, as over the last 100 years Japan has been at war with all the its neighbours in the region. Although relations have improved greatly over the last few years, the questions related to issues dating back to the wars of the 20th century are constantly appearing among the news and are definitely complicating the relations among neighbours.

To a certain degree, it is a part of the national heritage for countries and nationalities to bear with them a certain pride about their own history. As part of the nation-building process, we are already being taught from basic school, and indirectly by what our parents were being taught, our nation’s reason for being. However, the description of historic events must give a fair account on views as well as deeds during the described eras. In a world of just some decades back, a slightly lower level of authenticity, or more nationalistic to put it that way, could perhaps be seen as sustainable. At the time it could be argued that it was unlikely that the pupils at the receiving end of the education, as for the adults, were ever to interact with the foreign nations described. Currently, with an

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- 143 - unprecedented increase in contacts through business and tourism, to simply exclude the sufferings caused to innocent civilians during wars, is simply a behavior that belongs to past centuries.

China In 1931, Japan initiated the occupation of northeastern China and managed to create something of a state in Manchuria. It was not until 1937, when Japan initiated a larger-scale military operation in China, that any real resistance from the central government, already under pressure from communist forces, mounted. The combined resistance from the two against Japan proved more successful, although Japan established several governments that were supposed to lead China, for example in Nanjing. The combined communist and Chiang Kai-shek forces joined the Allied Group of forces in its resistance, after the attack on Pearl Harbor in 1941, and China was again to decide on its own future after the Japanese capitulation in 1945.

The aggression from the Japanese side against China in 1937 - 1945 has been an issue for Chinese demands for apologies and compensation. Apologies have been made, but it has not sunk in well in China when, periodically, Japanese politicians have provoked and hurt many Chinese. Japan has not exactly followed the example of Germany in dealing with its historical war memories in relation to its neighbours, although the situation is not really comparable between Europe and Asia as there are no land borders between the parties here. A geographical feature is bound to have reduced the pressure, and necessity, to reach mutual acceptance and understanding between the two neighbours. The building of mutual respect and trust will need even more time for two important political powers, that for long has paid tribune to two fundamentally opposing political and economic systems, even more time will be needed.

It was not until the Inter-Korean declaration had been issued, in late 1972, that diplomatic relations between the two came to be re-established. Back and fourth neighbours have considered if to let bygones be bygones, but a strong suspicion and the relation with China has newer really gone beyond history. One of the problems for leaders on both sides is that they would not like to be perceived by their home opinion as to soft on history. The present Japanese Prime Minister, since 2001, Koizumi apologized to China for sufferings caused by Japan during the wars in the 1930’s and 1940’s, in October 2001, and so had a number of previous prime ministers. Despite these attempts to satisfy the Chinese public, especially Internet based nationalism has been building up, but to measure its strength is very difficult. A large petition was circulated in China demanding compensation to wartime victims poisoned by e.g. chemical gas from dumped Japanese bombs and other leftovers from WWII. A number of court cases against

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- 144 - Japanese companies and the state for economic compensation have seen mixed success. Parallel there has been sentiment in Japan that it has been enough with excuses for past times and that it must be time to move on. The single act that has complicated co-operation in the region the most in later years is probably the Japanese Prime Minister Junichiro Koizumi's continued visits to the Yasukuni Shrine that also honors 14 Class A war criminals98. The official excuse has been that the visits have been of a private nature, an excuse that has found little acceptance among neighboring countries. The visits to the shrine by the Prime minister has by a court ruling in Fukuoka, in April of 2004, been condemned as being unconstitutional, due to the fact that a visit to a shrine is religious to its nature and religious acts by the state body are forbidden99. On August 22 2004, which would have been a likely next date for a visit, the Prime Minister did not visit the Shrine. Instead, the shrine was visited by four ministers of the Cabinet along with 58 members of the Diet. The importance of this question was shown in the informal meeting between Koizumi and the Chinese President Hu Jintao in Santiago in November 2004; this was the first issue brought up by that the Chinese leader (JT, 2004-11-23). No commitment was given at the meeting, as there proved to be only just over a month, on New Years Day 2005, until the Prime Minister were to visit the shrine next time. The shrine remains a thorn in the side of all neighbours, but between the two big there is also another larger dimension. Between the two nations there is something like mistrust and vigilance as they are indirectly competing for the regional leadership, of both today and for the near future. Much of this mistrust from the Japanese side could be derived from the fact that China has become economically open, but has not yet opened up politically.

Any fear on the part of Japan about China being able to rival its supremacy economically, which is sometimes voiced, is simply not realistic in the near future. The current Chinese growth level of near 10% must probably come down by some percents inside a few years time to be sustainable. At the same time the Japanese economy has shown growth figures of its own, which pushes any Chinese catch-up further into the future. Japan is already having a per capita income over 25 times larger than China, a closing of such a gap, under normal circumstances, is just practically impossible in the foreseeable future.

Japan together with its western neighbor China are Asia's two most powerful nations, being relatively close in the cultural field and irrevocably so in geographic terms. During the last two decades they have also come to grow increasingly closer in economic terms. China, being a developing economy is in need of Japanese investments and technology, at the same time as Japan has increasingly come to source its low-cost articles of everyday use in China. That the overseas market in this case has proved an opportunity for Japanese

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- 145 - companies is probably without doubt, and that the Japanese market would not have absorbed as much of the Chinese exports without the large investments, is probably as true.

Over the past 15 years of relative stagnation in the Japanese economy, companies that were early movers into the Chinese economy have generally done well on that market. These overseas units of Japanese companies are also expanding their sales more rapidly than the parent companies, 16% compared to just 3%, in ministerial survey for Q2 2004 (METI, 2004-09-30). Of 160 major Japanese firms surveyed 65% were largely positive to the Chinese economic growth and stated that it has had a favorable effect on the Japanese economy (Kyodo News, 2004-05-12). Out of these companies, 68% had business based in China, 62% were doing business with the mainland with 36% having made investments (multiple-answers possible). Only 6% showed concerns about the possible moving out of production or any reduction of jobs in Japan. The rise of China, that was generally viewed as negative just a few years back, seems to have been forgotten. Only ten companies (6%) declared no involvement at all with the Chinese market.

International contention, including the nuclear standoff on the Korean Peninsula, environmental concerns and the global combat of terrorism are questions that have generally contributed to a strengthening of ties between the two neighbours. History has hopefully learnt that co-operation benefits both countries while isolation, or mutual agonizing will severely hurt both. At least theoretically, the two could part again and to say who would loose out the most from that kind of divorce is more or less impossible. Both would in such a case have to find new markets for its products as well as sources for inputs. A positively reciprocal and friendly relationship, that must not mean that the two always can agree on every single issue and can overcome every aspect of a troublesome past, will greatly benefit both countries in the long term.

What could be seen as worryingly for both Japan and Korea, as well as for many other developed countries, is the rapid rise in technological level of the Chinese manufacturing output and export. According to a Japanese survey it is expected that the technological level of Chinese products could soon make these products into a strong competitors. The value for 2004, set by 440 Japanese companies rating the technological level of Chinese products, came to 2.6 on a scale of 5, with Korean at 3.3 and Japanese at 4.0. Taking a ten-year perspective these values are set to shift strongly in favor of China, as the 2014 values set China at 3.8 and Japan at 4.1. Of the outsiders, the US is expected to have come down from 4.6 to 4.5 and Europe to remain at a constant 4.0 rating (Nihon Keizai, 2004- 07-29).

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- 146 - Since 2001 Japan has started to scale down on economic aid and low cost loans to China, which has been far from appreciated in Beijing, where the loans have been seen as a symbol of friendship towards mainland China. Beijing had wanted to see the level of aid maintained, as many of the cross border investments between the two countries have benefited from these loans. However the level fell below 100 bn (USD 900 million) for fiscal 2004, for the first time since 1989, with the intention to phase out these loans completely during 2005 (MOFA, 2005-01-31).

What has become known as the “Fusosha textbook crises” is another of the issues that has contributed to negative goodwill for Japan among its neighbours. This history book for junior high schools, due to be introduced for the 2005 school year, has for the past several years caused friction as it fails to mention the e.g. Korean “comfort woman” and includes a controversial and forgiving descriptions of the events surrounding the “Nanjing Massacre”100. Already a version published in 2001, sparked criticism, but was adopted by only 0.04% of schools and criticism therefore faded. The new edition of the book is seen as worse because it does not include the few acknowledgements that existed for the criticized incidents in the 2001 version. Also Japanese civic groups have come to protest to the Japanese educational commission that is to approve the book (KT, 2004-09-01). To further put wood on the fire Japan granted a tourist visa for a private visit, to the former Taiwanese president Lee Teng-hui to spend a week in Japan in December 2004. Also Japan has declared its support to the One-China Policy, but from a Chinese point of view this was a break of the promise to bar official contact with the island and a sign of support for Taiwanese separatism101.

Also the Japanese side has had reasons to complain about Chinese behavior. The latest incident, with a violent outbreak of “anti-Japanism”, occurred at the final of the 2004 Asian Championships in football in Beijing. After China had lost the final to Japan, that included some doubtful decision making by the match officials, Chinese supporters rioted, Japanese visitors and diplomatic cars were attacked and supporters were filmed burning Japanese flags. Giving the incident a clear dimension beyond football. After this incident the Japanese side has also voiced its discontent over Chinese oil exploration in the Japanese Sea, leading to that also Japan has given away concessions for oil and gas exploration on what is considered to be Japanese territory. The conflict was aggravated further by the identification of a Chinese nuclear submarine clearly inside Japanese territorial waters in early December 2004. In early 2005 Chinese protests have mounted into several anti-Japanese mass demonstrations, which ultimately led to an official excuse from Prime Minister Koizumi for historic brutalities from the Japanese side.

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- 147 - As geography do counts, the two most important of the Asian economies have over the last few years surprisingly rapidly come to increase in importance to each other. Early Japanese investments in the Chinese market, and its support in extending production facilities in China, have enforced the economic contacts, creating considerable markets for each other’s export. Still, and despite the fact that a number of arguments can be brought forward pointing to uncertainties in the relationship, aggravated by still unsettled issues of the past and protests in recent times, too much is at stake for both sides not to move forward. China’s fast economic development has undoubtedly helped the Japanese economy to recover and China will continue to be a huge market, while Japanese investments and support has been crucial in the development.

Russia Since WW II it has been the small Kuril Islands that, more or less constantly, that has been complicating the agenda between Japan and Russia. Geographically, the two neighbours had, in 1875, signed an agreement that placed the Kuril Islands under Japanese jurisdiction and the island of Sakhalin under Russia. However, from the time of Japan’s modernization that coincided with that of Russia, and that for both were initiated from abroad, the tension between the two also started to build up. With increasing Russian interest in its Far East, as demonstrated by the building of the Trans-Siberian railway, in the direction of a weak Japan, tensions were soon to mount again. Leading to the 1904 – 1905 war when Japan took over the southern part of Sakhalin, which was to remain under Japan until the end of WWII. Just in the closing stages of WWII, the current Kuril Islands dispute emerged. It involves two larger islands, two smaller and a number of very small islets northeast off Japan’s northern island of Hokkaido. The Kurils were seized by military force by Soviet troops just days before the capitulation was signed with the US, on August 15, 1945. The occupation of the islands took place in the days in-between the first atomic bomb was dropped on Hiroshima and the Japanese capitulation. The unsolved conflict over the island has to this day prevented the two countries from signing a peace treaty after WWII. In 1956, the Soviet Union and Japan signed a joint declaration that two of the islands, Habomais and Shikotan, should be returned as soon as a peace agreement had been signed, while another joint declaration signed in 1993 confirms that the conflict involves four larger islands. The 1956 agreement has been brought back on the agenda from the Russian side as a suitable way of solving the conflict, while the Japanese side wants the negotiations to include four islands.

Despite this long line of conflicts, Japanese relations to Russia have continuously been improving during later decades, and especially so since the break up of the Soviet Union. Meetings between top-level leaders have been frequent while the

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- 148 - volume of both trade and FDIs are increasing, although riding on a bumpy road. In the background remains the dispute over the Kuril Islands that leave it mark on the relation. After the Russian peace agreement was signed with China in 2004, hopes increased that a break through on the Kuril Island issue could be reached. Instead, it has been admitted by the Japanese foreign minister that “clear differences exist” (JT, 2005-01-15). As a result, a visit to Japan by President Putin, initially expected to take place during early 2005, has been postponed until a better understanding has been reached.

Trade between the two has never been very large and stood at its peak during the 1980s. It then fell off to a new low in 1991 and again in 1999, but in the last two years, interest has started to pick up and trade is again increasing (Jetro, 2004-11-29). When the first investment opportunities appeared in Russia after the 1991 break-up, and especially in the Far East, Japanese companies were quick to move in. The number of Japanese companies investing reached its peak in the region in 1991 – 1992. With the problems that faced them, probably having exceeded both their expectations as well as fears, the numbers has since fallen sharply to just less than a handful of companies entering the market in 2000, with a slow increase having been registered since (MOFJ, 2004-05-02).

A long-standing issue related to the rumored existence of a gold deposit in Japan, which should have been brought over by royalists during the years of 1916 – 1920 has at least been settled. It has finally been proved that the gold were either used to buy weapons to the white army during the war, used by its owners or have been handed back (Polit.ru, 2004-04-30).

Korea In the case of Korea, that is the once unified larger Korea, the then king Sunjong had to give up his position to the Japanese occupation in August of 1910. From then on Korea served as the Japanese Government of Chosen. Resistance and uprisings opposing the 35 years of occupation occurred, along with the forming of an exile government in China. The development during this period came to focus more on the economic support of Japan than the best of the local population. At the time of the Japanese capitulation on August 15 1945, Soviet troops advanced into Korea from the north until the 38th parallel, while US forces reached the line from the south. Forming a divide that has remained in place ever since.

At the same time as the two parties concluded an agreement to normalize diplomatic ties, in 1965, the right of Koreans to make historic claims against Japan were also terminated. Based on the treaty, that included a Japanese one- time compensation payment of USD 500 million in economic assistance, no

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- 149 - Korean individuals can raise claims for sufferings occurred before the end of WWII. Although the legality of the agreement has been questioned since, it has been continuously been referred to by the Japanese side during disputes.

The former Korean President Kim Dae-jung took big strides in improving bilateral relations with Japan through his low profile and avoidance of historical issues. He proposed that the problems of the 20th Century should be resolved within the century. He also wanted to abolish restrictions on cultural exchange with Japan, although this could be seen as concessions to Japan. Much as a result of this the relation between the two has developed more into that of partners. As its concrete result, the two has seen booming trade and tourism, but also an increased numbers of ministry meetings. Most important, Japan and Korea agreed on an "Action Plan for the New Korea-Japan Partnership for the 21st Century", laying the foundation to jointly host the soccer World Cup in 2002. An agreement reached in two rounds of summit talks in Atami, in September 2000 between President Kim Dae-jung and Japanese Prime Minister Yoshiro Mori. Kim and Mori reviewed a number of bilateral issues, such as economic cooperation and respective North Korea policies. The “South Korea-Japan Information Technology Cooperation Initiative” includes an outline for the cooperation between the two countries in the information and technology sectors, aimed at invigorating the economies of the two countries. This joint study was also an initiative that has been further refined later to become the fundament upon which the discussion for possible future FTA between the two countries has been based.

To jointly organize the world’s largest event, The FIFA World Cup in football, became an overwhelming success, but also a significant and important step in normalizing the relation between the two neighbours. Not only that, the arrangement became a tremendous success in sporting as well as goodwill terms for both countries. Over the last few years the nuclear and missile threat from North has been a factor that has further favored the improvement of good Japanese – Korean relations. Contacts between Japan and Korea are constantly improving, with over 10 000 currently commuting between the two daily. Additionally, a number of smashing successes stories on the cultural front, in TV broadcasting and pop, have come to fuel contacts further in later years.

North Korean Apart from the general threat post by the North Korean nuclear program the abduction of Japanese citizens by North Korea, and their return, has been the most pressing issue on the agenda. The Koizumi one day trip to North Korea in May 2004, bringing home five abductees and promising energy to replace nuclear needs, moved the initiative in the negotiations somewhat from China in

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- 150 - the direction of Japan, for a short while. At the same time as the six party talk negotiations has become stalled, also the Japanese initiative has failed to produce more than just a single success and the momentum have faded. In all another ten abductees are still said to be unaccounted for from the Japanese side, of which the North have stated that eight are dead and the last two have never been abducted. A considerable complication to the relation has been that the ashes sent to Japan, said to originate from one of the dead, through DNA testing, proved to have no relation to the family. A fact that was met with outrage in Japan, and the domestic pressure was strong on premier Koizumi to introduce sanctions on the North in response. At the same time the bigger issue, related to the future of six party talks, could be at risked of a complete collapse if sanctions are introduced (Kyodo, 2004-12-20).

Asia Japan is the US most important alley in NEA and it has been of US interest to improve relations between Japan and Korea. Especially important when seen to the background of the raising strength and influence of China in the Asian region. During the two terms of Clinton as president, the position and importance of Japan was not as clearly defined, as it had become since the takeover by President Bush.

Although Russia used to be a security concern near the top of the Japanese agenda, and still today remains a county with whom there is no peace agreement, the two now have a working relation. Despite this, Russia is probably the country in the region that is of least interest to Japan in the near future. As for all neighbours in the region issues related to the development of the nuclear issue in North Korea is of immediate interest also to Japan. Over a little longer perspective the possible peaceful re-unification of the two Koreas would also affect the situation for Japan and widen a market where Japan is already strong. In relation to China a there is also a possibility of a re-unification between mainland China and Taiwan, peacefully or by force. If by force, and any other way in the near future is difficult to foresee, is bound to destabilize relations considerably in the region, and be very negative indeed on the relation with Japan. Also without a unification with Taiwan, the rapid rise of China as an economic and military power remains a long-term concern for Japan. To enhance its position as an economic power has shown to be both surprisingly simple and quick by the example of China. Its manufacturing and trade success has been followed up by large spendings on increasing the technical capabilities of a military power that already, in numbers, had an overwhelming strength.

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- 151 - 3.3. Energy

The years of strong industrial growth in Japan, from the 1950’ until the first energy crises in 1973, was build on an ever increasing import of oil that had shown an unbroken increase in imports during that period. From the first major crises, energy demand recovered, and had passed the 1973 level by the time of the second crises in 1979 – 80. Again a minor fall in consumption was registered, followed by a more or less uninterrupted growth since.

During the last forty years, there have been some major shifts in the pattern of energy consumption that deserves to be mentioned. It was not until first years of the 1960 that the consumption surpassed 100 mtoe for the first time, with industry consuming over 80%. At the time of the first crises, consumption had reached 280 mtoe with the share for the industrial sector had fallen to 65%. In 1974 the transport sector consumed 15% while the commercial/residential sector used up 20%. After the first crises it took total consumption three years to recover to its pre crisis level and eight years after the second crises, but the energy use in industry has not surpassed its 1973 level as a share of consumption. It is instead entirely in the other two sectors where the increase in consumption has occurred, driving the energy need over 300 mtoe in 1986 and above 400 mtoe in 1997, with the shares for transportation and commercial/residential sectors standing at 25% and 30% respectively (ANRE, 2004-07-10). This is not a development that is unique for Japan, but instead looks practically the same in most developed countries, wherever more electrical appliances have come into use driving up consumption. On the transportation side it is a strong increase in car ownership and a shift from rail to less energy efficient road transport, of the ever-larger volumes, that has caused the shift. To make matters worse, any improvements in engine efficiency, over the last ten years, has by far been offset by an even more rapid increase in engine effect in cars and trucks. With increased efficiency and lowered consumption it has been estimated that total consumption should be 10 – 15% under the 2000 level by 2010. The available prognoses also suggest that by 2010 it should only be the housing sector that has increased its consumption compared to the 2003 level (NEDO, 2004-08-08).

When it comes to the mix of energy sources it used to be oil that vastly dominated, being the source of 77% of the energy used in 1973. As a result of the world energy crises that year it became apparent that the mix of energy had to be widened and large-scale imports of thermal coal for heating and electric generation commenced. Parallel the use of LNG also increased, after having come into its first large scale commercial use only ten years earlier.

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- 152 - IEA has set the Japanese self-sufficiency rate in energy to 4%, the lowest among the G7 countries, with most of the domestic energy coming from hydroelectric power. In an as volcanic country as Japan it could be surprising that geothermal power supplies only 0.1%. If the nuclear sector is included the level of self- sufficiency rises to near 20%, but also uranium is imported. Japan has been trying to diversify its energy base and had a dependency ratio on oil on 49% in fiscal 2001, but with 90% of the oil supply arriving from the politically unstable region in the Middle East. The other major energy sources are coal with near 20%, while nuclear and LNG each contributes with 13% (IEA, 2004-07-07). The government has actively promoted the use of new energy sources and has by law, from April 2003, required power suppliers to use a certain percentage of designated new energy sources (JT, 2004-05-15). From the atomic energy group prices in generation has been estimated to about JYN 6/kWh for nuclear, with coal and LNG generated electricity at about 10% above that with oil near at double the nuclear price and hydropower at yet 25% more (JAERI, 2004-07-12). Also in the long term planning, alternative and sustainable sources, such as wind power and geothermal heating, are expected to supply less than 2% of the energy consumption by 2010 (ANRE, 2004-07-10).

Breaking down projected primary energy supply in Japan in fiscal 2030, a ministry draft says petroleum will account for 42%, natural gas 18% and nuclear energy 15%. The ratio may change depending on the progress of energy-saving efforts or a possible slowdown in the country's economic growth (METI, 2004- 05-18).

For the near future the greenhouse gas emissions in Japan are expected to exceed the targets set for 2005. The agency proposes the creation of a new system providing consumers with information about energy-saving methods as the Kyoto Protocol on global warming takes effect. Which it soon will after the Russian approval in January 2005. For the future that will follow under the regulations of the Kyoto protocol, Japan will probably have to buy its way out of a difficult future when it comes to emissions. As indicated in the above the use of fossil fuels will not be reduced enough to avoid a situation where Japan will be forced to buy carbon credits internationally, to find its way out of its dilemma.

3.3.1. Petroleum

Although Japan has ten on shore and offshore oilfields in production, with the first coming into production already in 1976, it can only supply about 1% of national needs (Japex, 2004-08-07). Oil consumption has remained relatively

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- 153 - stable over the last 15 years, having gone up about 10% between 1988 and 2003. From a level of 240 mty in 1988 to about 260 mt in 2003, which contrasts the increase of roughly 50% in consumption during the same time period in China and Korea.

From the point of view of energy security both Japan and China have an interest in trying to widen the sourcing of its oil needs, away from the instable region of the Persian Gulf. A Persian Gulf dependence that in the case of Japan stood at 75% at the time of the first energy crises, during 1994 briefly passed under 70% and has during the years of the 21st century been stable around 81% (Stat office, 2004-08-02). Both countries have proposed to Russia the building of a pipeline from Siberian oil fields, which have emerged as two competing routes. A set of conflicting interests that is of long-term interest to all the three parities involved. To build a pipeline, in accordance with the Japanese proposal, is estimated to take investments in the range of USD 10 – 15 bn. The plans include a pipeline from near Angarsk, west of the Lake Baikal to the Pacific coast and the oil terminal in Nakhodka. From the Russian side it in not only assumed that the project in itself should receive large-scale economic support from the Japanese side, but would also further promote investments in other sectors of the Russian economy.

A decline of 7.7 % in crude oil imports in February to 18.3 mt, made it the fifth straight monthly decline. Imports from the Middle East accounted for 92.6 percent of the total, up 13% from a year earlier, with The United Arab Emirates as the largest oil supplier, with imports increasing by nearly 10% percent to nearly exactly 5 mt (ANRE, 2004-03-31). November import level of USD 42.5/bbl

State owned Japan Petroleum Exploration may join a research project to gauge recoverable oil reserves in Russia's Far East and could become the first Japanese company involved in such a mission in eastern Russia. Estimations have set the available volumes to as much as 14 billion tons. Apart from the high political risk, severe weather and geographical restraints adds additional risk dimensions to the already high business risk of investing in the area. To participate in securing supplies from sources abroad, through investments in fields and exploration, has been set up as a part of the state policy for the future, and this initiative would therefore be fully in line with the policy guidelines.

Japan has suggested to neighboring countries and the ASEAN group of countries to jointly build up an Asian emergency oil stockpile, but this proposal has been largely rejected. To build such a stock would require huge assets to building a large enough storage, especially in times of higher energy prices. This is also in a region where the growth of consumption is three times that of the

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- 154 - world average (ASEAN and ADB, 2004-06-16 – 08-17). However, there is a need to ensure reliable and affordable energy resources for the future in the Asian region, where still 20% of the population is living near or under the poverty level. How this is best achieved is still to be agreed on.

3.3.2. Gas

The first energy plants using LNG were introduced already in 1963 and the first domestic findings of commercial gas was made in the late 1970’s (Japex, 2004-07- 17).

Although gas came to be imported to Japan in the form of LNG relatively early, it was not until after the first energy crises that any widespread investments in its use came about. The imported LNG’s main use if for electric generation and has been expanding its use from about 1% of generation in 1970 to about 25% by 2003.

As Japan has limited findings of natural gas of its own, it alarmed Tokyo when China found natural gas near the median line of the East China Sea. Tension over a Chinese gas prospecting in the East China Sea has started to mount, as from a Chinese point of view, this is Chinese territory and Japanese requests for detailed information about the exploration are seen as not justifiable. The two countries have never demarcated any border in the disputed East China Sea, and Japan has announced a median line as border, but has only discussed this with China and there is no border treaty. A new 470 km pipeline will by May 2005 connect this new Chunxiao field to mainland China, allowing for the full exploration of the field. This is by the Japanese side seen as a possible intrusion of its ocean zone. Japan has, as a counter measure, also declared its intention to explore for hydrocarbons near the median line. In the 2005 budget, 23 bn has been set aside by the government for exploratory drilling and for a new marine resource prospecting ship to be used in this area (Kyodo, 2004-12-15). Both sides talk about negotiations, but so far, this has not materialized, although the presidential meeting in November concluded that the East China Sea should not become a “sea of confrontation” (Xinhua and JT, 2004-09-08 – 11-23).

3.3.3. Coal

As in many other fields of minerals Japan has domestic findings of coal, but these have been relatively small and spread out, first of all on the island of Kyushu and Hokkaido. Domestic sources have played an important part in the

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- 155 - early development of Japan, as was the case also in Europe, and partly maintained this position up-until the 1960’s. Faced with competition from new large-scale and open-pit mines, in first of all Australia and Brazil, the high extraction costs in the small domestic under-ground mines has nearly completely forced them out of business.

The use of coal in Japan was much an import of coking coal to the steel industry up-until the first oil crises. At the time the import of coal came from the US, but slowly came to arrive from a wider spectrum of countries. This widening from the time of the first crises was partly a result of national initiatives, initiated to secure future supplies in the near abroad, e.g. in Australia, Canada and in later years also increasing from Indonesia and Kina. With a relatively stable steel production, in the range of 100 mty, also the input of coking coal has also been kept relatively stable around 60 – 70 mty. During the same 25 years the import of thermal coal, on the other hand, has increased from a level of 12 mty around 1980 to surpass 100 mt for the first time in 2003 (Coaltrans, 2004-07-05).

Japan, with its only symbolic domestic mining, is the world’s largest importer of coal with 173 mt imported during 2003. During later years it has been the problems with the nuclear plants that have maintained the consumption of coal at power plants and that made thermal imports pass 100 mt. Originally the METI had estimated that a 10% reduction in coal consumption would be needed to meet Japan’s CO2 targets, but near capacity steel production in combination with an considerable increase in the use of thermal coal due to the nuclear problems has played havoc with the planning. A reduction that was originally meant to mean a 10% and 6-mt reduction by 2010 for coking coal would in the current situation mean a 27% and 20-mt reduction to reach the 53-mt target. For thermal coal to follow through on the METI estimations, it would also require a 30% reduction from the current level until 2010 (METI, 2004-05-10).

Of the generation the effect generated from thermal coal reached 7% in 1990, and despite having doubled its capacity to 25 GW by 2000 the share in the generating had reached only 11%. Still the extension of a number of thermal coal power plants in Japan is expected to add another 7 GW of capacity inside the coming five years (Coaltrans, 2004-08-02). With prices following the rising oil prices settlements for coal has surged, from about USD 40/ton to USD 80/ton and expected to go well above USD 100/ton for coking coal during 2005, while thermal coal has increased from USD 25 – 30/ton to around USD 45/ton (ibid., & JISF, 2005-01-19). This is partly a new situation as a buyer cartel organized by the Japanese electric companies has for many years been practically setting world prices for the year to come in negotiation with the major suppliers. The outcome has then been a used by others all over the world as a benchmark in

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- 156 - negotiations. This co-ordination has fallen apart in later years as the number of both exporters and buyers on the market has increased considerably.

Still the sourcing of energy is an arbitrage between security of supplies and having the possibility to profit also from market changes. Coal is to play an important part also in the future, being much cheaper than LNG, and environmentally better than oil power. The increasing use of coal in later years is emerging as a considerable problem for the near future, going contra to Japanese environmental commitments.

3.3.4. Electricity

By 2004 there are 10 electric power-generating companies in Japan, with an integrated high voltage grid for transmission from Hokkaido to Kyushu. Since the introduction of the revised Electric Utilities Industry Law in March 2000 large consumers are free to negotiate prices with any of the originally regionally oriented suppliers.

At the time of the first energy crises oil showed a considerable dominance in the generation of electricity in Japan being the source of 73% of the generation. At the time coal was a long distanced second on 8% with both LNG and nuclear generating a tiny 2% each. With rising oil prices this pattern was set for a through overturn, and by 1990 the share of electricity generated from oil had fallen to 28% and further to 10% by 2002. The change was in reality even more dramatic as during these same 12 years electric consumption increased by 28%. What happened was that the share generated by coal increased from 9% to 22%, while the share for nuclear increased from 26% to 31%. The not mentioned generation, about 12% of production, comes from renewable sources, where hydroelectric dams generate practically 95% of the volume. The large shift that has taken place in the market is that the share of electricity in total energy consumption in Japan has increased dramatically. In 1965 it stood at 15% and was on the decline until the first oil crises, when it suddenly jumped to 25% by the second crises in 1979. It has since continued to increase and stood at around 44% by 2002 (ANRE, 2004-09-04).

As mentioned above it is the household sector that has, and especially will, increase its energy use the most. Perhaps not surprising in a country that already in the early 1990 had more than one air-conditioner per household. Of the 193 TWh consumed in homes in 2001 combined heating/cooling and air- conditioners are the fastest growing of the major items taking 13% and 11% respectively102. As a curiosity it could be mentioned that the by far fastest

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- 157 - growing of all items, having existed as a statistical item for less than five years, is “toilets with wash shields”, using 3.5% of household electricity (METI, 2004-08-12). Another trend in the Japanese electric market is that private consumers are encouraged to convert houses to become fully electrically heated, which is completely in contrast to policies in most European countries (e.g. Tohoku, 2004- 09-04).

For the future there will be an increase in the use of nuclear energy, including the re-commissioning of some generators still under repair. Together this will lift the share of nuclear energy from 34% in 2000 to about 41% by 2010. The proportion of electricity generated from oil would during the period until 2010 fall from 11% to 6% at the same time as the LNG share will fall off slightly, from 26 to 24%. Also the share for coal is planned to fall slightly, from 18% to 16% compared to the year 2000 figure (METI, 2004-07-03).

3.3.5. Nuclear

In 2004 Japan has 54 nuclear power stations that supply about 35% of the country’s electricity.

The Natural Resources and Energy Agency has in its long-term outlook, from late 2003, suggested the building of ten new nuclear reactors by 2030 (ANRE, 2004-07-12). At the same time the Advisory Committee for Natural Resources and Energy, an advisory panel to the Minister of Economy, Trade and Industry, has in its latest draft lowered the projection of the number of reactors that would start operations by fiscal 2010 to four, less than a half its initial target. The construction of nuclear reactors will partly depend on demand and taper off after peaking in fiscal 2021. Apart from the fact that reactors generally have shown stable production results at low costs /kWh, the sourcing of raw uranium has over time proved to be a relatively unproblematic market. That is both in regards to security of deliveries and prices, and especially so compared to other energy sources.

The running of nuclear plants in Japan has been followed by a large number of incidents and smaller accidents, often the result of faults in maintenance. Some of the errors that have occurred have been on the brink of becoming major accidents. What was, probably, the worst occurred in 1999 at Tokaimura where human errors resulted in two dead and a large evacuation of nearby residents. A number of other incidents, including a closure of 17 plants for security checks in 2003, have had a clearly negative influence on a previously relatively strong public support for the large-scale domestic nuclear program (Commondreams, 2004-08-10).

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- 158 - Heavy investments have also been made to create a fuel cycle and a full scale reprocessing plant has been build in Rokkasho, near Aomori, on northern Honshu. Also this plant has had a history of cost over-runs and production problems, but shipments of spent nuclear fuel to the plant was restarted in the summer of 2004. At the time the plant had been closed 20 months for maintenance, due to leaks caused by welding defects. It is hoped that the full scale reprocessing can be restarted during 2006, and by then some 1 600 tons of spent nuclear fuel will be stored at the plant (JT, 2004-06-06). The perspective plan suggests that it should become possible to complete a nuclear fuel cycle at Rokkasho. This will be achieved by way of upgrading the spent fuel for future use, mixing-in plutonium-uranium oxide fuel to create MOX. This MOX fuel will then be used for power generation under the pluthermal program, alternatively in a future, still to be fully developed, fast-breeder reactor (JNF, 2004-09-01).

3.4. Transport

Being a relatively large country in terms of surface, with 377 000 km2, Japan is still spread out over four major islands. Of the available surface only 25% is considered to be suitable for human habitat, mostly due to its topography. With a population of about 128 million population density comes to well over 1 300 km2, if only the inhabitable land is taken into consideration. As a result, the space available for transport and infrastructure is severely limited in many areas. Also on the remaining ¾ of the surface, road and rail construction faces great difficulty in overcoming, or drilling through, numerous and high mountains and bridging uncountable rivers and canals for rise farming. Additionally, weather conditions, with frequent strong typhoons as well as several metes or snow in winter in other areas, forces into place width of bridges, protections against landslides, man made wave breakers outside ports and so on, that for nearly 365 days of the year can look un-necessary. Together these are factors that considerably raise the cost and difficulty of infrastructure project. Additionally the sharp competition for land not only raises costs further, but also makes projects face intense scrutiny.

3.4.1. Railway

The international profile of the Japanese railways is beyond doubt carried by the Shinkansen high-speed train system. On October 1 1964 the first Shinkansen train departed on the 553 km Tokyo and Osaka line, just in time for the Olympic games, and celebrated its 40 years jubilee in 2004. Since its inauguration Shinkansen trains have carried 4.16 billion passengers and run over 1.5 billion

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- 159 - km; a distance that is long enough to circle the globe 38.000 times. It has maintained it popularity over the years and carried 360.000 daily passengers in 2003. Even more impressive is the average delay during 2003, which was kept on the level of seconds, and still most impressively of all – with a history that is accident-free. That while running a system with high speed trains reaching beyond 300 kph in a country with a large number of both weak and stronger earthquakes yearly (RTRI and JR, 2004-10-01) 103.

Railway construction in Japan started with English equipment and even paid for by railway bonds issued in the UK. Opened in 1873, 29 km of narrow gauge tracks connected Tokyo with Yokohama, which was one of the few ports open to foreign trade at the time (JRTR, 2004-07-07). Expansion was very rapid and already inside 20 years the railways from Tokyo reached across Honshu, north to Sendai and beyond Kobe. During its early build-up period all the major Japanese railways were state controlled, with a large number of regional train lines being private, but nationalized in 1905. The next important year was the US led reorganization into a public corporation called Japan National Railway (JNR) in 1949. The state dominance was finally ended with a reorganization into a number of regionally oriented companies in 1987. Still the Japan Railway (JR) Company is the holding company for the six railway operators and the three service companies (Japanrail, 2004-09-01). Of the six railway companies three have been listed on the stock exchange.

At the end of WWII few other means of transport than railways were available and the dominance of the railways stood at 92% in 1950 when measured in passengerkm. With the introduction of more cars the share fell constantly during the coming decades, standing at 76% in 1960, 49% in 1970 and 40% in 1980 (JRTR, 2004-07-07). At the later year car ownership was already widespread, but due to the limited availability of parking commuting by train in combination with the continued popularity of Shinkansen kept, and has since kept, the share for trains relatively high.

As a result of the domestic development of high tech rail equipment Japan has a number of internationally well known producers have been able to attract high profile export orders. One such example is the USD 12 bn upgrading of rail routes in China where the ministry of railways in China has been taking in tenders. The Japanese-Chinese consortium will upgrade tracks and introduce new equipment to make it possible to increase train speeds of up to 200 kph. The project includes five routes that are to be upgraded, totaling about 2,000 km, including those linking Beijing, Shenyang, Jinan and Qingdao (CW, 2004-07-30).

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- 160 - Also the Shinkansen train has found its first export order with the first train being shipped to Taiwan in the middle of May 2004. The Taiwanese high-speed rail system is scheduled to go into operation in late 2005. This was the first of 30 trains that are to be delivered according to a contract signed with a consortium led by Mitsui & Co. This first export contract for the Shinkansen has been valued at about USD 12.7 billion in hardware for the rail manufacturers (Mitsui, 2004- 05-19). Trains on the 330-km high-speed line being built in Taiwan will make the trip between Taipei and Kaohsiung in 90 minutes, instead of the four hours needed today. The export of the system has not been unproblematic, as the Taiwanese buyer has decided to partly run the train on a single track, which is never done domestically. Fundamentally changing the signaling system needed, which could well come to delay the introduction of the train (JT, 2004-12-14).

Freight Due to the lack of other means of transport after WWII the railways held a 52share of transport work in 1950’s, which consequently fell to 39% by 1960. This was just the beginning as it was in the following years that the real crises for rail transport were to set in, with increased truck production and much-improved roads. Rail freight lost out dramatically during the coming years and saw its share in transport work fall to 18% by 1970 and further to 8% by 1980 (JRTR, 2004-07-07).

Jrfreight is one the three service companies inside the JR Group that was formed as a result of the 1987 privatization. Fright on trains in Japan has not been able to maintain the volumes like in many other countries, as the interaction of cargo over land, at long distances, has never come to be established here. Japan also lacks a long distance basic bulk flow of e.g. coal that could boast tonkm figures. Currently the variety of goods transported is not as big as in other countries. It is tank wagons and containers that can be seen on trains although seldom of international TEU standards. Instead a domestic size container, in the size of 0.5 TEU, suitable for local distribution, is what is favored on the railway (Jrfreight, 2004-09-01). Efficiency is high and somewhat unique is the handling of containers on trains without shunting, which greatly enhancing the efficiency of container transport and minimizing waiting times.

3.4.2. Road

During the years of the 1950’s and 1960’s the situation in Japan when it comes to roads, was in, certain aspects similar to the present situation in Russia and China. In the years after WWII there was practically no cars available and the share held by cars in total passenger transport work stood at only 7%. With the

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- 161 - introduction of more cars the share increased constantly during the coming decades standing at 15% in 1960, 39% in 1970 and to 48% in 1980 (JHPC, 2004-07- 07). A rapid growth in private car ownership filled the few roads available and the growth exceeded the efforts made by the state to extend the network. The first toll-roads in Japan were introduced already in 1952 and much of the financing for new roads came from the petrol tax that was introduced in 1954 (JHPC, 2004-07-10). The building of new roads in Japan has been facing all the physical restraints mentioned above. The limited space available has meant that much construction work for new large roads has been forced into tunnels or up on pillars through build up areas. The construction industry has also been given a reputation of having formed a strong lobby that has effectively been promoting the launching of new and expensive infrastructure projects. The industry has in return proved very generous with financial support to political parties.

In all there are about 1.2 million km of roads in Japan, with about 7 300 km of motorways and 53 000 km being national roads. The largest part of the road system falls under the municipalities, 980 000 km, out of which 74% is paved (JHPC, 2004-07-10). In 1957 the cost of construction for the first motorway, between Nagoya and Kobe, stood at 0.6 bn/km having risen to about 5 bn/km for the projects about to start. The national motorways have in later years been under discussion to be converted into three private companies, with a new law being established in June 2004. The law call for the JHPC to be split-up by into three companies and with the privatization decision to be taken in 2006. As driving force to speed up the preparation of the law, was a 2003 scandal that emerged inside the JHPC with “creative bookkeeping” having made the financial results during some years look much better than what had actually been achieved104. The political resistance against privatisations in this field remains strong and if the Prime Minister will really be able to follow through his intention has been put in doubt.

- Local motor industry production Car production at a larger scale came to a start in the years after WWII, being based on licenses granted by French and British manufacturers. Initially both capacity and demand were limited but by the late 1960’s both factors had improved greatly and the first export of Japanese cars overseas was initiated on a small scale in the early 1960s. Car production in Japan later came to top at 13.3 million in 1990 and has since been on a slow decline, except for a minor increase in 1996 and 1997, and stayed below 10 million (Japan Automobile, 2004-07-10). During 2004 domestic production has been increasing again, with about 3%, to just over 10 million (ibid., 2004-12-28). Vehicle sales in Japan also peaked in 1990, with 7.7 million units, but have since fallen to a level around 5.7 million for fiscal 2003. Domestic sales of cars for 2004 reached 3.4 million, down 1% on 2003 with

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- 162 - truck sales reaching 550 000 (JADA, 2005-01-05)105. Exports of vehicles from Japan topped already in 1986, with 6.7 million units exported. It then fell off to reach its lowest point in 1996 with 3.7 million, but has increased again to about 4.7 million in for 2003. A volume that corresponds to practically half the shipped volume of new cars in the world during the year (MOL, 2004-09-29).

Japans biggest auto producer, and the worlds number two producer, is Toyota. Including subsidiaries Daihatsu and Hino, Toyota produced 6.8 million units during its 2003 fiscal year, at 12 domestic plants, and its 51 other plants in 26 countries/locations with 260 000 worldwide employees (Toyota, 2004-06-20). The model that has symbolized Toyota more than anything is the Corolla model, which for 22 consecutive years was the most selling model in Japan, before overtaken by the Honda Fit model in 2002. However, the Corolla made a come- back in 2003 selling 200 000 units to again becoming the biggest selling model, only to be overtaken again during 2004 by the Honda Fit model, selling 150 000 units. Despite producing the best selling car Honda is second in size, producing about 3 million units at 6 car plants in Japan and at another 10 in other countries, with 130 000 worldwide employees (Honda, 2004-06-20). Nissan is Japans third producer with 2.7 million units during 2003, with 6 car plants in Japan and 15 overseas, employing about 130 000 (Nissan, 2004-06-20). Next in size is Suzuki that produced 1.8 million units from 3 domestic and 7 overseas production facilities, employing 14 000 in Japan (Suzuki, 2004-06-20). Number five in production volume is Mitsubishi that produced 1.6 million units from 8 pants in 6 countries, employing about 11 000 in Japan (Mitsubishi, 2004-06-20)106.

The motor industry in Japan is not only big it is also highly innovative. A good example of this was given at the most prestigious “International Engine of the Year Awards” in 2004 when the Toyota Prius hybrid motor concept won a record breaking three out of eleven awards. The engine, produced in earlier versions since 1997, was given the title “truly remarkable”, by the international motor journalists that voted for the award. With the launch of the new engine, sold in about 230 000 cars already, Toyota will be the first manufacturer to offer a hybrid engine in both passenger cars and SUV’s (autointell, 2004-05-26).

After having started to export from domestic plants all the major Japanese companies have invested heavily abroad. Japanese producers were also among the first to understand the coming might of the Chinese market and have enjoyed many of the early mover advantages in this market. Over the last year a new battle between Japanese producers, Suzuki and Daihatsu, is being staged in India where Suzuki for years have been the biggest producer. Investments in the USD 200 million category, by first Korean Hyundai and then Daihatsu during 2004, has forced also Suzuki to upgrade its capacity in the Indian market (Hyundai, Daihatsu, Suzuki, various dates).

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- 163 - 3.4.3. Water transport

Being an island nation with a 34 000 km coastline, with what is topographically a very difficult landscape, water transport has always been an integrated part of the national transport structure. The costal traffic with rapid long distance ferries continues to play an important part in the national transport network. All islands are now connected, with bridges from Honshu reaching both Shikoku and Kyushu and the worlds longest and deepest railway tunnel connecting Hokkaido in the north107. Infrastructure that has increased the national transport efficiency, but has also resulted in a dramatic decline of the ferry sector.

The two by far largest high sea shipping companies in Japan are MOL and NYK, with the two being the second and third largest shipping companies in the world with a fleet of 24 million dwt and 20 million dwt respectively (Lloyds, 2004-10-12). Both companies control approximately 300 ships by way of direct ownership, additionally a large number of ships are controlled by way of different forms of charter. Both companies are the result of a number of mergers over their 120 and 130 years of existence respectively. NYK was the first in Japan to take up international linear shipping with the first line connecting Yokohama with Shanghai already in 1875, and the first long distance line, to Bombay, coming into service from 1893. In 1965 the first specialized car carrier was introduced by MOL, and with NYK sailing the first fully containerized ship to the US in 1968. From this time the two has developed into what today is companies owning a liner fleet with a capacity of about 180 000 TEU each, with NYK having the smaller average ship size of the two. The liner shipping section for the two has now reached a scale where the NYK ships are largely sailing as a part of the Grand Alliance and the MOL group is a participant of the The New World Alliance (MOL and NYK, 2004-11-09) 108. Both companies have many more ships under order, with eight of these for NYK to become among the largest in the world with a 8 100 TEU capacity.

Although container shipping is the most high profile in this line of business, liner services only constitutes about half of the business for NYK and about a third for MOL. Still, both companies have many ships in tramper service (contracts for one or just a few voyages) with other used for long-term contract shipping, accounting for the remaining part. Ships used for contract shipping are normally specialized vessels, but also include a large fleet of both bulk carriers and crude carriers. In practically all sectors the two are among the largest shipping companies in the world with the dominance for dry bulk carriers being the largest, where MOL is the largest in the world with 9.5 million dwt, at the beginning of 2004, with 7.8 million dwt in the NYK fleet. NYK being the biggest in car carriers 76 ships against 65, with MOL the bigger in LNG, 27 against 14, and for tankers with 11.7 million dwt against 8 million dwt.

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- 164 - Third biggest shipping company in Japan, K-Line, is in the number of owned container ships even bigger than the others, with 197. In number of car carriers it is also bigger, with 63, but has a smaller fleet in other segments. As for the other two, also K-line operates a lot of ships outside of what is actually owned by the company, but still under its control through charter contracts or ownership of companies (as well as individual ships) in co-operations with other companies. As such contract can be both long- and/or short term the controlled fleet of a shipping line can be relatively volatile over time (combined from Clarkson, Lloyds, and Fearnleys, 2004-10-12).

Shipbuilding Shipbuilding in Japan has a long tradition, with e.g. IHI Marine having a 150 years tradition. However, Japanese shipbuilding was long a highly fragmented business, with most yards building smaller vessels. The first wave of restructuring came with the first oil crises in the beginning of the 1970’s. The latest wave of mergers came as late as in 2002 when two new larger corporations were formed. There are currently five major corporations that compete on a global scale inside most lines of shipbuilding. The three long time shipbuilders Mitsubishi Heavy Industries (MHI), Mitsui and Imabari, and the two newly formed IHI Marine and Universal. The two latter formed from a merger of IHI's shipbuilding and Sumitomo Heavy Industries, while Universal was formed by a merger of NKK Corporation and Hitachi Zosen Corporation. Together these five currently operates 15 shipyards for new-buildings, with facilities capable of producing any kind of ships in all sizes in use in the world fleet. The yards have attempted to focus on innovative design and product development to compensate for higher wage costs. So far this has largely made it possible to attract a sufficient number of orders, with the inauguration of a brand new yard for Imabari, with a 500.000 dwt dock as recently as in 2000, serving as a strong indication of optimism. The different yards are located on all islands of Japan, with a concentration to the Inland Sea area, with all but Imabata being headquartered in Tokyo (MHI, MES, Imabari, IHI, Universal, various dates)

With the success of Korea shipbuilding Japan has been overtaken in later years as the worlds leading nation. The world’s biggest shipyards are currently to be found in Korea and in 2002 Korea passed Japan, for the second time, as the worlds largest ship producer. Out of a total world ordering of 43 million CGT during 2003, Japan secured 29% of orders while Koran shipbuilders secured 35% of the volume (Fearnleys, 2004-03-07). The trend has been further reinforced during 2004 with orders for about 9 million CGT being placed in Japan, and nearly twice that volume, or 18 million CGT, in Korea (KOSIP, 2004-12-25). Both countries shipbuilding industries have been facing the same economic problems during 2004, where both supply problems and dramatic price increases for first

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- 165 - of all steel has severely reduced the profitability in the industry (MHI, MES, IHI, various dates). The signing of orders at the yards over the year has been upbeat and few new-building slots are currently free for delivery before 2008.

3.4.4. Aviation

The international airfreight volume in Japan is to over 70% concentrated to the Narita International Airport some 60 km east of Tokyo. In a time when economies in the surrounding world are growing, so is the volume of airfreight, which here contains a large share of electronic appliances. Between 1986 until 1996 the cargo handling at Narita was the largest in the world, when the top position was taken over by Hong Kong, but Narita has remained second in the world since (Narita Airport, 2004-07-20). 1.1 mt were handled during H1 2004, with the full year volume having been estimated to 2.1 mt. In the beginning of 2005 the new Chubu Central International Airport is scheduled to open near Nagoya and is expected to take over some air cargo from Narita destined for central Japan. Currently some 60% of cargo destined to this region of central Japan is being handled at Narita. The sheer size of Narita is also its strength, as it daily operates some 470 international flights to near 100 cities in the world. For the future volumes are expected to increase considerably, with capacity at Narita being increased to 2.4 mt during 2004, while volumes are expected to exceed 3 mt by 2012.

In the total turnover figure of freight Narita is about three times as large as its closest competitors, Osaka and Tokyo Haneda, which handled 790 000 and 722 000 tons during 2003 respectively. Volumes that placed the two as number 23 and 24 in the world (ACI, 2004-12-01).

On the passenger side, the by far biggest airport in passenger numbers is the central Tokyo Haneda airport, ranking fourth in the world after Atlanta, Chicago and London with a turnover of 63 million, up by 3% over 2003 (ACI, 2004-12-01). The opening of a second terminal at Haneda in December 2004 allowed the two main airlines, ANA and JAL, to use separate terminals, which should mean further increasing passenger volumes in the coming years (JAT, 2004-12-01). The previous single terminal was designed for 40 million, had allowed for only 60% of passengers to board from the terminal and the remaining by bus, which now will change to 90%. The two airlines have also shown other signs of good (?) co-operation, as out of 140 bids for domestic postal transport that the two had placed, 115 bids happened to be fully identical (Kyodo, 2004-12-12).

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- 166 - Outside of Haneda, Narita has been about the 25th biggest of the world’s airports during the last ten years, having seen about 23 million passengers during 2003, a fall by near 9% compared to the 2002 figure (ACI, 2004-12-01). Competition among airports will increase in Japan during coming years as the Osaka Kansai airport has decided to reduce landing fees by 90% from early 2005 to attract more domestic flights, with a new Central Japan International Airport to open in Aichi Prefecture (Nagoya & Toyota) for the World Expo in February 2005. Already in 2006 a new Kobe Airport is to open in between the two mentioned (JT, 2005-01-27).

3.5. Other

3.5.1. Iron and steel

Between the years from 1950 to 1980 Japan was the world’s third largest producer, but overtook the US in the beginning of the 1980, when the US volume started to dwindle and the Japanese stayed more or less flat. Then, with the falling apart of the Soviet Union, Japan became the worlds largest crude steel producer in 1991, only to be overtaken by a rapidly expanding China in 1996. Production volumes have over the last 30 years been maintained over or near 100 mt y, with highest volumes being produced in 1973 – 1974, 1980 and 1990, with 120 mt, 116 mt 115 mt respectively. Average production costs for basic steel products in Japan in 2003 were estimated to be highest among all major producer countries, and among the highest in the world. Only the US of the larger producers are estimated to have about 5% higher average costs, while among producers in the NEA region Japanese costs are set about 20% above that of China (combined from IISI and WSD, various dates).

The first major crises in the Japanese steel industry came in line with the general economic crises triggered by the oil crises in 1974. From rapid production expansion until the middle of the 1970’s, the coming years was marked by price war and downsizing. Nippon Steel, e.g., produced over 40 mt in 1974 and had to reduce its volume by over 25% in the coming years. As a result of the crises of the 1990’s the consumption of steel in the domestic construction industry collapsed at the same time as the government scaled down its public works. Further downsizing followed and later another price war commenced among desperate producers. A merger between the then second and third biggest producers, NKK Corp. and Kawasaki Steel Corp., forming JFE Holdings Inc. was conducted in September 2002. With a combined production of near 30 mt the two are nearly the size of Nippon Steel. Nippon Steel, on the other hand lined up with Sumitomo Metal Industries Ltd. and Kobe Steel Ltd. through a minority

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- 167 - cross-ownership, later the same year. As a result of this the market suddenly had been restructured from five to practically two key players. This new market structure allowed the producers to regain much of its lost bargain power towards both consumers and suppliers, at the same time as it was facing a market in slow recovery (NS, JFE, SMI, KS, various dates)109. Measured in production capacity of crude steel the biggest producer in Japan 2004 is Nippon Steel, followed by JFE Holdings Inc., Sumitomo Metal Industries Ltd. and Kobe Steel Ltd.

Japan's iron and steel industry has during the last two years shown signs of strong recovery as crude steel production 2003 reached 111 million tons, which is the highest since fiscal 1990, and the fifth highest ever. With total production having increased by near 3%, production is increasing the fastest in the special steel category with near 9%, to reach a volume of 22 mt, with ordinary hot rolled steel making up 82 mt. Domestic steel consumption for 2004 is estimated to exceed 70 mt, highest in four years, but still export markets remain very important for the Japanese steel industry. Of the 35 mt exported during 2003, Korea was the destination for nearly 30% of the steel export, with Korea also being the most important origin of the 6 mt Japan imported during the year (JISF, 2004-08-15). Production during 2004 has increased slightly from the 2003 level, near the capacity of the industry, at the same time as prices has been on a clear upward trend during the period. As a result, the steel sector, which was in deep crises a decade ago, now expects record profits for fiscal 2004, but is fearing the price increases that will be necessary to cover cost rises in 2005 (NS, JFE, SMI, KS, various dates).

Just a few years back the steel industry was under pressure to make further reductions of production capacity, but the boom in the Chinese market has come to postpone this. The demand from Chinese consumers became real strong from about 2000 and onwards, but the latest recovery is also a result of increased domestic demand. The Chinese demand has been for wider uses in infrastructure building and social infrastructure, while domestic demand has been increasing the fastest from car producers and from shipbuilding. From the steel industry the strong demand is not expected to fall off until after the Olympics in 2008 or possibly until after the Shanghai Expo in 2010 (JISF, 2004- 08-15).

Steel producers have over the last decade become increasingly involved in FDIs in attempts to acquire both production facilities and raw material. Although companies have adopted different strategies, FDIs in e.g. Brazil, Australia and Africa has generally focused on the development of new coal and iron ore findings. However, large investments have also been made in the Chinese

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- 168 - market to secure a foothold in production facilities and to develop new products. The so far most advanced step in this direction was made by JFE Steel in 2004 that plans to construct a new blast furnace steel mill integrated with a steel work in the Guangdong Province. It will be producing high quality flat- rolled steel for the car industry as its main end product. When opened, it will be the first Japanese furnace build overseas since the end of WWII (JFE, 2004-08-12).

New in the industry is also its increasing dependence on the Chinese market, exemplified above, but Korea still remains the by far largest export market. These foreign markets remain under close observation as exports have grown rapidly over the last few years, and a possible restructuring could be up coming already in the medium term on the Chinese market. With a demand of over 250 mt also a fall in demand of just 10% in China would equal the production volume of one of the two largest Japanese producers and will be strongly felt in the market. For the moment, however, all major Japanese producers are harvesting record profits and expects demand to remain high for the time being among its most important domestic customers like shipbuilders and carmakers as well as on overseas market. If also domestic private investments will start to increase, as a result of the ongoing economic recovery, that would come as a bonus for the producers.

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- 169 -

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- 170 - 4. China

4.1. Introduction to China110

The future of China is under the current development, getting ever more closely connected to, and interdependent with, developments in the surrounding world. Still China, in its position as one of the world’s leading powers, pursues an independent foreign policy based on five basic principles: mutual respect for other countries sovereignty and territorial integrity, mutual non-aggression, mutual non-interference in internal affairs, mutual equality and benefit, and peaceful coexistence in developing diplomatic relations and economic and cultural exchanges with other countries. At the same time as fundamental changes to the previous system will be described in this chapter, the constitution indicates continuity:

Article 1 of the Chinese constitution, adapted in December 1982, reads:

“The People's Republic of China is a socialist state under the people's democratic dictatorship led by the working class and based on the alliance of workers and peasants. The socialistsystem is the basic system of the People's Republic of China. Sabotage of the socialist system by any organisation or individual is prohibited.” (Xhinhuanet, 2004-04-20)

Furthermore the constitution’s first paragraph gives the power to the people, exercised through the National People’s Congress, under the principles of a democratic centralism. Meanwhile, Article 6 of the constitution is probably the one that has been most clearly surpassed by the development in recent years as it reads:

“The basis of the socialist economic system of the People's Republic of China is socialist public ownership of the means of production, namely, ownership by the whole people and collective ownership by the working people. The system of socialist public ownership supersedes the system of exploitation of man by man; it applies the principle of 'from each according to his ability, to each according to his work.” (Xhinhuanet, 2004-04-20)

China is in the early 21st century the world’s most populous country and has an economy that is demonstrating a long-term economic growth at an unprecedented speed in its history. It remains a country based on a Socialist democracy, and this has not stopped it from launching far reaching reforms in

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- 171 - many fields. Most of the larger companies are still state owned or, if partially privatized, the state remains the owner of a controlling share. Despite the fact that, China now has many fully private large companies, which could be seen as against the constitution, it has also received innumerable FDIs and offers both “special economic zones” as well as generous tax and tariff breaks to foreign investors. Still the restructuring of state enterprises has so far proceeded slowly, but has nevertheless come to result in staff reductions on a grand scale on occasions.

In many respects 2003 was an unusual year for China as it experienced a transition of power at the Party Congress in March, when former president and chairman of the ruling Communist Party, Jiang Zemin, resigned in favor of Hu Jintao. At the same party congress Wen Jin was named new prime minister.

4.1.1. The Chinese Economy

As in many other countries, the main focus of politics in China is to improve people's lives and to adjust the problems that arise from disparities between the rapid economic development and the often-slower social development. Opinions on the means needed and the speed these problems should be attended to can vary greatly based on the political standpoint of the decision- maker or observer. However, despite the fact that practically every economic indicator has remained positive for many years now the disparities in the society are increasing. The distribution of the benefits obtained from the positive growth figures is a continuous problem of by the central authorities. So far there has been little balance in the distribution neither between different regions nor between social groups, and instead income gaps between social-strata of the population are widening. This is especially seen not only in western but also central regions of the country, which have been falling behind not only in income terms, but also in educational and health terms. Cash rural income level remained at about 1/3 of the urban level, that stood at about USD 1 050 by mid- 2004. There is an understanding from Beijing that a coordinated, yet sustainable, development must be upheld to generate surpluses that can be distributed. The long-term plan suggests that the country should at least triple its GDP by 2020, while the prescribed path for this growth is oriented towards a regionally balanced development. For the future stability of China, it will be crucial that these aims can be fulfilled to guarantee more than a subsistence income and development for its population, including a considerable degree of social fairness.

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- 172 - It is beyond doubt that the reform path followed so far by China has been successful, at least if the measurement used is GDP growth. China's economy has expanded by a factor 45 over the past 25 years and much of that development has been made possible by the profits earned from free trade. Over these 25 years, average per capita GDP has increased from less than USD 200 to over USD 1 000, with an increase in life expectancy from 61 to 71 years (ESA-UN, 2004-05-10). As China has come to base much of its economic development on exports, this has also increased both the dependence and the exposure to changes in the international economy in a way never seen previously. Internationally, this is not unique, but in the future China will not be a nation that can retreat to the use of its own resources for development and will hardly be able to reverse its development to follow any kind of socialist principles of self-sufficiency.

According to international sources, such as the IMF and the ADB, Chinese exports will remain strongly vibrant, but there are fears of a possible overheating and at some stage investments will have to come down. A controlled appreciation of the Yuan has been suggested as a way to cool down the partly overheated economy, while allowing increased imports, to surpass exports in value, could be a way to shrink the current-account surplus.

China, over the past 25 years, had an average GDP growth of over 9.4% and the growth is expected to be maintained around 7% for the coming 15 years, according to Vice-Premier Zeng Peiyan (CD, 2004-09-13). In 2002, the Chinese GDP, for the first time, passed the benchmark CNY 10 trillion level reaching 10.3 trillion, up by 8% over the year before. During 2003, China managed to stop the threatening SARS epidemic and at the same time, despite the epidemic, reach a 9.3% GDP growth. The strong growth of GDP during the year, totaling 12 trillion Yuan (USD 1.4 trillion) made the per-capita income pass another benchmark of USD 1 000 for the first time111. According to the Ministry of Economy, the national GDP/capita by 2020 is estimated to have reached over USD 3 000 and combined GDP to have passed USD 4 trillion. In economic terms, the primary sector in China contributes about 14% of GDP, construction and industry to 55% while the service constituted above 31% (Bofit, 2004-44). The growth level for the three sectors was 2.9%, 9.9% and 7.3%, respectively, which indicates that the share of the secondary sector, industry, is still growing as the fastest, despite its already large share of the economy. There are probably some statistical problems involved here, but it is clear that the large surge in the service sector that usually follows after a country has seen its industry expand, still awaits China (CEC-CEDA, 2004-09-20). For 2004, the country's GDP grew 9.5% to 13.7 trillion (USD 1.6 trillion) (NBS, 2005-01-25). A slight slowdown, especially during Q3 of 2004, was seen as a product of reduced bank lending and

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- 173 - restrictions to investments in overheated sectors (CW, 2004-11-03). Overall fixed investments slowed by one percent during 2004, to 26% percent, but were restricted considerably after having increased by 43% during Q1 2004 (NBS, 2005-01-24). Total industrial production during 2004 increased by 11.5%, down from 17% in 2003, while production in companies with foreign ownership grew by over 20% (NBS, 2005-01-24).

With increasing living standards and incomes, the Chinese consumer goods market is becoming increasingly important with consumer good sales for 2004, having increased by 10% in real terms, to 5.3 trillion (USD 650 bn), and with overall sales passing 15 trillion (USD 1.8 trillion) (BNS, 2005-01-24). However, the figures for the latter part of 2004 indicates a lowering of the increase in domestic demand to a one digit level, which, together with a stabilization of consumer prices, could indicate future sustainability of the general growth (WB- Ch, 2005-02-02). Although consumer prices rose by 3.9% in 2004, 2.7% more than 2003, driven by an above 10% increase in food and fuel prices, there was a slowdown in the later part of the year. The sharpest rise was seen in rural areas where prices were up by 4.8%, but by only 3.3% in urban areas (NBS, 2005-01- 25). One of the big shifts in the consumer market is that both the product types and the price level of goods have risen dramatically as new consumer durables, foreign travels, cars and apartments are included in the consumption pattern for many more. Consumption figures that are supported by rising disposable incomes that for rural residents increased by average 16% and 12% for urban residents during the first nine months of 2004 (NSB, 2004-09-14). This pattern can be expected to be maintained, for at least the near future, as the Chinese consumers have a positive view on both employment and incomes in the longer term (NERI, 2004-09-13). If the planned economic development can be maintained, then the Ministry of Economy predicts that there will be about 100 million of middle-income families in China by 2010, each holding assets of at least USD 70 000. In continuation of this development, the Chinese market will be second only to the US by 2020 (China Economic Net, 2004-09-20). In the meantime, China's consumption remains relatively small, about similar in size, in relation to the share held by investments. As indicated above, this will become increasingly better balanced by a fast growing consumption, which in the future will contribute to a reduction in the level of export dependence.

The framework for China's next stage of development is indeed encouraging with the national GDP increasing rapidly, it will have dramatic effects on the living standards and settlement patterns. The level of urbanization will, by 2020, have reached 55%, from 37% in 2003, and urban areas will then house a population of about 750 million. By 2020, it is hoped that the country will have come to terms with both energy and resources consumption, and that both will show a zero growth level, and as a result, ecological deterioration will start to

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- 174 - decline (CAS, 2004-03-06). If the estimations of future migration flows will prove correct, then it would mean that the country will see over 200 million new city dwellers in less than a generation; that in a county that already in 2004 had 22 “second cities”, mostly inside 300 km off the coast, with a population above 2 millions. This one-sided development strategy, with a strict focus on increased production volumes, has included excessive consumption of both energy and other resources, often resulting in considerable environmental degradation. For every USD in GDP generated, Chinese producers need four times the energy, compared with US producers’ need for the same production volume. If environmental degradation is taken into account, the GDP growth in the 1985 - 2000 period would be reduced to about 6.5%/year (SEPA, 2004-09-02).

Despite all the positive factors having been mentioned above, there are also some worrying signs on the horizon related to both domestic and international concerns. However, economic growth in China and the Asian region could be expected to stay higher than world-average, but is unlikely to perform on the level of 2003 and 2004 in the near future. With an orientation mainly focusing on GDP growth through promoting economic efficiency and increasing productivity, the social side of development has partly been overlooked. Internally, China's economy has been developing very unevenly in the regions, at the same time as it has long been developing dangerously close to being overheated elsewhere. The diversity inside the country and its size can be reason to question especially economic statistics presented. In 2005, the NSB wants to increase accuracy in its reporting and the “First National Economic Census” will be undertaken with 10 million census takers about to visit 35 million companies and institutions. It is expected to cover about 85% of all economic activities with information to be directly fed into the planning for the 11th Five-Year Plan for 2006 – 2010 (NSB, 2004-12-19). Companies are generally doing well and based on the financial results of the 100 largest companies in China, the rating company S&P (Standard & Poor’s) predicts that growth will continue. Companies in 2003 increased their revenues by 30%, compared to a 14% increase in 2002, at the same time as the return on capital increased from 14% to 16% (CW, 2004-10-29). These figures cover companies that have more or less adapted to international accounting standards, which most companies have not, and with a majority still far away from meeting such standards. However, there are considerable problems with the reliability of the figures produced inside the state company sector, which has been revealed by the Assets Supervision and Administration Commission of the State Owned Enterprises (SOE). Out of 181 revised SOEs in 2004, 80 were found to have had serious asset losses over the last two years that had not been properly declared. This was much attributed to the fact that these companies had used over 300 financial intermediaries that in numerous cases had helped the SOEs to conceal facts (CD, 2005-01-12).

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- 175 - Internationally, but especially in China, there are several insecurities for the near future, like oil and energy prices, but also lower growth in developed countries and future US trade policies. In the same way as Japan came to serve as a scapegoat, to be given the blame for economic problems in the developed world in the 1980s, it now China that has come to take over this role. The valuation of the Rembindi/Yuan is one such issue that is frequently being quoted as a cause of much harm among trade partners (to be further discussed below). The domestic agenda for 2005 is set not only on promoting rural development, but also to continue economic reforms, continuing to internationalize while maintaining social harmony. The goal is to "maintain steady and relatively fast economic growth with more emphasis on quality and efficiency" (Hu Jintao, Xinhua, 2004-12-12). To achieve such a target, and to develop the economy in a sustainable way, the Chinese Government must at the same time smoothen out its differences in interest with the outside world.

Investments In 2002, FDIs in China climbed by 16% over the year before and increased again in 2003 by another 27%, to USD 54 bn and during 2004 by 12% to 61 bn (Bofit, 2004-05-19 & Dow Jones, 2005-01-08)112. In 2004, total investments increased by 26%, to a total value of 7 trillion (USD 840 bn) (NBS, 2005-01-25). Urban areas received 85% of these investments and saw a rate of increase slightly above average. However, development has been very uneven in different sectors and agriculture that accounted for only 3% of the total during 2003, investments were up by 4%, while the industry sector showed a 39% growth while raw material processing reached 72%. Focus for investors in 2004 were the service sector that received 60% of investments, with manufacture taking practically the rest. Until recently, FDIs in China focused on manufacturing and only the odd projects was aimed at other sectors, while in the near future, there will be a large inflows of FDIs in other sectors. Banking is not only one such sector that is opening up, but also tourism, commerce and consulting are other examples of sectors that can be expected to attract large FDIs in the future (CSI, 2004-07-10). The state or regional governments were participating in 73% of investments, showing an increase on par with the average. The financing of domestic investments in China was to a third out of companies’ own cash flow and borrowing from banks accounted for about a ¼ of the total.

During later year’s the FDI flow has been in the range of about 4% of the national GDP, with FDI companies representing only 6 - 7% of total investments, but with a growth rate far above the domestic (Xinhuanet, 2004-10-28). FDIs often go into JV projects with local companies or to privatization of state companies in China, although privatizations have not been as aggressive compared to Russia, it is still ongoing. Of total FDIs, it is Japan, Taiwan and USA

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- 176 - that serve as the most important origins (Xinhuanet, 2004-07-12). Accumulated FDI totaled near USD 2 trillion by December 2004, of which 562 billion have been materialized (MOFCOM, 2005-01-18). By the end of November 2004, a total of over 250 000 foreign-owned companies had been set up in China, with 490 000 companies that includes foreign participation. Out of these 40 000 there were new enterprises having been set up during the first eleven months in 2004. Accumulated inflow of FDI until the end of 2002 from Japan, as China’s largest trading partner, had reached 25 000 investment projects, with a contract value of USD 50 bn, of which USD 36 bn (72%) had been realized. At the same time China had seen 14 000 investment-projects from the EU to a total contractual value of USD 61 bn, with just USD 33 bn (55%) having been realized. The same figures for Korea were 22 000 projects to a value of USD 28 bn, with USD 16 bn (57%) having been realized, with the figures for the combined group of ASEAN countries being USD 58 bn, with realization USD 29 bn (50%) of this realized. Since China established diplomatic relations with the US in 1979 until the end of 2003, US companies had invested approximately USD 30 bn in China. During 2003, the US invested a total of USD 4.3 bn in China in about 2 500 different projects, with machinery and oil as the two most important sectors (CD, 2004-09- 13). Russian investments in China are relatively small and are expected to reach about USD 800 million in 2004 (CW, 2004-09-18). Another important origin of large FDIs is the worldwide expatriate Chinese population living outside of the mainland. By 2003, it has been estimated to have reached over 60 millions. This group has also been eager to invest in the mainland and have had great advantages in doing so from their linguistic, ethnic and family ties. The importance of FDIs cannot be underestimated as companies involved in FDIs generated more than 10% of urban employment during 2003, 30% of the industrial output and over 50% the export volume (ibid., 2004-08-15). Over 400 of the 500 largest companies in the world ranking have invested in China, with over 30 operating their regional HQ in China (MOFCOM, 2004-09-08 and 12-25).

These are impressive numbers, especially so as China is not given a very high ranking for its general competitiveness. Ending up as number 46 out of 104 in the World Economic Forum’s 2004 ranking, with its stable macroeconomic environment being seen as the Chinese strength and the low level of advanced technology as its main weakness (WDF, 2004-10-13). In the authorities, attempts to cool off overheated sectors, over 5% of all projects, especially in steel and cement, has been delayed or scrapped, involving a total of near 4 000 projects. Sectors that have been seriously straining the economy, such as infrastructure and transport, have also been growing well above average. The real-estate market has increased just under the average while ferrous manufacturing, that is seen as overheated, still has raised the most; by 46%. Generally, investments slowed during the first months of the year, but rebounded with growth during

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- 177 - the mid-year period compares to low figures for 2003. In a year with a continued strong FDI inflow, preliminary figures show that investments have started to spread into new regions that previously had seen relatively few FDI (CW, 2004- 09-02). In some important regions like Hainan and Fujian, the fall in FDI reached 60% and 40%, respectively during the first seven months of 2004 (China Radio International, 2004-09-03). In contrast, other previously less favored regions for FDIs have seen dramatic increases, as in provinces like Yunnan and Shanxi where the increase has been nearly 600% and 200%, respectively. The regions and the state, including state companies, accounted for about 60% of total investments in these regions, which can be seen as part of state policy to spread the economic benefits into new areas (ibid.).

Although there are a number of regional stock exchanges having been opened in major cities, The Shanghai Stock Exchange was the first to open in late 1990, and is the most influential. This exchange builds on a tradition from the early 1920 when the first security and commodity exchange opened, that had become the trading centre of the Far East by the 1930s. However, the exchange was closed in 1949 to be reopened again 41 years later (SSE, 2004-04-10). By the end of 2003, it had 913 securities and the shares of 780 companies listed, to a combined value of 3 trillion. In 2003, a combined 56 billion was raised by companies over the exchange from the 34 millions holders of an account at the SSE (SSE, 2004-05-30). The problem with the stock exchange is that companies often do not pay dividends, as they are not JSC in a conventional sense, and primarily use the exchange to raise capital. Share values at the stock market in 2004 already peaked in April, and kept falling in value in the rest of the year. By September, values had reached its lowest since June 1999, as measured by the Shanghai index (SSE, 2004-09-10). The development at the second stock exchange in Shenzhen, opened in 1990, much resembles that in Shanghai. Here, 506 companies and 629 securities were listed at the end of 2004 with a total of 250 bn having been raised by companies over the year of operation (Shenzhen, 2005-01- 15). With many of the important listed shares at the exchanges belonging to companies in overheated sectors and with Central Bank’s credit restrictions for investments, the market cannot be expected to make any major recovery in the near future. A structural problem for the trading is that about 2/3 of the shares of larger companies are not being traded, reducing the influence on the companies from small owners. The lack of influence from minority owners has also been recognized as a problem by the authorities. New legislation should be introduced to increase transparency from the point of small owners, as well as it is expected to allow increased access to information.

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- 178 - The government has indicated its intention to sell its interests in most of its stock companies, but this would flood the market, with the state being the largest owner in a majority of listed companies on the stock exchanges. There will hardly be demand enough to absorb what could triple the supply of shares. So far, the trading of state-owned shares has not been allowed on the exchanges. Near future sales by the state of a variety of companies are instead expected to take place in Hong Kong during 2005, and could be expected to generate some 5 bn to the state coffin. Also, a smaller number of energy-generating companies are expected to be put-up for sales, which will allow its buyers to be among the first to enter into energy generation (HK-esd, 2004-08-25). By the end of 2003, the value of Chinese stock exchanges were among the ten biggest in the world, valued at about USD 400 bn. Having increased its value compared to national GDP to about 25%, from about 1% ten years earlier (Bofit - CR, 2004-1).

Outbound investments It is not only inbound investments that have increased, but also Chinese companies are increasing their FDIs abroad. Outbound investments, with state sanctions from oil companies, miners and steel makers to secure supply for the future, have also contributed to considerable outflows. The Ministry of Commerce and National Bureau of Statistics has released its first report ever on China's direct investment in overseas market for 2003. The report indicates outflows of USD 2.9 bn from China to foreign markets for the year, or about 6% of the inbound. By the end of 2003, a total of USD 33 bn had officially been invested in foreign markets by Chinese entities. The geographical origin of these investments has first of all been Beijing and other coastal provinces, with Guangdong Province having made the largest investments (PD, 2004-09-08).

Banking and monetary policies A far-reaching reform agenda for the Chinese banking sector has been initiated and is continuing, but has become a debated topic. The banking sector has long remained more or less untouched in the transition process, with the state banks covering up much of the losses and the bad loans of unprofitable state companies.

In the process of entering the WTO, the differences between laws and regulations in banking and financial services, as well as opening-up for foreign actors, were hard to overcome in the negotiations. Domestic laws should be respected, but a new member is obliged to undertake the changes needed too allow market access. If necessary, this can be implemented during a grace/transition period allowed and written into the final charter. As a result of the increased inflow of FDIs, and the rapid increase in trade, in later years, the banking sector has indirectly been forced to internationalize its operation at an

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- 179 - even more rapid pace than what was foreseen in the negotiations. However, still many laws and regulations, including the major privatisations in the banking sector, have not been sorted out from the governments side, but the sector has undoubtedly made considerable progress. Time is rapidly running out as the WTO membership agreement forces China to open up its banking market to foreign competition by December 2006 at the latest. Already by the end of August 2004, 62 foreign financial sector companies had been established, in addition to 152 foreign banks from 38 countries. Together, these had opened about 220 offices in 22 cities (CD, 2004-09-14). By mid-2004, over 100 of these banks had obtained the right to handle Yuan transactions in 13 selected cities, but foreign banks deposits remained under 0.5% of national banking assets (PBOC, 2004-08-01). However, this is only the beginning of the process and it must be a worrying sign for the state that in a study of competitiveness among banks, by the PBOC itself, the four biggest state banks ended last in the ranking (PBOC, 2004-10-01). There is a lot at stake, as the four largest state banks controlled no less than 70% of the loan market in Beijing.

In the early years of the 2000s, it was generally estimated that some 20% of loans given by the Chinese banking sector was “non-performing”, although official statistics sets the figure at about 15% (Xinhuanet, 2004-09-14). What makes this a serious issue for China is the volume of such loans at a time were estimated to some CNY 4 trillions; or half of the GDP (BOFIT, 2004-04-02). In 2004, the volume of the loans declined by near 5% to about 13% of the loan stock among the major banks, or 1.7 trillion, with 1.5 of this held by the state banks (CBRC, 2005-01-28). Unconventional measures have been used when attending to this problem, e.g., when the China Construction Bank (CCB) and Bank of China (BOC) reduced their non-performing loans stock to below 9 % of the total, which is much lower than other state-owned banks113. To make this possible the CCB and the BOC each received a USD 22.5 bn bailout from the state in late 2003. The situation is gradually improving as the five state-owned banks reported 16% of nonperforming loans by the end of Q3 2004, which was down from over 20% at the beginning of the year (CBRC, 2004-10-28). The Chinese government has declared that it will inject money into the remaining two of the four largest banks Industrial and Commercial Bank of China (ICBC) and the Agricultural Bank of China (ABC) (CBRC, 2004-12-04). ICBC and ABC have long been regarded as the weaker of China's big four state banks and are both burdened by billions of dollars of nonperforming loans. A number of rural credit cooperatives and four asset management corporations were established by the state in 1999 to administer this kind of nonperforming loans. Assets that at the time had a book value of 1.4 trillion (USD 170 bn) were to be sold to willing domestic and foreign investors. However, this has proved more complicated than initially expected. In late April 2004, the Citigroup announced the purchase of USD 240 millions of

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- 180 - such assets from the Great Wall firm, administrating loans of the ABC (Citigroup, 2004-04-27). It took Citigroup seven months to get an official approval for the deal. However, at the same time, the regulations for such sales were considerably relaxed to speed-up the process and to have the sell-offs completed by 2006 (NDRC, 2004-11-08). In the reform that started in 2003, two examples of future partial privatisations in the banking sector have been indicated for the BOC and for the CCB. The privatization of the two banks is to take place within the next three years and the two should have become JSC by the end of 2006 (CRBC, 2004-09-08). The reform will continue by preparing the ICBC and ABC to follow the same reform path. An indirect confirmation by the market of the reform of the CCB was given when it became the first bank in China to issue a subordinate debt loan in July for 2004, for USD 1.8 bn. The loan was fully subscribed by the market, and the bank will therefore issue a second one. These operations have been done with the aim of raising the capital adequacy of the bank to over 8%, in preparation for its future privatization (CW, 2004-09-13). By the end of 2004, the four state banks held assets of about 16 trillion (USD 2 trillion), accounting for 54% total bank assets in the market (PBOC, 2004-12-26).

To somewhat increase the liquidity in the growing market, PBOC has been slowly increasing the volume of bills it sells to the banks. The liquidity of the Chinese banking market has for long been relatively high, facilitating the impressive volume of investments. The state has in early 2004 issued investment guidelines to banks urging them not to issue further credits to sectors showing signs of overheating. In an attempt to cool down the lending market and indirect investments, the PBOC raised the required reserve rate for the banks from 7% to 7.5% in the summer of 2004 (PBOC, 2004-07-08). Although the general desire to save is strong, the negative real interest rates are likely to have made people spend more on consumption and to search for higher returns from funds, real estate and non-official lending. Higher interest rates will also lead to that the inflow of foreign capital would increase further. At the same time, as there is a risk with higher interest rates as it contributes to further swell the volume of non performing loans, as with more companies could be hit. Higher official interest rates also contribute to increased savings, which could be needed, as over the first eight months of 2004, when bank savings fell. The banking system held deposits of 2.7 trillion by the end of September 2004, which was 0.5 trillion less than at the beginning of the year, with near half having been withdrawn by individuals (PBOC, 2004-10-26). During H1 2004, investment funds grew near explosively as they increased their holdings by 132 bn; 127 bn more than during 2003. Still, real estate was the by far largest receiver of savings as near 300 bn went to down payments for housing, up by near 50% over the same period one year earlier (CD, 2004-1018). In a developed country, real estate or owning a

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- 181 - home would be an established way of long-term saving, but this is still an unconventional or at least new way on the Chinese market. With incomes and demand for homes having risen faster than supply, prices have responded quickly. As a result, the real estate market has come to show clear signs of overheating despite the fact that the government has made attempts to squeeze credit flows from the banking sector. What instead has happened is that customers of flats pay their builders directly, bypassing the banking sector, and this indirectly reducing the intended effect of a classical macroeconomic tool for the government. Not only cool the market, but also to limit risks, the requirements for down payments by individuals have been raised to 35%, and additionally, housing loans are not allowed if loan payments will exceed 50% of the buyer’s incomes (Bofit, 2004-37). However, in areas of the most rapid growth, large scale unofficial lending is also said to have developed and has taken over near half the market for new loans. Unmanaged money flows on this scale constitute a considerable risk for both the individuals and for the companies that are involved. To some extent, the money comes from unrecorded speculative money flows, which are generated by expectations of a revaluation of the currency and could amount to USD 40 bn (CW, 2004-12-05). Capital inflows of this magnitude increases liquidity and as demonstrated above, control measures taken towards lending by the PBOC have proved largely insufficient. As a result, on October 26, 2004, for the first time in eight years, the interest rate was raised to cool off the investment market. Savings rates went up from 1.98% to 2.25% and lending rates from 5.31% to 5.58% (PBOC, 2004-10-27). At the same time, the PBOC lifted the upper limit of interest rates for financial institutes, although not for credit cooperatives, to allow for greater influence of market forces. The new liberty was given with an attached warning against using the freedom to do “blind rate rises”. The change seems to have paid off as new accounts already went up in the following month by 60%, and with sharp increases in both private and corporate savings (Bofit, 2004-51). At the same time, the basic reserve requirements levels for all banks, foreign and domestic, was adjusted to 3% in January 15, 2005, instead of the previously differentiated rates of 5% and 2% (ibid.).

Under the current currency regime, the PBOC buys the excess supply of incoming foreign currency from the market at a rate of 8.28 Yuan per USD (PBC, 2004-05-10)114. The exchange rate of the Yuan to the USD has remained unchanged since 1994, and the downward pressure on the dollar especially during the latter part of 2004 depreciated the Yuan further in relation to the currencies of important trade partners. There has, for a long time, been an ongoing debate in the west about by how much the Yuan has been undervalued, with estimations ranging from about 5% to near 50%(IIE, 2004-08-10). Official policy statements have indicated that a float of the Yuan is out of the question, but several initiatives that would give the more or less the same results are

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- 182 - available115. Despite this, Premier Jiabao, at the China-EU Summit in late 2004, stated that China will gradually move toward a more flexible exchange rate (FT, 2004-12-08). A step in that direction could be to widen the fluctuation range, inside which the Yuan can float. Another is not only to allow increased imports and larger outbound investments, but also to reduce the quota that companies earning foreign currency must exchange to domestic currency. Alternatively, it could also be time to change the peg of the currency to a basket of currencies of main trade partners instead of a pure peg to the US dollar116. Chinese leaders and bank officials were officially invited to attend the G7 meeting in Washington D.C. in October 2004 where western leaders and the IMF pressured for a readjustment. The suggestion is that an adjustment should first mean a readjustment by some 15% and that the Yuan would then slowly be allowed to float (CW, 2004-10-02). Currency valuation is an issue that is frequently coming back in the discussions around the development of both the Russian and the Chinese economies in relation to their major trading partners. The problem with any revaluation is that it must be big enough to be seen as creditable by the market, and if it is made that big, it is probably bound to hurt domestic interest.

As a result of the strong foreign currency inflow China has seen a considerable current-account surplus, which reached 2.9% of GDP in 2003 (up 0.1% over 2002). Much of this came from a capital inflow that grew by 86%, to over USD 60bn, while also the errors and omissions item in the balance of payment contributed with USD 22 bn on the positive side. This is a dramatic change for a national current account that as recently as in 2001 had been in the negative. The statistics shows a considerable inflow of capital that has not been officially accounted for and this contributes to the strong growth of China’s ever-larger foreign exchange reserve. A reserve that during 2004 grew by over 50%, despite a trade deficit for the beginning of the period, to a total of USD 610 bn (PBOC, 2005-01-12). However, at the same time China's foreign debt has been building up rapidly, reaching USD 220 bn at the end of June 2004, increasing by 14% in the last six months. It is first of all new borrowing that had increased by nearly 100% compared to the same period the previous year, to reach USD 83 bn (SAFE, 2004-08-31). An increase that can be largely attributed to increased international involvement and seen as positive from the point of view that foreign partners are increasingly willing to lend.

Facing a trade deficit, which China looked in danger of during H1 2004, the situation is conventionally problematic, but not when the currency reserve is one of the largest in the world. Running a moderate and controlled deficit could somewhat even offset the pressure from its larger trade partners about revaluating the currency. An initiative with that purpose was the Chinese slacking of its currency restrictions in April 2004. It then became permitted to take a considerably larger amount of foreign currency out of the country, at the

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- 183 - same time as less money was allowed to be exchanged for Yuan when entering. The result of this should, at least in theory, be an increased demand for foreign currency and a reduced demand for the domestic currency. From mid- November 2004, foreign companies were allowed to transfer foreign currency among its Chinese units without approval by the SAFE for each transaction (SAFE, 2004-11-20). A change that represents a major simplification, which can only be interpreted as a sign of a generally relaxing attitude towards the use of foreign currencies.

As many other areas under reform, the tax system has also changed dramatically in later years, and during periods (from what it seems), somewhat outside of coordinated state control. The official Chinese company tax is currently set to 33% for both domestic and foreign firms. But especially during the early boom years for FDIs, foreign investors were frequently given extensive tax-breaks to attract investments. Initiatives that could include full tax exemption for several years, at the same time as investors in the many “Special Economic Zones” (SEZs – sometimes called “development zones”) have overall been offered a tax rate of 15%117. The lower level has also been offered to investors in western China, in a maximum of ten years. These kinds of offers are said to explain why the real tax collection rate for foreign companies is estimated to only 10 – 15% and some 25% for domestic companies. A revision of the tax system is underway and could lift the overall tax level for companies to 25 – 30% (Bofit, 2004-37). The value-added tax (VAT) is the largest contributor of tax incomes. However, the collection of VAT in China is not consumption-based, which is common practice in other countries. Instead, it is production-based, leading to that companies making fix investments must pay VAT on investments. As a result, a company cannot reclaim the tax paid when making investments in new equipment, which is indirectly slowing the upgrading of production facilities (Xinhuanet, 2004-04-19). As a result, there are large advantages to be gained from a shift in focus for the VAT collection. But such a drastic changes to the most important tax source would not only include a certain degree of political risk, but it would also be a considerable information challenge to make such a fundamental shift. However, a shift could be coming in the future as the Heilonlijang province has been selected to run a full-scale test of such a change. Still, the state has, in later years, and in several respects, improved the tax system, and in relation to GDP, collected taxes have gone up from 13% in 1998 to 19% in 2003. In the perspective of a 7 - 9% growth of GDP during the period, it is a monumental achievement to increase tax intake by 50% during the same period. Total government revenue in 2003 reached 2.2 trillion (USD 260 bn), or up by 15% in 2002. Revenues are not only generated from taxes paid by companies and individuals, but also from dividends paid by the companies in the state sector (CW, 2004-11-01).

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- 184 - Employment As of January 6, 2005, China is statistically a country with a 1.3 billion population (NSB, 2004-12-18). Without the strict family planning programs of previous years, the current population could have been nearly twice as big118. Although the one child policy has partly come to erode in later years, it has instead become a major concern that the number of boys being born is higher than girls, and in some areas, 30% higher. Also, the Chinese population is generally aging and the number over 16 is just under 1 billion with those over 65 is nearly 100 million. Out of those in the 16 – 65 age group, 760 million are considered to be economically active, with this group having increased by over 50 million since 1998. These somewhat incomprehensible large figures of just economically active correspond to near five times the total population of Japan, near three times that of the US or well over one and a half time the total population of the entire EU 25. Of the economically active, about 250 million are working in urban areas with 500 million employed in rural areas, indicating that rural / agricultural areas in China still generates about 2/3 of employment (China.org, 2004-07-12).

In the different sectors, the primary sector remains the by far most important in China today. In employment terms, the changes that have occurred over the last 15 years have largely been a transfer of workers from the primary sector to the tertiary sector. What has happened in the labor market is that the primary sector, as share of employment, has contracted from 60% in 1990 to 49% by the end of 2003. At the same, time the 11% that has left the primary sector has been absorbed by the tertiary sector that has increased its share from 18% to 29%. During this period, there has, of course, been a lot of movement in and out of sectors by individual employees, but as a share of employment, the industry sector has kept a stable share of above 21%. During this time, the working population has increased by about 7.5 million per year, adding about 100 million to the labor market. Until 2008, the increase will be in the range of 10 million per year, with an average increase of near 6 million until 2020, when the working population is expected to peak at about 940 million. What has also happened is that the number being employed in cities has risen from about 225 million in 1998 to 256 million in late 2003 (Xinhuanet, 2004-04-26). Additionally, large-scale educational programs have been drawn up to give vocational skills to about 10 million rural migrant workers over the next few years. Many of the migrants are female, but it is still the urban areas that supply work for most of the 340 million female workers. However, as there is no clear border between salary work and household farming that include some temporary employment, probably makes such statistics no more than indicative.

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- 185 - Out of the many millions of new entrants to the work market, an increasing percentage, currently some 25% have improved their skills in the higher educational system. With higher education having expanded rapidly during transition years to become a vastly versatile, and for some highly lucrative business. In 2003 in 83% of Chinese graduates from institutions and universities found regular jobs in which was 5% more than in 2002. This figure nearly corresponds to the Japanese figure for the same year, when the number of university graduates that had secured a job after finishing their studies in Japan stood at 82% (CD, 2004-03-06 & JT, 2004-03-05).

As previously mentioned, agriculture remains the most important sector for total employment, although its economic importance is declining. At the same time, as the country’s population increases, there is a push away from farming also by the fact that farmland is increasingly being lost to development and that mechanization is increasing. This is a conflict that is opening up between micro- production policies and the changing demand structure, between environmental considerations and agricultural development and between the support needed for development and the government’s ability to render that support. Furthermore, this also leads to conflicts between the benefits of reducing China’s grain self-sufficiency and the state’s need for economic and political security, an aspect that is most obvious in the energy field where China already is strongly dependent on the outside world. Currently, most of the developed countries support their agricultural sectors with either subsidies or other measures, which have not been possible in China due to the sheer size of the sector. Allowing grain and agri-products prices to rise has been a way to transfer income to farmers, although a sensitive question as it is important for consumer prices and affects the living cost of all citizens. As a WTO member, agriculture will also increasingly become exposed to market risks, unemployment risks and security risks. This is a sector that would need continued protection to have a chance to adapt. The agricultural sector has already been supplying much workforce for the rapid industrialization in the coastal regions, and continued efficiency gains will free millions more that will be forced to find work elsewhere.

Official Chinese urban unemployment has started to decline as it stood at 4.2% by the end of 2004. About 70% of these are under 35, but still a fall of 0.1% during the year; the first in a decade. The newly added employees in urban areas during the year reached 9.8 million, 800 000 more than expected (NBS, 2005-01- 26). The current figure is even under the target set by the government; to keep unemployment at around 4.7% in urban area in the coming years (Xinhuanet, 2004-04-26). Unemployment has remained more or less stable for more than one year after having seen a continuous rise from about 3% in early 2000. However, the statistics measures only unemployment in terms of those officially registered

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- 186 - as unemployed, and it tells very little about the actual employment situation. The major deficiencies that can be identified are, first of all, unemployed people must live in a city to be able to register for unemployment. Second unemployment statistics does not apply to workers laid-off from overstaffed state-owned enterprises or cooperatives, as these organizations are supposed to provide former employees with a basic income for three years. Third, unemployment figures are not made to include former agri-workers that have migrated to urban areas to seek work (ILO 2004-05-12). Despite this the number of people that are drawing unemployment, insurance money has been on a steady increase from about 500 000 in 1998 to 4.2 million by the end of 2003, with over 100 million having signed up for a plan. This figure has risen by over eight times since 1998 (CD, 2004-03-12). Increased awareness of the existence of the available benefits can largely be seen as explanation for the rapid increase in both registration and usage. However, the state is actively supporting job seekers, having set-up 18 000 of the 26 000 job agencies in the country (Xinhuanet, 2004-04-26). Unemployment is given much attention and with some 30 millions having been laid-off from state structures since 1998, and with another 3 million per year expected to become redundant 2005 – 2007, dramatic changes will take place. In an attempt also to also streamline procedures redundant workers from state companies and organizations will be covered by the insurance for a time of up to two years, beginning from late 2005 (Minister of Labor, Silin, CW, 2004-12-21).

At the Communist Party Congress in 2004, Premier Wen Jiabao stressed the urgency of job creation and promised to create a total of 14 million new jobs in 2004; 9 million for urban areas and another 5 millions to re-employ laid-off workers. In 2003, an estimated 8.6 million new workplaces were created and 4.4 million jobs were created for replaced workers (CD, 2004-03-15). Every percentage point in GDP growth is important as it is estimated to create 700 000 additional job opportunities. However, there are already concerns being voiced that the shifting focus towards more capital-intensive industry sectors will lead to an industrial development that will not generate enough work opportunities (NDRC, 2004-03-15). The employment by state-owned entities among urban employees has dropped sharply from about 105 million in 1990 to 70 million in 2003. During the same period the workforce at private companies has increased from almost 7 million to 43 million, generating 50% of new employment during the period. Others are employed by what is statistically being called “new forms of employment”; like temporary, part-time, seasonal and jobs with flexible working hours. In an attempt to further open-up for private initiatives in job creation it has been indicated that through an amendment to the corporate law, it will, in 2005, be made possible to start up one-person limited liability companies. Currently, it takes at least two persons, legal or individuals, to set up

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- 187 - a limited liability company, while one person companies are currently subject to infinite liability (CD, 2004-09-14). The development is nevertheless impressive, with a total of over 570 000 private enterprises set up in the mainland in 2003, or around 1 500 enterprises established per day (TDC, 2004-09-16).

Average incomes in China have seen a very rapid development over the last 15 years. During this time, the difference in income between the yearly disposable income for urban and farmers has also increased sharply. In 1990, this difference stood at 1.2 times, had, by 1995, risen moderately to 1.7, but by the end of 2003, it had reached 3.3 times. This shift represents an increase in urban incomes from 1 510 to 8 478 while farmers have only seen their incomes go up from 656 to 2 622 during the same time period (CW, 2004-05-09). Farmers’ incomes have not only been lifted by the fact the authorities have allowed higher prices for crops, but also lowered tax on rice and grain, but over 10% of total farming incomes are money transfers from migrant workers (Bofit, 2004-45). Currently, there is also a rapidly increasing difference in wages among conventional workers, as workers with higher technical skills are becoming increasingly short in supply and can receive wages tens of times higher than normal workers. At the same time it has become honorable, or at least accepted, to become rich in China. Leading to that other strata of the population, especially successful entrepreneurs and business owners have gained considerably from the changes in the economic policy that has taken place. No less than two individuals, on the list of the richest for 2004, 31 and 35 years old, respectively, controlled beyond USD 1 bn, with the 100 richest combined controlling in excess of USD 50 bn (Forbes, 2004-10-11).

China is often given the blame for attracting the workplaces that move out from industrialized countries to low cost labor countries. The importance of low wages is evidently largest for labor-intensive products, but not necessarily so for all lines of business in industry, and especially not so for more knowledge- intensive production. From its low wage levels, it can be understood that China remains strongly competitive in labor-intensive commodities, like toys, textile products and shoes; all being industry sectors that employ large numbers of less qualified workers. As a result of this, the Chinese contribution to world trade was initially, more or less entirely, based on products with a high level of manual labor. The abundance of workers has kept wages low, and wages have even been falling in relation to prices (CW, 2004-10-12). The average monthly salary in the Pearl River Delta has remained practically unchanged for more than a decade around 600 Yuan/month (about USD 75) (NBS, 2005-01-25). As a result a shortage of migrant workers has been unfolding, despite the huge labor pool, which can seem contradictory. Like other commodities, labor supply is also closely associated with its price - in this case, the wage. Wage fluctuations will also here tip the balance of labor supply and demand. When looking at

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- 188 - wages, it should take notice of the differences between its nominal and real term, with the real wage strongly affected by the Consumer Price Index (CPI). For migrant workers, the price of food and lodging, which accounts for a large portion of their consumption, takes a considerable part of their wages. According to statistics, urban workers' real wage has registered an annual increase of 6% over the past 10 years, but migrant workers' nominal, let alone real wage, in the Pearl River Delta stayed almost static over the same period. While their nominal wage has basically remained stagnant, their real wage has actually plummeted. When the CPI rose from -2% to 6% in 2002 – 2003, migrant workers' real wage plunged.

Low wages have been a strong enough factor to make many products competitive, but costs have also been kept low due to sub-standards when it comes to working conditions, labor safety and, evidently, the large supply of willing workers. Repressive labor treatment is said to have lowered labor costs in China by an additional 45 – 85%, which should have reduced employment by 730 000, only on the American market. With millions of emigrant workers, predominantly young females, bonded to workplaces by the need of resident permits and unpaid / withheld wages (Aflcio, 2004-05-10). Working days of 11 – 12 hours, often seven days per week, directly or indirectly lead to near slave like conditions. However, this reminds of how life was in a European or US factory some 50, or fewer, years ago in terms of labor standards, health standards, job security, monotonous jobs, wage levels, long workdays and often a six-day working week. Dreadful working conditions have, by some, been seen as an unavoidable stage for a country to pass before starting to move up the development ladder. This is especially so in a country where perhaps 1/3 or more of the population still live on incomes that are in the range of USD 2 per day. In later years, China has ratified all major international conventions, like minimum age, limiting the use of child labor, about equal pay between sexes and the establishment of worker unions at the companies. Examples set by foreign companies, like the Korean Samsung group; not allowing any labor unions at all at its Chinese units have even lead to confrontations with the state- controlled unions and the Samsung policy being challenged in court (AFCTU, 2004-09-10).

Other related issues in brief Problems facing China in the near future are monumental in some respect, with one of the more urgent being the degradation of the environment. Many parts of China face a severe scarcity of clean water, while large areas of land as well the air is heavily polluted following the many years of focus on economic growth. In the World Health Organisation’s (WHO) listing of the most polluted cities in the world, seven out of the ten most polluted can be found in China. The reason for

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- 189 - this is often the unregulated use of unwashed coal, resulting in high emission levels of sulphur dioxide in addition to particular matters. The projected emission levels of carbon dioxide in China will, despite this fact, increase the most in the world until 2020 (WHO, 2004-11-30). In this respect there will be a major shift in China in the near future as it will be the cars that take over as the largest polluter from industry and coal burning. Cars are already, in 2004, the largest emitter of carbon monoxide and nitrogen oxide (CW, 2004-10-06). China has not agreed to any binding targets under the Kyoto Protocol when it comes to limiting carbon dioxide emission levels. At the same time as the State Environmental Protection Agency (SEPA) has estimated, if the costs for the environmental degradation of the country over the last ten years had been included in the GDP, then it should have been lowered by at least 2% per year (SEPA, 2004-09-02).

A drawback of this kind of industrialization and improvements in living standards, seen in China over the last ten years, as has been seen in other developing countries, is that also the consumption of water increases rapidly. In this respect, China has not been an exception. Especially the densely populated areas in regions along the Yellow River are facing water shortages, as the river has lost most of its former might. Water shortages have plagued 400 out of China's more than 660 larger cities, with the situation ever worsening in 100 of them, including metro areas like Beijing and Tianjin119. Being a costal nation, China could use the expensive method of desalinating seawater, but in 2002, only 12 billion cubic meters of seas water was processed in China120.

It is in the light of this process that the South-to-North Water Diversion Project should be seen. To divert water from water rich rivers to regions scarce of water is far from a new idea, but it is the scale of the operation and the distances involved in the Chinese case that makes this project go beyond any other such project in the world121. Water will have to be transferred from the upper reaches of the Yangtze River and its contributory, the Han River, to the valley of the Yellow River in a gigantic 1 400-km canal. Together with additional canals that are to divert water further downstream, approximately a third of the water flow, or 10 – 15 bn cubic meters of water per year will be diverted away from its natural direction of flow (Water Diversion, 2004-06-10). The scale of the four major projects of the kind that have been initiated, and will need investments in the range of USD 12 bn, and are hoped to relive the situation for about 300 million living in the receiver regions before 2008. The groundbreaking ceremony of the project took place in Hebei Province on September 1, 2004, with the large- scale works to start in the spring of 2005. The aim is to relief Beijing of its water shortage problem in time for the Olympics in 2008 (CD 2004-09-02).

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- 190 - Farmland is increasingly being used for industrial purposes and the fastest rates of industrial growth have been registered in the regions where farming traditionally has been most intensive and population density is the highest. The average access to farmland per capita in China is only 40% of the world’s average, but offset by the intensity in Chinese farming. However, only due to industrial development about 7 million hectares were lost from 1996 to 2003, 2.7 of this during 2003 alone. The government has probably realized that this process cannot continue as some 40 million farmers have lost their livelihood on land already redeveloped. It was not until after the 2003 National Party Congress that farmers' were given user right to their land and should be fairly compensated when the land is taken over for other purposes. It seems as if an understanding has emerged in the highest circles of the administration that the problems of poverty and infrastructure shortfalls must be dealt with to improve conditions also for the country’s about 800 million that is directly or indirectly living off the land. A large part of the population of farmers often lives on a standard at about 30% of urban. Additionally, some 20% of the population lives in the poverty-stricken interior with even lower living standards, with only limited involvement in the monetary economy. To handle this is an administrative challenge of a size that can probably only be compared only to what is facing the Indian government.

Corruption is another important problem area to attend to, and that has proved hard to come to terms with, also in more developed countries. Corruption in the legal system, among judicial and public security officers, within the police, leads not only to additional costs for citizens, but it also slowly erodes social stability. Since the communist revolution, there have constantly been a number of convictions every year of high-ranking officials accused of having accepted bribes. The number of cases seems not to have decreased in later years despite the very severe punishment given by courts in such cases, with a number of life terms yearly and even capital punishment. In an economy under transition, with its legal system under revision, loopholes can be found, but the increasing number of court cases is probably also a result of both increased and improved surveillance. Fields where corruption is most common in China are related to land use permits, the granting of official loans, the authorization of tax reductions and awarding of infrastructure contracts. This is largely similar to what could be listed for many other countries at the same stage of development. In the international corruption index, China is on the lower end of the scale, at a shared 71st with Syria and Saudi Arabia, given a score of 3.4 out of 10; slightly better than the Russian 2.8 (Transparency, 2004-11-08). In 2004, China handled about 40 000 corruption cases leading to the retrieval of near 5 billion Yuan (USD 460 million)(CW, 2005-01-27).

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- 191 - What has changed in China over the last decade though is the scale of the crimes taking place and that some of the involved flee the country before its revelation. The extradition of the former Bank of China President in Guangdong from the US in April 2004, accused of having embezzled public funds to a value of USD 483 million with the help of a handful of colleagues, became a first major breakthrough against such attempts (CRI, 2004-05-13). Also, the state ICBC bank has seen a swindle with an estimated USD 600 million having been given in unauthorized loans and with hundreds of employees being involved (RCI, 2004- 10-30)122. Working under what is a nontransparent system, it could well be tempting for officials to become corrupt, but the cost of being revealed is high. It has frequently been so that once the stone have come into motion (a person has started to accept bribes or swindle) the scale of the transactions, often sooner than later, gets out of hand for the person(s) involved.

As in so many other branches of the Chinese economy research and development has also been expanding fast. According to an estimation made by several ministries, the R&D spending for 2003 was up by over 20% to a total of 154 bn, or 1.3% of GDP. Companies were the most important in this field, funding 60% of R&D, with state institutes and universities funding 26% and 16% respectively (MOST-CH, 2004-10-16). In 2005, the share of basic research will be increased to an international level of about 20%, up from about 5% in 2004. To show the nations, research capacity, space technology has been chosen as a way to demonstrate the Chinese technical advancement to the world. After having launched numerous rockets into orbit, China's first manned space flight was lifted into orbit by a domestically developed Shenzhou–5 rocket, on October 15, 2003. It conducted a 14 revolutions mission and was labeled a complete success. "These achievements indicate that China's overall national strength has reached new height," the premier said, adding: "They have boosted the confidence and courage of all the Chinese people to continue forging ahead” (Xinhua, 2003-10-17). Another space industries, although “cyber space”, is expanding nearly explosively; like the use of mobile telephones and the Internet. The mobile telephone market has expanded rapidly, and currently China has over 200 million mobile telephone users who often focus their use on the Short Message Service (SMS). SMS has become highly successful in China with about 90 bn sent in 2002, jumping to near 220 bn in 2003 and expected to reach 300 bn in 2004. A growth that is due to the fact that the cost of sending an SMS is probably the lowest in the world at USD 0.12, and only 1/10 of the price in Hong Kong (CW 2005-02-02). Also, the growth rate of China’s Internet industry has been impressive, with 22 million new users registered in 2003, to reach a total Internet population of 80 million and reached 94 million by the end of 2004. At the same time the Internet use had reach beyond 50% in both Hong Kong and Macao. By 2006 or 2007 Chinese Internet users are expected to reach over 150 million, to overtake the United

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- 192 - States for the No. 1 spot in this respect (Business Week, 2004-04-15 & CNNIC, 2005-01-19). However, Chinese authorities are still actively working on control aspects and the possibilities to limit access to dissident, pornographic and other non-authorized pages.

The outbreak of the Severe Acute Respiratory Syndrome (SARS) has been another plague to the state that has proved equally difficult to control. However, large resources have been channeled into research for a vaccine; and progress in this field during 2003 and 2004 has been rapid. Already in late 2004, the first trials of SARS vaccine started to undergo clinical trials, on humans and China has undoubtedly taken the lead in the global race to develop a remedy for the deadly illness. At least 10 different types of SARS vaccines are under development, according to China's Ministry of Science and Technology. The fight against HIV/AIDS has to be stepped up as this costly threat, seen both from a human aspect and the cost of treatment, looms all over the country and could easily gain momentum123. Compared to the over 100 000 killed on the roads every year, the SARS outbreaks have had practically no human effects, but nevertheless injected fear in whole society for long periods of time. However, the economic effects of SARS vastly overshadow the effects of traffic accidents, as it caused a fall in GDP by several percent for months during the outbreak.

In 2003, China had about 80 million foreign visitors that spent USD 11 bn to generate near 5% of GDP for the year. In 2004, China’s number of foreign visitors increased to near 17 million, with Japan, Russia, South Korea and Taiwan as the leading origins of these, but with many more visitors coming from Hong Kong and Macao. Tourism is hoped to continue to grow and is expected to generate over 10% of GDP by 2020, at the same time as that would make China the world’s most popular tourist destination. In 1978, only 200 000 Chinese citizens went abroad, while in 2003, the figure surpassed 20 million, indicating that it is not only inbound tourism that is growing rapidly, but also outbound tourism is growing even more rapidly. The trend continues sharply upward and during H1 2004, it was up by over 60% to 13 million, over a SARS-affected H1 in 2003, with the Hong Kong and Macao being the favored destinations receiving over 10 million of these. During the Mid-Autumn Festival and National Day Holidays in early October 2004, about 7.5 million were estimated to have crossed the border between the SARs and the mainland.

As mentioned above, the undoubtedly most important project facing China in the near future will be the Beijing summer Olympics in 2008. This will give a huge boost to tourism, post a major chance to improve China’s international image and raise its profile in the eyes of the world. The Olympic Games will not only mean a mounting media focus on Beijing and China sports at the highest

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- 193 - level, but it will also mean something like USD 16 bn in business opportunities for domestic and foreign investors during the build-up to the games. Beijing has officially listed 375 projects that involve everything from new infrastructure construction and renovation, to the building of Olympic gyms and stadiums to the highest of international standards. Included on the list are also education facilities, expanding tourism and environmental protection capacities. Among the largest of these projects is the building of over 100 km of new metro lines in the capital, which will result in three new metro lines. The build-up for the Olympics in 2008 is bound to become a major driving force in the near future for both the local and national economy. The next chance to make an impression on the global stage will be two years later with the 2010 Shanghai Expo.

4.1.2. The Special Administrative Regions (SAR) of Hong Kong and Macao

The two regions of Hong Kong and Macao have been integrated, but in a number of ways, they still live separated lives in relation to the mainland. Both regions hold their own local elections, but they have their principal administrative officer appointed by Beijing. The central government runs a Hong Kong and Macao Affairs Office in Beijing, including a Hong Kong and Macao Affairs Office of the State Council, and in each of the SARs there is a Central Government Liaison Office Macao. Both the SARs have since the adaptation of the "one country, two systems" principle, that has applied since incorporated, shown a considerable social stability and economic development. Much opposed to what was predicted by many at the time, life has much remained the same as before the transfer for most residents.

As a part of the two agreements signed between the mainland and Hong Kong in 2003, and later with Macao, called the Closer Economic Partnership Arrangements (CEPA), the application procedures for companies have been relaxed and handling times will be reduced to two months. As for business, it has until the end of 2004 to get the required approval from the Ministry of Commerce for business entities from the mainland to establish production and offices in the SAR region, which about 2 000 already have. The introduction of the CEPA also lifted import tariffs on about 1 000 different products, with financial services gradually being added to the list of services that can be freely transferred (China Economic Net, 2004-09-12).

Increased contacts and a possibility for the SARs, and especially Hong Kong, to act as stepping-stones for mainland business on its way to internationalize is set to greatly strengthen their position. As the number of mainland companies is counted in the millions, and if just a very tiny percentage would establish a

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- 194 - small office in the SARs, it would bring a considerable boost to the local economies. In response to the new regulations, representation offices of the SARs will be set up in 12 major mainland centers, with the aim of attracting new investors. The total value of mainland firm’s investments in Hong Kong, until the end of 2003, had reached USD 25 bn (Investhk, 2004-09-15). In both Hong Kong, at the end of 2003, and Macao from October 2004, certain banks have been allowed to provide Yuan transactions, still with strong control to prevent money laundering via gambling (PBOC, 2004-08-01). The new relaxed regulations for the establishment of companies, and judging from the investment figures, indications are strong that after the 7 (and 5) years that have passed since the incorporation of the SARs, real integration could well be on its way.

Hong Kong Hong Kong came under British jurisdiction in 1842, with the northern parts of about 1000 km2 area, the so-called New Territories, being leased from China for 99 years, from 1896. As this lease was running out, it was decided that the British Crown Colony, after long negotiations and much hesitation, should be reunited with China as a Special Administrative Region in July 1997. It currently holds not only a population of about 7 million and has since long been a bastion of free trade, multicultural from heritage and its extensive tourism, but also a first class shoppers’ paradise.

The regional GDP in Hong Kong rose by just over 3% during 2003 compared to 5% during 2002 generating a per capita GDP of about USD 26 000. The best performing parts of the economy were financial service and insurance that rose by 14%, while restaurants / hotels and the manufacturing sector both declined by just over and just under 10% respectively (largely an effect of the SARS outbreak). Economic growth in the region has reached 12% during H1 2004, the highest in over four years, with the full year growth expected to about 8%124. A major problem for the region has been the creation of new jobs, having been much slower than expected, with about 100 000 new jobs being created over the last year (CD, 2004-08-29). Still, the unemployment level in Hong Kong fell to its lowest for three years by the end of 2004, 6.5%, with underemployment at 3.1%, the number of employed at the same time reached a historic high at 3.3 million (HK-esd, 2005-01-19). Hong Kong has over many years established itself as a world-class business-, financial-, and logistic-services centers. To add to this, Hong Kong has a long established and strong legal system steering an economy that is possibly more open to the world than any other economies (HK, Census and Statistics Department, 2004-08-15). It is also another world here when it comes to corruption, compared to the mainland, being placed as number 16 in the world, just behind Germany, compared to 71 for China (Transparency, 2004- 12-01

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- 195 - Hong Kong signed its CEPA agreement with mainland China in June 2003, that from January 2004, it will give duty-free access to the mainland for 273 products and services from 18 sectors. The biggest competitive advantage for Hong Kong is proximity coupled with the long relationship that has given a probably unchallenged level of knowledge of the mainland. This has led to that Hong Kong’s logistic network handle about one-third of the mainland’s foreign trade while companies based in Hong Kong are said to directly employ over 10 million people in and around the Pearl River delta (HK, Chamber of Commerce 2004-08-15).

The Hong Kong stock exchange is becoming increasingly important to mainland companies listed abroad, as over 90% can be found in Hong Kong. Mainland firms use the HK stock exchange to raise capital of over 80% capital raised abroad, over the past ten years, has come from listings here. With the largest pool of capital for private equity investment in the Asia Pacific region available in HK, and a venture capital business of only a very embryonic size in the mainland, HK remains a major attraction for expanding Chinese firms (TDC, 2004-09-16).

Few countries in the world are as involved in world trade in relation to its size of the economy as Hong Kong. Foreign trade is focused on mainland China as both its largest export and import markets, especially export from the neighboring Guangdong province, which in 2004 is estimated to export USD 150 bn, out of which some USD 60 bn go to Hong Kong, being the regions outstanding trading partner (CD, 2004-05-14). Second most important to Hong Kong is Japan, as the second biggest import market and third biggest export market. What makes foreign trade special in Hong Kong is its huge re-export volume. In the case of Japan, conventional export in 2003 was valued at just under USD 400 million, while the re-export volume reached USD 12 bn, with an import volume from Japan of USD 27 bn (HK, Census and Statistics Department 2004-08-15). The mutual importance of the two is shown by the fact that holders of Hong Kong SAR passports from April 2004 can travel visa-free to Japan, which mainland Chinese cannot (HK, Public Administrative Association, 2004-08-15). Hong Kong is also a considerable transport hub with the world's busiest container port, that in 2004 handled a record of 21.9 million TEU, up 7.3% over 2003, and in all over 215 mt of cargo. About 60% of this was handled at the highly efficient Kwai Chung terminals, but the main problem for the port is that road transport of a TEU from southern China costs over USD 300 more on average than shipping from the competing Shenzhen port (HK Port, 2005-01-18). The Hong Kong airport is another hub that has transited 27 million passengers during 2003 (24th in the world), but its air cargo volume of 2.7 mt, is second only to Memphis (AIC, 2004-10-12).

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- 196 - Since the transition in 1997, Hong Kong has been lead by a nominated and Beijing approved Chief Executive, Tung Chee Hwa, who began his second 5- year term on July 1, 2002, after his nomination by a selection committee established by the Basic Law (HK, Special Administrative Region 2004-08-15). There has been a growing movement for free elections of the leader to follow after Tung Chee Hwa. In June 1 and July 1 2004, hundreds of thousands demonstrated in Hong Kong, dressed in white shirts, for democracy and the right to elect its own leaders (Muzi News, 2004-07-20). Not even opposition of this scale is likely to be enough to convince Beijing to reverse its previous decision to not allow a direct election of the next leader in Hong Kong. In the run-up to the elections, opinions were divided on the development as Human Rights Watch labeled the past year as the most undemocratic so far (HRW, 2004- 09-12). It was also shown in the elections for the 30 elected seats at the Legislative Council in September that there is perhaps an increasing fragmentation, as 18 seats were won by pro-democrats (+1), while pro Beijing won 12 (+5), from a 56% turnout (Elections, 2004-09-13). However, in early March 2005, Hwa unexpectedly resigned, quoting health reasons, perhaps, leaving an opening for a more democratic appointment.

Macao Macao is a former Portuguese protectorate 150 km southwest of Guangdong and 50 km west of Hong Kong. Macao is set on the tip of a peninsula with an area of only 17 km2 and a population of about 500 000. For Macao, the reunification with China and the cutting off of its formal connection to Portugal, that came to last from 1887 till 1999, has meant a revival of the city.

In 1999, Macao had seen four consecutive years of economic decline. This was much a result of the negotiation process on how the terms in the final agreement would turn out, and this generated insecurity in the business community as well as among residents. Once the agreement was put in place, and the handover had taken place, the region was soon back to “business as usual”. Currently, Macao is doing very well and the regional GDP rose by nearly 17% during 2003, compared to 10% during 2002, generating a per capita GDP of about USD 18 000 for 2003. During the first half of 2004, the GDP has jumped by a massive 36%. That is over a comparable period in 2003 when SARS severely limited traveling. Flourishing tourism from the mainland has again started to stimulate the Macao economy. The gambling industry is the main attraction for tourists, with gambling alone generating over a third of the GDP in Macao (CD, 2004-07-15). Outside of gambling, it is the textiles and clothing sector that provides not only the largest economic contribution, but is also the largest employer.

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- 197 - Chief executive of the China's Macao SAR, since its reunification with China in 1999, has been Edmund Hau Wah Ho. Mr. Ho has been reappointed for a second five-year term that began in December 2004 (Xinhuanet, 2004-09-20).

4.1.3. Taiwan province

What today is known as Taiwan is largely constituted of the island of Formosa, about 150 km east of the mainland China Fujian Province. It also claims some smaller islands in the strait between the mainland and the island, that are located closer to the mainland. The total area available for its 23 million inhabitants is 36 000 km2, which is partly very mountainous with the highest peak reaching near 4 000 meters. The population is concentrated to the western plain, with over 3 million living in the capital of Taipei, and another two million in the islands southwestern port city of Kaushong. The economy of Taiwan, being one of the four so called “tiger economies”, saw extremely strong growth during the years from the 1960 and nearly 40 years on. Presently, it is the service and industrial sectors that dominate the economy, with transports, electronics and chemicals being strong sub-sectors inside these. The GDP per capita for 2003 reached near USD 13 000. As a result, Taiwan has also seen labor intensive manufacturing being transferred abroad, and first of all to the mainland, by way of FDIs.

In the 16th and 17th century, the island of Formosa was dominated by European nations and saw its first sub ordinance to the mainland in the late 17th century. After having been taken over by Japan in 1895, it then remained under Japanese jurisdiction until the end of WWII. During 1946 to 1949, as Mao Zedong was winning the war on the mainland against the Chang Kai-shek led forces, many of the followers of the latter fled to Formosa. Despite the fact that the ruling of Chang Kai-shek was limited only to the island, he continued to claim himself as the true leader of the mainland until his death in 1975. His son, Chiang Ching- Kuo, who succeeded him, introduced some political reform in the late 1980s that opened up for democratization and legalized some forms of direct contacts with the mainland. The first open presidential election was held in 1996. In 2000 the first president was elected who did not represent the National Party. The change of leadership has not only meant new blood, but also the new president and other leaders from the DFP party have been arguing in favor of national independence. As a result, relations between the two neighbours have been shifting over the last decade. Some of the cold years have seen strained relations as a result of military maneuvers and rocket threats, while other years have seen clear improvements in the relations.

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- 198 - The fact that the political relationship has been both tense and somewhat antagonistic in recent years has not stopped the cross-strait economic and cultural exchange. Still, by the end of 2004, mainland companies cannot invest in Taiwan, while the opposite is allowed. In the cultural field it is allowed for Taiwanese to visit the mainland, for both business and tourism, which has still to be permitted for visitors from the mainland. The cultural exchange between the two has also ballooned, as in the era before contacts were re-established; the Chinese population on Taiwan received most influences from the West. It is of course an impossible mission to try to estimate to what degree the “Chineseness” has been lost, or could be regained. Of the two “nations”, it is clearly Taiwan that has been adopting the most restrictive policy for contacts of the two.

The policy of the Taiwanese political leadership has over several years now been a “two-state policy” with “one country on each side” of the strait. With time, this has, as shown by surveys, developed into the mainstream will on the island, with a reunification having received reduced support in pulls. Although changes are relatively small, the support for an independent Taiwan has been rising, at the same time as most people also believe that "Taiwan independence" would lead to war. What the people in Taiwan do agree to in the pulls is a desire for peace, stability and economic development.

Relations between the two came to pass two lows in 2004. The first was during the Taiwanese presidential elections in May and then again in the parliamentary elections in December. Statements made on the mainland in relation to the May 17th election were sets out in a conciliatory for a peaceful reunification to ensure that "Chinese do not fight against Chinese" (Xinhuanet, 2004-05-18). Again so in the parliament vote as the Kuomintang party came out with a slight majority, with the nationalistic side, lead by President Chen, coming short of majority (Xinhuanet, 2004-12-13). This time, the message was that peace on both sides of the Straits must be the goal, because the fighting of compatriots would be a tragedy and would not lead to security for Taiwan. On the other hand, the fact that President Chen did win a second term has strengthened independence groups and the president has indicated that he wants a new constitution in place on the island.

Both countries are, since 2002 members of the WTO, with Taiwan having been allowed in just weeks after the mainland, but trade between the two had, for many years, been restricted. As a result of these restrictions, trade between the two, are used to be conducted through Hong Kong. The existence of the "three direct links" of mail, trade and transport between the two has become increasingly important for the growth of Taiwan's economy and for the development of cross strait economic and trade ties. During 2003, the surplus for

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- 199 - Taiwan in the trade with the mainland was USD 30 bn. The relation in the economic field, with the expanding trade, has created a situation where both side can profit hugely in the future. Taiwan's investments in the mainland during H1 2004 exceeded USD 3 billion, up by over 50% over the same period in 2003 (MOEA, 2004-09-14)125.

Any peaceful solution to the Taiwan question is probably impossible without the full consent from the US, that as late as in the beginning of this century has stated that it will, in full, defend Taiwan. At the same time, it is opposing any action aimed at the independence of Taiwan and has declared its support for the “One-China” policy.126 The two positions can look somewhat contradictory, or perhaps intentionally blurred. US relations with the mainland is constantly improving, and the statement from the US Minister of Foreign Affairs, Powell, that included the mentioning of “…a reunification that all parties are seeking”, came as something of a surprise to the island authorities (CD, 2004-10-30). A comment that was probably aimed at easing Beijing worries about the US position, but also a hidden warning to independent groups on the island not to push forward. The joint intention by the mainland and the US that the Six Party Talks should find a continuation after the North Korea crises has been dismantled, but with a new focus on the China / Taiwan question, could only be a clear step forward (CD, 2004-10-30).

With the mainland’s stance on the issue being non compromising when it comes to national sovereignty and territorial integrity, the solution to this problem could well turn out to be a status-quo for a long time to come. Another alternative could be to let Formosa form an even more independent SAR then what has been allowed for Hong Kong and Macau, with both alternatives representing solutions where peace has been won without a war. Perhaps not the best of solutions, but it will at least see to that none of the parties involved will loose too much face and will also secure that “Chinese do not fight Chinese”.

4.1.4. China in Brief

China, (People's Republic of China) is the third largest country in the world, after Russia and Canada, with an area of 9.6 million km2, with a 1.3 bn population. From east to west, from the confluence of the Heilong river to eastern Wuqia County in Xinjiang Uygur Autonomous Region, the distance is 5 200 kilometers. From north to south, from the city of Mohe in the Heilongjiang Province to the southernmost island, Zengmu'ansha, in the South China Sea the country stretches about 5 500 kilometers.

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- 200 - The border stretches over 22 000 kilometers on land and the coastline extends well over 18 000 kilometers, washed by the waters of the Bohai, the Huanghai, the East China and the South China seas. The Bohai Sea is the inland sea of China. The largest island is/was Taiwan, with a total area of about 36 000 km2, and the second biggest being the 35 000 km2 Hainan in the south. The South China Sea Islands are the southernmost land of China.

As for administrative division, the People's Republic of China is made up of provinces, autonomous regions and municipalities subordinated directly under the Central Government. On a second level, these provinces and autonomous regions are divided into autonomous prefectures, counties, autonomous counties and cities. On a third level, counties and autonomous counties are divided into townships, nationality townships and towns. Some of the largest cities and certain municipalities, organized under direct Central Government, are also divided into districts and counties.

The area occupied by what today is The People’s Republic of China has a human history dating back nearly 4 000 years. Long before that, however, the pre- human “Yuanmou Man” lived in the area, approximately 1.7 million years ago, while the earliest primitive man walking upright, the “Peking Man”, has been dated 600 000 years back.

The first dynasty was founded before 2000 BC, at a time when the technology of smelting bronze had already been know for nearly 1 000 years, with the making of iron tools to emerge about 100 years later. The First Emperor of Qin, who supervised the standardization of the writing system, weights, measures, currencies, and establishes a system of prefectures and counties emerges in 221 BC. It was at this time that more than 300 000 people were mobilized for the initial building effort of what was to become the 5 000 km long Great Wall. Qin’s also built the mausoleum in Xian that houses the 8 000 terracotta warriors. As early as 100 BC a Chinese emperor sends the first envoy, along what was to be called the “Silk Road”, to establish contacts and trade with the region that today is called Central Asia.

The unification of the country, with Beijing as its capital, came into being around the turn of the 13th century, an era that also saw the development of four important inventions: printing, papermaking, the compass and the gunpowder. During the early 15th century, Zheng He explored the seas west of the country reaching as far as today’s Kenya. During the late 17th century, Tibet and Taiwan was also brought under the rule of the then Qing Dynasty.

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- 201 - The 19 th century was a troublesome time for China and a ban on the use of opium resulted in a war with Britain in 1840. In the outcome of the war, China had fallen in grace to become a more or less semi-feudal country. In 1911, the Qing Dynasty was overthrown in a revolution, and the Republic of China was established. In the aftermath of WWI, China was again disgraced, which led to a new protest movements at a time when the Marxism - Leninism came to be established also in China. The Communist Party of China was first established in 1921,by Mao Zedong and others, at what was called The First People’s Congress. In the 28 years to come, a number of wars were fought, the Northern Expeditionary War (1924-27), War of Agrarian Revolution (1927-37), War of Resistance Against Japan (1937-45) and War of Liberation (1946-49). The last of these led to the establishment of the People’s Republic of China on October 1 1949, in a ceremony that is said to have been witnessed by over 300 000 people in Beijing’s Tiananmen Square.

One of the first actions by the new leadership was to carry out a large-scale land reform where some 300 million farmers were granted the right of use to 47 million ha of land. The First Five-Year Plan was introduced some year later, 1953 to 1957, and the country started to build up a domestic manufacturing industry that had practically not existed previously. Economic growth was strong as many new large industries were established. The ten years of “cultural revolution” (May 1966-October 1976), came to be a period of both economic and social stagnation. After 1976, Deng Xiaoping was reinstated and China entered on a new reform path that included the “ping-pong” diplomacy and the gradual opening towards the West in the early 1970s. Major reform moves have been made from the early agrarian reforms until the ongoing socialist modernization process, where the progress during later years, especially in the manufacturing field, has been rapid. This policy has made major advances possible and has markedly improved living standard for many, although the problem of a fair distribution of the economic benefits among all citizens remains to be solved. (Partly based on; China.org, 2004-04-30)

4.2. Trade

The dramatic increase in importance of foreign trade has had for China over the last decade is well shown by its increasing power as a trade nation. When 2003 was summed up, China had advanced into being the world’s fourth most important trading nation, up from having been ranked just outside the ten most important as recently as in 1994 (WTO, 2004-09-12).

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- 202 - An important index measuring a country's trade openness and integration with the global market is the percentage of total foreign trade volume to its GDP. The nations, new-born dependence on foreign trade, having reached 60% for 2003 and over 80% for 2004, shows the dramatic shift that has happened in this respect over a relatively short period. At the time of the opening up to the rest of the world in the late 1970s, this rate was well under 20%, rising to 20-40% from 1985 to 1999. Trends here are showing a nation opening up for foreign trade and then witnessing fast growth with the 40% mark broken in the year of WTO membership in 2000. Foreign trade is an increasingly important factor in China, supporting the nation's rapid transition towards a market economy. This growing dependence on foreign trade has made the country clearly more exposed to changes in the international economy than before. With a swelling international trade for all countries of the world, this is far from a unique phenomenon, but it is increasingly involving the regions of China that has acted as economic motors of the country. Determining what should be the driving force in an economy, if it is the domestic market or rather the international market that should be promoted to sustain economic growth, is a major question in any developing nation. In the current, century it would go against the trend of globalization and regional integration to focus on domestic demand and overlook overseas markets. Meanwhile, it is probably impossible to downgrade and overlook a market of 1.3 bn consumers and over emphasize exports.

Total trade in 2003 was up by an impressive 37%, to USD 851 bn and to generate a trade surplus of USD 25 bn. Foreign trade for 2004 was, by mid 2003 expected to grow by 8%, compared to the near explosive growth during 2003. However, these expectations have been proved wrong and instead, total trade during 2004 grew by over 35% to a total of over USD near 1.2 trillion for the year (MOFCOM, 2005-01-10). Increasing trade has been the pattern with strong surpluses each year having added up to USD 250 bn from 1997 including 2004. In relation to developed countries, trade has been more volatile as it was positive in 1999, USD 10 in the negative during 2000, more or less balanced during 2001 – 02 and has then been USD 10 bn in the positive during 2003 and 2004.

In early 2004, the Chinese trade pattern showed strong signs of change as during the first month of the year exports rose by 29% to USD 70 bn while imports rose by 42% to USD 78 bn with the February figures showing an increase of 40% and 77%, respectively. As a result, Q1 2004 came to show a trade deficit, and suddenly China looked likely it is on its way towards a trade deficit that would have been the first since 1993. The deficit for Q1 totaled USD 8.4 bn, out of a total trade of USD 240 bn. During later years China’s foreign trade has generally had its weakest months in the beginning of the year and its strongest late in the year. Precisely according to this pattern, the 2004 trade deficit came to flatten-out and

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- 203 - for the first nine months of the year the surplus was back, although only as small as USD 4 bn. This is from an export of USD 416 bn and imports from USD 412 bn, after the two had seen increases during the year of 35% and 43%, respectively (Xhinhuanet, 2004-10-15). Minor tax reductions came to have little influence compared to the strong domestic demand for raw material as well as machinery and equipment, which have been the most important factors. This demand saw investments rocketing by over 40% in the beginning of the year (MOFCOM, 2004-10-18). The year ended with a strong trade surplus of USD 32 bn, up 25% and with nearly 1/3 generated in December alone. This from an export of USD 593 bn and an import valued at USD 561 bn (ibid. 2005-01-21). For 2005, a 25 billion trade surplus from an export volume that is expected to increase by 20%, to well surpass USD 700 billion, and a 23% increase in imports, to reach about USD 685 bn. As the trade volume already during 2004 reached 86% of GDP, and with a 10% difference in growth rate, the trade volume looks likely to equal the GDP volume in 2005.

At the same time, as high demand from China has much contributed to maintain world economic growth in 2003 and 2004, it has also been given the blame for the fast growth in raw material and energy prices during the same period. It is still the imports of raw material that account for the bulk of Chinese imports. Being such a large purchaser in the market, as China has become in later years, its increasing demand has pushed prices, on especially the kinds of raw materials that are in high demand in China, upwards. As the situation with large- scale sourcing on the international market is relatively new for China, it is probably so that the knowledge of how the international markets work has not been sufficiently widespread in all business circles. This situation has lead to that raw materials, which have become a seller’s market where the upward trend in prices has been further supported by speculation about just that: increasing prices. This development goes in hand with the market economic system, where each link in the chain is supposed to focus on, and as far as possible, optimizing his own profit in each transaction. One possible way to reduce risks in this situation could be to negotiate long-term delivery contract with large suppliers, internalize sourcing by way of ownership in producers or spread-out the concluding of contracts both geographically and in time. Additionally, trading of raw material remains a question of timing, and not seldom, pure luck, if the deals concluded will result in prices that are lower or higher than what is being paid by competitors.

Competition should be focused on increased quality and a widened composition of trade instead of only volume (Premier Wen, when looking ahead to 2004 at the 10th NPC – CD 2004-03-22 and NDRC, 2004-04-11). In line with this desire, exports from China are getting increasingly sophisticated with machinery and

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- 204 - electric devices are increasing by over 50% during the first nine months of 2004 constituting over 40% of trade. High-tech products, like computers and digital cameras, increased by near 55%, to a 27% share of total exports, while the share of the conventional textile export fell 1%, to 17% after having increased by, what here is a modest, 20%, or about half the average. On the import side, raw materials increased in value by near 60%, with oil up by some 35%127. Machines and electric devices increased by 30%, covering just over 40% of the total. The most surprising change is that the import of steel and steel products, that declined by 15% during the period, which is the first in three years (MOFCOM, 2004-10-18). Companies with FDI partnership contributed a massive 57% of exports during the period. Both imports and exports related to these companies have been growing faster than the average, but they still record a trade deficit for the period of USD 1.6 bn (MOFCOM, 2004-10-18). China’s export to developed countries includes a high degree of labor-intensive products, typical for a newly industrialized country. Although the share of machinery and high- tech products in its exports is increasing, it still has its base in lower-end products. However, official statistics show that to increase Chinese exports by USD 1 million on average requires increased imports by over USD 500 000. Being an average value, it indicates that the proportion of imports needed to increase exports for higher-end products is likely to be even larger. A Chinese computer contains not only a Windows operating system, it will also be based on an Intel processor and a liquid crystal screen that has been produced in Japan or Korea. Additionally, with well over half of Chinas, exports originating from subsidiaries of companies owned from abroad, paying interests to their parent companies and probably sending dividends and royalties abroad. Other important exporters work under OMCs (Original Marketing Contracts) where it is the owner of the brand name that market and sell the product and could be expected to pocket the largest revenues from its sale. A possible rise in the value of the Yuan would hurt Japanese electronics makers' subsidiaries in China as a high percentage of production is being exported to third world countries. On average, such subsidiaries sell about 40% percent of their production to third countries, about 35% locally and with the remaining 25% exported to the “home” market (UFJ, 2004-06-12)

There are still very few, if any, major Chinese brand names that send any positive signals to consumers outside China. Establishing of global brand for the best of the Chinese products can, not having the skills or the experiences in marketing, come to take another 5 - 10 years. In surveys of brand names, only one Chinese name appeared among the 100 most known in the world (Haier, at 95), and only two among the 25 most well known inside China (Kingdee, 2004- 09-05). The first really serious such attempt, or at least laying a foundation for such a widening of its market, has been made by the computer manufacturer

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- 205 - Lenovo. The company has closed a deal with the International Olympic Committee to become global supplier of computer for the Olympic movements build up from 2005 and beyond to Beijing 2008 and taken over the IBM production of laptop computers (Lenovo, 2004-08-12).

By regions in the country, it is primarily in the East and South part of China that the results from the economic reforms have been seen, while western parts have seen little of the improvement. In eastern parts, the average rate of trade dependence among 12 provinces was 75% in 2000, while the same rate among provinces and autonomous regions in the central and western regions was only 10%. The country’s leading regions, in this respect, for 2003 were Shenzhen in Guangdong Province and Shanghai, showing a trade dependence rate of 356% and 149% respectively.

Total trade for Guangdong in 2003 constituted USD 283 bn, with exports valued at 153 bn and imports at 131 bn, up 29% and 27%, respectively over 2002128. The province generated 33% of Chinas, foreign trade during the year and could post a trade surplus of USD 22 bn. Its export volume was USD 94 bn larger than China’s second most important export province, Jinagsu, and its import was USD 67 bn bigger than the import of the second most important import province; Shanghai. Guangdong’s most important trade partner though was, Hong Kong, that took USD 45 bn of exports, or 30% during the year and is expected to increase that share to 40% of an expected USD 150 bn export during 2004. The five most important items in its exports were machinery, electronic items, high-tech products, garments and shoes while the five most important items in its imports were high-tech products, production lines and equipment, auto-parts, steel and agricultural products. Since this type of trade reliance ratio calculations is determined by several factors, they should perhaps not be seen as very exact, but remains a strong indicator of differences between the different provinces129. What percentage that could be said to be the best for China, or its individual provinces, at present and in the near future, is not a question that can be given an objective reply.

The process of increasing China’s international trade has not been proceeding without problems, as the number of trade conflicts with several of its biggest trade partners has started to mount. Trade partners that are both few and big, with just three, the US, Japan and the EU being partners for over 50% of the trade volume. A fact that enhances the importance of both the political relation to, and development in, these three for the future development in China.

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- 206 - Japan is China’s most important trade partner, where trade including Hong Kong, for 2004 reached USD 213 bn, accounting for over 20% of Japan’s foreign trade. Total Chinese trade with the EU 15 was, in 2003, worth over USD 125 bn and for the extended EU-25 trade reached USD 180 bn for 2004 (Xinhua, 2005-01- 23). The figures that place China as the second biggest trading partner for the EU, after the US, and the EU as China’s second biggest trading partner behind Japan130. The EU-25 market, having 450 million citizens, accounting for roughly 18% of world trade and over 25% of world GDP, will continue to grow in importance for China. Future trade will be facilitated further as the average tariff rates in the new member states decreased from 9% to 4% as a result of membership (EU, 2004-05-06)131.

Outside of the already existing wider group of the Asia Europe Meeting (ASEM), a special China-EU Industrial Dialogue forum has also been established in an attempt to keep the dialogue open and to avoid/prevent trade conflicts132. At its first meeting in the Dialog group, it discussed tricky issues for the relation like auto industry, metals and textiles (CW, 2004-09-22). One recent problem in the relation has been the Chinese export of coke to the EU, that in May was set to 4.5 mt for 2004, same as in 2003, but where exports have faced both administrative and environmental restrictions on the Chinese side. With China being one of the world’s leading coke suppliers, this has had severe effects on prices. In the opposite direction, the EU has maintained an arms export embargo against China since the violent quelling of freedom demonstrations in Beijing in 1989. Although some limited arms export has been taking place from the UK, France, Germany and Italy, it is expected to be liberalized from mid-2005, despite internal opposition, but with the total arms volume not being allowed to increase (EU, 2004-12-22).

Trade with the US has grown considerably, from a total trade value of USD 6 bn in 1989, to USD 74 bn by 2000 and reaching USD 126 bn by the end of 2003. As China’s largest trade partner at the time, the US generated about 5% of foreign trade in 1998, having nearly doubled to 9% by the end of 2003 (CD, 2004-09-13). Chinese exports for 2003 came to just under USD 75 bn, up by 33%, while imports grew by 26% for the year.

At the 2004 meeting of the mutual Joint Commission of Commerce and Trade, established in 1983, the relation between China and the US was described as the “best in history”(CD, 2004-04-19). The future of the relation could be bright, but at the same time increasingly insecure in respect of the mounting US trade deficit. The former strong critique over human rights violations and workers rights record from the US side has faded in later years. Instead it has been trade-related measures that have come to fill the mutual agreement. The US has already

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- 207 - adopted dumping measures against TVs and safeguard measures against the imports of some textile products from China and this could well be the beginning of several such measures. The US has also repeatedly declined to declare China a market economy, which could have served as a strong boost to the mutual relation. Instead China has been urged to re-evaluate its currency and has been pointed out as the cause of the industrial job losses in the US. Given the blame for much of the 2.8 million jobs lost inside US manufacturing during 2000 until mid 2004 (AFL- CIO, 2004-05-12). The problem could instead be said to be one of job creation in the US and the West and not of job losses to e.g. China. If over 700 000 US jobs have been lost to China, it still only represents less than 1% of US jobs and about 4% of US manufacturing jobs in 2000.

With the signing of the agreement that China supports the Russian WTO entry, this became a relatively early statement in support of the Russian entry (Kremlin, 2004-09-26). The Chinese Premier, Wen Jiabao, sees Russia as a “strategic cooperative partner” and after a WTO entry the trade relation will "gain new strength of growth within the framework of the WTO" (Interfax, 2004-09-13). In later years, trade between the two has been growing at an average of 20% per year, and after having reached near USD 16 bn in 2003, it is expected to pass beyond 20 bn in 2004 and to reach USD 60 to 80 billion by 2010 (CW, 2004-09-21). To make such predictions possible, the exchange must have been widened from conventional commodities to include services, tourism, finance and high-tech equipment.

4.2.1. The WTO and (free) trade agreements

After years of difficult negotiations, China entered in the World Trade Organisation (WTO) in November 2001. Current and ongoing Chinese measures to liberalize trade and investments are much a result of commitments made during the WTO membership negotiations. This includes the opening up of the domestic market for imports of most investment goods as well as the competition that have followed. China is seen by the WTO as such an increasingly important country that its trade policy will, in the future, be evaluated and reported every two years, which the WTO does for the five biggest trading nations, and less frequently for smaller nations (WTO, 2004-10- 28).

As mentioned, China’s comparative advantage on the industrial level is chiefly found in production and to a large extent results from low labor costs. Still, this has not been enough to create the international competitiveness needed to shape brands or any major international company groups. China’s strongest

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- 208 - competitive advantages are mainly to be found in labor-intensive sector products like clothing, textiles, shoe/leather and stationery, but also the production of electric appliance and basic chemical industries.

In line with increasing involvement in the international trade, China has had to recognize the US as a major player in world trade and as active in drawing up international trade rules. The US, with its large economy, is also one of the biggest beneficiaries from international trade and an advocate of free trade in most fields. In later years, the US has implemented a string of protective measures in various labor-intensive industries, where it has a weak competitive edge, such as for basic steel and textile. That is apart from providing considerable government support measures to domestic agriculture.

On March 18 2004, the US officially filed the first complaint to the WTO against China since it joined the WTO in late 2001 (WTO, 2004-03-18). The reason for the complaint was the Chinese VAT reduction to 3 – 7%, instead of the normal 17% VAT, to exporters using domestically produced semiconductor products. US producers accused the Chinese side of giving most of the 17% VAT levied on imports in rebate for domestic producers, i.e., subsidizing domestic products and giving them an unfair advantage over imports. From the Chinese side, it is being stated that such financial benefits are not only for domestic manufacturers, but can also be enjoyed by foreign-funded businesses. "China imported more than 80% of its semiconductors last year, and I do not see how much more open our market could be?" (Zhang Qi, director-general, Ministry of Information Industry, 2004- 04-05). The USD 19 bn Chinese semiconductor market has become a major buyer for foreign-made chips, including USD 2 bn from the US in 2003. Semiconductors are products that the Chinese government sees as a product for the future and can give restricted support. That is without interfering with WTO regulations, by way of allowing companies deductions for R&D expenses.

Under the dispute resolution rules set out by the WTO charter, the two parties must hold consultations during no less than two months before the complaint will be handed over to a panel that will evaluate the complaint. If the WTO accepts to take up a complaint officially, then it usually takes 15 to 24 months to make a decision. Later in the same month, both the EU and Japan have asked to be included as observers in the consultations, which the Chinese side accepted.

By early 2004, 610 different cases of this kind had been filed against Chinese products, involving over USD 10 bn worth of Chinese exports. By mid-2004 China itself levied 27 cases of anti-dumping against exporters, with 19 of these against Korean manufacturers (WTO 2004-07-15; KITA 2004-06-17)133. A number of similar examples can be given inside the NEA region that involves especially

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- 209 - food products. One such example is dried laver (a frequent ingredient in Japanese cooking), which is not imported from China, although made by the same process as in Korea, with only Korea having quota access to Japan. No quota has been given to China due to claims of overuse of pesticides, a reason that has been extended to cover various vegetables, that for this reason cannot be exported to Japan. In the same way both Japan and the EU have banned imports of aquatic products due to the widespread use of antibiotics in fish farming. Trade in agriculture is another product segment that is restricted by the use of technical standards, quarantine and quality inspection measures, custom procedural requirements, environmental protection and labor standards. The latest and increasingly problematic field is intellectual property rights infringements134. This has emerged as a major problem for China especially in relation to the US, with the Secretary of State having set the lost US incomes from “pirated goods” to USD 3 bn per year. However, the local awareness is also rising sharply with the number of lawsuits, in Shanghai only, having reached 640 during 2003 (CD, 2004-12-18).

To overcome some of its own problems of the direct and indirect trade barriers that are faced by its exports, China has also initiated the process of negotiating bilateral FTA agreements. In this process of looking for suitable partners, Chile has become a frontrunner, as it was for Korea. Negotiations were officially initiated when the two presidents, Hu Jintao and Ricardo Lagos Escobar, met at the APEC meeting in Santiago in November 2004, with the hope of concluding a deal in 2005 (CD, 2005-01-28). Trade between the two has increased by over 50% during H1 2004, to USD 2.4 bn, and is expected to pass USD 10 bn by 2008. Copper is the focus of the negotiations, as this is a relation between the world’s largest producer and consumer; with over 60% of China’s H1 2004 imports from Chile being copper (Ministerio de Economia, 2004-08-30).

Another near future Chinese FTA partner is Pakistan, where negotiations are expected to be concluded by the end of 2005. Negotiations here should be relatively free from difficult issues, as over 70% of Pakistani exports to China falls in the cotton yarn or fabrics category, with total trade for the two in 2003 having reached about USD 2.5 bn (MOFCOM, 2004-12-25).

As the first of its more important trade partners, the ASEAN group officially granted China the market economy status in September 2004135. Trade with the ASEAN group is becoming increasingly important for China and constituted 11% of foreign trade in 2003, with exports having increased by over 50% and imports by 30%. Total trade for the year has reached USD 78 bn, generating a surplus of USD 13 bn (Min of Eco, 2004-07-10). Trade with this 100 million inhabitants area is expected to reach near 150 bn in 2004 and 400 bn by 2010.

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- 210 - Discussions a possible FTA between China and the ASEAN has been on-going since 2002, with an agreement on Comprehensive Economic Partnership and a declaration of Strategic Partnership for Peace and Prosperity signed in 2003. The latest step is the signing of a memorandum of understanding on transport cooperation in November 2004. A possible FTA with the ASEAN group of countries would include the six major countries from 2010 and all nations from 2015. If completed successfully, then it could potentially become one of the world's largest FTA areas (ASEAN, 2004-11-29).

Textiles and its trade The production value of the world garment industry is estimated to have been in the range of USD 380 bn for 2003. In 2003, China was the world's leading clothing and garment producer, in terms of both capacity and export volume. Over the last ten years, textiles and clothing have served China as its best money earner in international trade. In 2003, Chinese exports of textiles reached USD 80 bn, producing over 20% of the world garment volume, with textile products generating about 18% of China’s export value (CCC, 2004-08-12). The volume of textiles in the foreign trade has increased by an average of 13% per year from 1994 to 2003, but the share of textiles in total trade has nevertheless fallen from 28% to 18% during the same ten years. During this period, the trade surplus generated by textiles and clothing has increased from USD 21 bn to USD 63 bn; three times the USD 21 bn that was the overall trade surplus for China during 2003136. The leading production regions are all eastern, with Zhejiang that has surpassed Guangdong as the most important, with the two generating about 21% of the total each, with Jiangsu and Shanghai both supplying around 15%. The three most important regions each recorded over USD 10 bn in exports for 2003, within all ten regions that generated an export value above USD 1 bn. During the same ten years, imports in the sector have increased only marginally, from USD 13 bn to just less than 16 bn. Consequently the share of textiles in imports during the same time period has fallen from 11% to below 4%. Basic products, like fabrics, yarns and fibers are dominating the imports and have only seen a minor reduction in its share of import, to about 80%. China is also one of the world’s biggest cotton growers, and has allocated ever-larger areas to this crop. Genetically manipulated (GM) cotton was introduced already in 1996, and has since seen its output rise to a level where it now represents over 50% of the crop (CNFTI, 2004-06-30). In 2003, the cotton production reached just above 5 mt, which still had to be supplemented by imports to cover demand that stood at about 6 mt. The problem with the domestic cotton production is that it usually competes for land with grain, and in later years, the grain production has also been below demand.

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- 211 - As briefly mentioned in the introduction, trade in international textiles has, since 1974, been governed by the "Multiform Arrangement" (MFA). This was an agreement reached under the principles of the pre-WTO, GATT agreement, but the MFA still allowed the continued use of quotas in textiles trade. After long and difficult negotiations, the "Agreement on Textiles and Clothing" was reached, during the later stages of the Uruguay Round of GATT talks in Punta del Este in Uruguay in 1994. The new agreement brought the MFA into line with the GATT principles and enabled the gradual liberalisation of international trade in textiles during a 10-year grace period. The establishment of a new regulator system for international textiles trade soon had, and will continue to have, a far-reaching impact on the international pattern of textiles production and trade.

These agreements are of utmost importance to China as the world’s largest textiles producer and exporter. For China, the production and export of textiles are of vital importance to its economic development and a strong contributor to its foreign exchange balance. Beginning from 2005, and in accordance with the WTO accord, China was allowed to eliminate its remaining textile export restrictions, as quotas would largely be abolished. This presented new openings, not only for the domestic textile and garment industries, but also presents a major threat to foreign competitors. The already fierce competition in this field has even made some developing countries resort to anti-dumping cases for setting up barriers against exports from other developing nations.

From the outside it has been estimated that the Chinese expansion in the textile and clothing field could cost some 30 million jobs globally until 2007, with 650 000 of these in the US (Bofit, 2004-32). The undervalued Chinese currency, direct and indirect government subsidies together with tax rebates, is said to make products up to 75% cheaper than what they should have been. Although small in relation to the total economy, textiles are still an important sector in the US, with a production value of USD 50 bn in 2003 and about 2 million employees (US Department of Labor, 2004-11-09) 137. Much of the US imports have been under a quota, manufacturers have to pay USD 80 for 12 pairs of trousers, valued at USD 100. The cost to obtain such quotas has often placed the total cost for Chinese products approximately in line with similar quota-free products from other Southeast Asian countries (CCC, 2004-09-14). The US import of socks from China could serve as an example of how powerfully a low-price product can take over a foreign market. In just three years the import of socks from China has increased from USD 9 million to USD 170 million. In number of socks this converts to an increase from 1 million dozen in 2002 to 42 million dozens in the 12 months ending in August 2004 (CW, 2004-10-24). This is the kind of increases that are feared by textile importers in the future, for numerous kinds of products. Socks have been set under quotas, with other product groups being considered by the Department of Commerce for quotas (Cotton, 2004-10-01).

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- 212 - As a result of the conflicting interest among countries, the textile and garment industry has become one of the categories confronted with most quotas and technical barriers in world trade. If importing countries can show that imports disrupt markets or threatens local producers, then it will still be able to use protective measures like high duties and safeguard quotas. These measures can be used until 2008, but from then on, existing special textiles and clothing sectors’ protective measures will be terminated (WTO, 2004-08-29). During early 2004, it was requested that the WTO should organizes an emergency conference to discuss a proposed extension of textile quotas until the end of 2007, which never came about. Soon after, in Turkey, as Europe’s largest textile producer, US and other textile manufacturers joined forces for a petition that received support from a number of European as well as African states (ATMI, 2004-03-04). From this group it is feared that China and a few other countries could come to monopolize the textile market, resulting in large unemployment and bankruptcies in other nations, dependent on textile and garments industries (CD, 2004-04-30). To make the US government act against China in this matter, the AFL-CIO filed a petition to the Bush administration under Section 301 of the Trade Act of 1974. Under this Act, the government can take action against countries that engage in “unfair trade practices” against the US. Section 301 had previously only been used, often extensively, to protect corporate interests, but it had never been invoked to protest against a foreign nation’s labor practices138. The petition was later rejected by the government, much because it could have become a new interpretation of regulations connecting trade with workers rights.

The positions taken by China, in discussions about trade liberalisation, always mentions the possibilities that free trade in textiles will give profits to developing countries, although it is first of all China that can harvest such profits, at least in a short term perspective. However, the decision has been taken by the WTO to eliminate quotas restricting trade in textiles and garments from 2005, but it will probably need a considerable amount of time before unrest in this field has calmed down (WTO, 2004-09-25). In the case of US, the opinion of the labor unions has been made clear above, while other liberal-minded policy makers argue that the US, as well as other countries, should face the trade competition head on. Instead of fighting imports, the concentration should be focused on the work to shift production into other high value production (Cato, 2004-10-10).

At the time when the agreement to abolish trade restrictions on textiles was agreed on, the 10 years until 2005 was seen as a sufficiently long period for the production systems of the world to adopt. After this period of transition, the textile industry was also expected to enter a new era of a liberal trade regime.

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- 213 - Since the signing of the accord in 1994, a then unforeseen speed of globalization has led to a severely unbalanced trade system. At the same time, it is getting increasingly unlikely that the old GATT accord will be fully honored by all parties, especially so as competition among textile exporters is getting ever fiercer with more developing countries entering the market. With the elimination of quotas in accordance with WTO rules, the Chinese competitiveness strengthened further in 2005, with exports expected to increase considerably as a result. China has a long tradition as a producer of clothing and has gained respect for its scale of production, but also for the quality of the products. It is, again, the low cost of labor that is the most important factor in attracting contracts in this line of industry. The average per-hour salary in China's textile and clothing sectors was USD 0.69 in 2000. This level is less than 3% of wages in the same sector in Japan, about 5% of that in the United States, and about 15% of South Korean wages in the sector. Although labor costs in China's more industrialized eastern regions have risen rapidly in recent years, there are still vast western and central regions in the country where labor costs remain low (Werner Int., 2004-07-12). Wage costs are very important as of the wholesale price of garments wage cost often make up 30 – 40% of the total price.

A postponement of quota lifting in the textile sector, which seriously was suggested by a number of countries, would severely damage the creditability of the WTO. Such a measure would probably have been the final blow to the chances of finishing the ongoing WTO-led round of trade negotiations, the Doha Round, somewhere near on time. Textiles can be seen as an example of a question where the interests of the developing countries are being looked after, including that of China, but, as is the case with agriculture, this is a highly sensitive field. If new US trade restrictions will be imposed on textiles, it will probably come to serve as an example in other sectors, and to encourage other protectionist forces, in e.g. the EU, that could be expected to pressure for wider renewed restrictions. The Chinese side has also understood that this is a serious issue for its trade partners and has declared that a new export tax of 2 – 6% on textiles will be introduced from 2005 (MOC, 2004-12-14). Too little too late is the response from many and the EU has decided to simplify internal formalities for trade complaints, related to textiles, and to cut the handling time from 15 months to just weeks (EU, 2004-12-23). In Europe, it is Turkey that has moved ahead by introducing quotas for 42 categories of Chinese textiles from 2005 (CD, 2004-12-26). It is not surprising that the US and the EU have taken a tough stance, as they are the destination for about 12% each of the Chinese export, but still with Japan and Hong Kong being the most important destinations, taking near 20% each. In the trade relation with Japan, it has not been textiles and clothing, but instead towels that has so far been the most problematic field, having seen Japanese intervention in both 2003 and 2004.

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- 214 - China's clothing production and export volume will likely maintain its fast growth for yet some years, but at some stage, perhaps around 2008 - 2010, other Asian states should have become competitive enough to challenge the Chinese dominance. By that time, China's exports will flatten out, or even decline, but there will still be a huge domestic market with much increased demand from its then well over 1.3 bn population. Additionally, the current situation with China holding about 20% of the world’s textile and clothing sector, but practically no designers of its own and not one single brand name recognized outside the country, will probably also have changed.

The WTO dumping facility and its use In late 2003 the US Department of Commerce started an investigation into the possible dumping on the behalf of Chinese color TV manufacturers on the American market. As a concession during the WTO negotiations China had to accept that other member countries can see its economy as a “non market economy” for 15 years. Based on this fact, it is possible to use labor and input costs from a surrogate country’s market in calculating what should be the “normal” cost of production in China. In this case, India was used by the US Department of Commerce as its surrogate for the calculation, although India has no TV industry comparable to the one in China, and especially not an industry that can be called “market-oriented”. If the Chinese TV industry had been granted status as a market-oriented industry, it would have avoided the whole process. To receive this status, it is required that there is practically no government involvement in production or pricing matter, producers must be privately or collectively owned, behave like market-oriented companies and their producers must pay market prices for all major inputs. The US Department of Commerce had not found that the producers in this case are free of state ownership and as a result, such a status cannot be considered. The ruling of the investigation, if proofs are found that dumping has occurred, could result in punitive duties on imports of that kind of products. Often, a preliminary ruling is released, indicating the final ruling, which gives the other side a chance to respond by supplying additional information and details in the case. If the final ruling is negative, then, as a rule, it is very hard to accept from the other side and is mostly referred to as unfair and based on inaccurate information.

Arbiter in these kinds of conflicts, when the US is involved, is the US International Trade Commission (ITC) that makes the final ruling on whether the US television industry has been hurt by the imports or not. It is, of course, a matter of principle to have a ruling against a producer but market considerations could well make producers accept a ruling for the time being, especially if sales remain profitable. In this case, a negative ruling resulting in high duties would probably make color TV producers upgrade their product

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- 215 - range into higher value products faster than would otherwise had been the case, and thereby enter into product segments where domestic US manufacturers are still active. Labor unions at the largest TV producers in the US have been among the most active in demanding an anti-dumping ruling. As these producers happen to be owned by Japanese companies, like Sony and Toshiba, it has from the Chinese side been rumored that the whole process was set up by these Japanese companies. A negative ruling for the exporters could also lead to the establishment of production facilities inside of the NAFTA area; just like the Japanese TV producers once did inside US borders, in the era before the existence of NAFTA, and in both cases to avoid borders. The difference now is that these Chinese investments are more likely to land in Mexico than in the US. The final level at to which a party can appeal in this case is the US Court of International Trade. Complaint to the highest level can actually be dealt with very positively, as was shown by a ruling in favor of a number of Chinese apple juice producers in February 2004. The Department of Commerce had set high duties for all producers, but in some cases the Trade Court reduced duties from over 50% to zero (US Department of Commerce, 2004-04-10). The latest product to be subjected to punitive duties from the US has been Chinese wooden furniture where the duties have been set at near 200% for most producers (CW, 2004-12-14).

If the ruling is considered to be fair or not, then it is seldom so that a supplier withdraws from a market just because of being ruled against. In the case of the Chinese TV makers used here, the US market remains the biggest single market in the world and for a big manufacturer, withdrawal is not really an alternative. In this case, the Department is said to have used information from a website that was unauthoritative as basis for its calculations. As a result, the duties first considered never came to be introduced and instead what was levied in the preliminary ruling, resulted in large reductions of the duties, from the range of 30% to below 5% for some of the manufacturers (Willkie Farr & Gallagher, 2004)139.

Since joining the WTO, also China has issued a number of dumping charges against foreign producers. However, sometimes the market changes quicker than regulations. This was shown by the withdrawal of the dumping charges from the Chinese Ministry of Commerce against foreign exporters of cold rolled steel, ruled in September 2003, but in operation from January 2004. The reason for the withdrawal was that many domestic consumers, first of all, could not find enough cold rolled steel in the market and additionally had to pay higher prices, which hurt their competitiveness (MOFCOM, 2004-09-08). At the same time, this as the measure had contributed to an artificially high domestic price level in the already overheated steel industry.

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- 216 - 4.2.2. Neighbours relations

Although China share land borders with no less than 13 countries, the by far longest with Mongolia, and sea borders with another 4, it is the relation to Japan that remains the most important one140. The later generations of leadership in China have inevitably come to understand the advantages of the country’s peaceful economic rise to might, has been made possible by peaceful co- existence with neighboring nations. To allow the opening up and to see this tremendous transformation take place in the country has necessitated a great deal of adaptation from a formerly strictly followed socialistic perspective. To continuously find common values among different strata's and regions of the population, during times of fundamental change on many levels and takes both sensitiveness and endurance in behalf of the political leadership. The peaceful rise is perhaps a strategic choice of China, which could be seen to conform to its historical experience. To make this possible, China have been lucky to have a peaceful environment where neither Japan nor Russia, as any other neighbours, has seen as a threat to any other nation. In this case, China's rise has instead generated a momentum that is big enough in the region to also lift its neighbours from years of relative economic pessimism. However, further improvement of the already well established Sino-Japanese relations would require concerted efforts from both sides of the East China Sea.

Over the years, China has supported an exchange with Japan on the level of individual political parties and foreign ministers level, but it has excluded official direct contacts with Prime Minister Koizumi. On the foreign ministers level irregular meetings have taken place, although Japanese invitations to arrange top-level meetings between the two neighbours have remained unaccepted. However, top-level meetings between the two neighbours have been conducted yearly in later years, but on the sidelines of major international meetings141. It has been agreed to include South Korea in future triangular meetings and to increase the frequency to twice a year. The failure to arrange an exchange of visits between the state leaders of the two countries due to Koizumi's shrine visits has undoubtedly had a negative impact on the Sino- Japanese relations. Nevertheless, in the economic, civilian, and cultural areas relations are still pushing ahead, without the exchange of visits between state leaders. Currently it is more of a modern era necessity for trade between the two neighbours to go on, than there is a solid need of a political relation at top level: “The stream rolls on in circumvention of the rocks”.

The problematic relation between the two neighbours was regulated with the signing of the 1972 Japan-China Joint Communiqué. Despite this there has been continued attempts to seek compensation for injustices by some few of the

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- 217 - survivors of the about 39 000 unpaid workers taken to Japan by force during the war. When these cases have been brought to courts in Japan, judging has been irregular, as cases have been both won and lost by the plaintiff. This has happened while the official Japanese policy has remained firm that the Joint Communiqué has made such claims invalid and, furthermore, the 20-year statue of exemption has expired142.

Japan should regard China’s growth as an opportunity and not as a threat. This is a positive development for the peace and stability in the region and the world at large. Although the Japanese side should show sincerity in settling the “shrine issue”, remembering that history works as a mirror and look forward to the future. In early 2004, the two countries were again forced to revive the dormant and unsettled issue of the Diaoyu Islands as Chinese activists made a landing on one of the islands in the uninhabited archipelago. The intruders were captured and promptly returned to Beijing unhurt, but the incident caused a sudden stir in mutual relations143. On the Diaoyu Islands issue, both sides should hold out and thoroughly negotiate disputes on the island issue, to ensure that the China- Japan Joint Statement signed in 1972, remains undisputed.

The possibility that China might become a long-term military threat to Japan has been voiced in Japanese defense reports, but this is strongly rejected by the Chinese government (SDF and CW, 2004-09-17). According to Beijing, the total Chinese defense budget for 2003 was to about USD 25 billion for a country that is 25 times larger than Japan, with about 10 times the population. The comparable budget in Japan for the same year reached USD 60 bn. The Chinese view is that it is seeking friendly, peaceful and mutually profitable relationship with its eastern neighbours (MOFA, 2004-09-10)144.

4.3. Energy

The Chinese energy sector is still largely state-owned, although a number of large foreign investments have been allowed. In 1998, the state launched a major reorganization of the oil and gas sector, with the aim of breaking the existing monopolies. Since 2003, the new State Energy Administration (SEA) is overseeing the energy sector. The tenth five year plan for 2001 - 2005 in the oil and gas sector gives the following description of the development planned for this time period:

“China will undertake a strategic reorganisation in the oil industry by means of market liberalisation, internalisation, cost-effectiveness, scientific and technological breakthrough and sustainable development” (First sentence of the Five Year Plan 2001 – 2005 in the Oil and Gas Sector)

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- 218 - As China is a large country as to surface, the total quantity of the available variety of minerals and other resources are considerable. However, the degree of difficulty in looking for mineral resources by geological means in the eastern regions has increased, and the content in the proved reserves here has started to decline. The production in many mines and wells, especially in old production regions, has entered the middle or late phase of exploration, and their reserves and output are decreasing year by year. Arrangements in mining and oil production areas has not been satisfactory, while prospecting and mining technologies have been much improved in later years, there are still serious waste problems in the handling and consumption of resources. In its attempts to solve these problems, China has been trying to maximize its coal and hydropower resources. In 1999, China set up its third Geological Survey, which organized a new round of large-scale survey of domestic resources145. When presented in early 2004, it showed 171 discoveries of a variety of mineral resources, with 158 of these holding proved reserves large enough for exploration. The Tarim and Junggar basins in Xinjiang, the Ordos Basin on the borders of Shaanxi, Gansu, Ningxia, Inner Mongolia and Shanxi, and the Quidam Basin in Qinghai, all have a considerable potential in the field of petroleum (NDRC, 2004-05-02). Other mineral resources in the western regions will also be used to accelerate the change from resources advantage to economic advantage. Important discoveries of petroleum resources have also been made close up shore in the north Bohai Bay area. With reserves estimated to over 20 bn tons in the Bohai Bay area, with about half the volume proved, the area could potentially become as important as in the Tarim basin (CD, 2004-12-23). The government has adopted a new policy when it comes to enterprise income tax and value-added tax to develop and explore these mineral resources. It also aims to encourage the enterprises that explore resources to raise the level of the multipurpose resources utilization. The management of the geological data gathered during the latest survey has been conducted in accordance to the WTO's principle of transparency. This has broadened the scope of geological data to be released to the public to ensure its availability for foreign investors. Technological progress and innovations, a larger proportion of different minerals contained in known reserves should be explored relying on science. Resources, at the same time, have been invested into the development of cleaning technologies for coal, including coal washing, dressing, liquefying and gasifying technologies146.

The Chinese government formulated a new policy on the import and export of mineral products to fulfill its WTO commitments. The intention was to coordinate both the export of its dominant mineral products and the import of mineral products in short supply, especially as direct imports of mineral products will remain important in the foreseeable future. What has worried the

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- 219 - Chinese government is that the proportion of the spot trade among mineral commodities in imports is high, including for crude oil. The intention is to gradually change the situation and to encourage the signing of long-term supplies contracts with foreign companies. This should lead to a diversification of sources and to a situation where resources from abroad supplement the domestic supply, which is to include the import of foreign capital and technology for this sector. Foreign investors are encouraged to participate in all sectors of the industry, from exploration of both gas and crude, production of petrochemical products, building power station and in retail activities to consumers. China has clarified, simplified and standardized the approval procedure for foreign investment in all forms of prospecting and exploiting mineral resources. A boom in the building of new capacity has been seen, after two years of considerable energy shortages with investment growth of over 50%, still with little foreign participation. With possibly as much as 30% of these new energy investments being unapproved for mostly smaller plants, banks have been ordered to stop these loans, and when necessary, take on an increased bad debt (NDRC, 2004-12-18).

China, in its attempt to modernize the society, will have to continue to explore and expand its domestic mineral resource base to secure the process. As for most industrial countries with a fair share of mineral resources, probably over 90% of the country's primary energy, 80% of the industrial raw materials and some 70% of the agricultural means of production come from mineral resources. Furthermore, this policy includes the use of foreign mineral resources, some partly or fully owned and controlled by Chinese companies as a result of FDIs. Such actions taken by the government, e.g. in the oil sector, are aimed at securing supplies to cover surging domestic demand in the foreseeable future due to strong auto sales and continued economic growth.

4.3.1. Petroleum Policy As in other sectors, the Chinese petroleum sector suffered from the effects of the Asian financial crisis in 1997 - 1998, which put the world oil and petrochemical market to a slump. This prompted many multinational corporations to adjust their development strategies and product mix throughout the world while attempting to improve competitiveness. With China approaching WTO at that stage, it also had to agree to a future opening of its market, where the petroleum and petrochemical industry would face competition from international corporations. As the market is still dominated by what is more or less a domestic oligopoly, under the two state-owned giants Sinopec and PetroChina, changes have not been as dramatic as was expected, yet. Although a new environment is

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- 220 - developing in the Chinese petroleum industry, creating a more complicated and competitive market, and free competition remains a distant goal.

In accordance with the WTO commitments the domestic oil market is slowly approaching deregulation as price controls and entry barriers previously upheld will be eliminated. This will not change such a huge market overnight. After the revised price system has been finalized, the third revision in five years will pave the way for final phasing out the state control and allow market forces to direct the price. Meanwhile, the process has given Sinopec and PetroChina more freedom to set retail prices, as prices have been allowed to fluctuate in relation to the government-set benchmark. Still, prices have not reflected the international market situation, where oil prices have frequently fluctuated in the wake of the SARS crises and the US led invasion of Iraq. This government policy has resulted in losses that have had to be compensated by the oil companies themselves. This policy has been estimated to have caused extra costs of USD 2.4 bn during 2003 alone (Sinopec & PetroChina, 2004-08-07). With a dramatic surge in world prices, having taken place at about the time of China’s entry into the WTO, the reduction/elimination of tariffs and NTBs never had a dramatic effect, as was expected. There has been a strong influx of imported oil, but this has been caused by a dramatic increase in local demand and not from the granting of trading rights as was expected at the negotiation stage. The government is expected to introduce price hearings in the sector to maintain control of prices also in the future. A similar system that has been used in other monopolized industries, like aviation and the railway sectors, will be utilized in an attempt to ensure fair prices. The rapidly growing demand for oil to heating stations, electric generation and from the transport sector was not really foreseen at the time of shaping the duopoly that rains in China on the supply side. It becomes even more complicated in times of strong market demand to set up some kind of more relaxed control system for the sector and maintain central control over prices. China, over the last few years, has been the fastest growing consumer of the world's larger oil markets, but with huge regional differences in consumption levels. There are still some considerable regional monopolies, at the same time as there is a national duopoly that has to be attended to.

Much as a result of the increased dependence on international sourcing, discussions on how to build a national strategic oil reserves has materialized in concrete actions. An oil reserve office has been established, as a first step, within the State Development and Planning Commission (SDPC). In 2003, it announced that China was to build four strategic oil reserve facilities. With the participation of the major companies, it has been decided that the reserve in its first-phase should have a capacity of 9 mt. Oil reserves can be used as an important factor in stabilizing supply and demand in times of high, as well as low, demand. After

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- 221 - the two global oil crises in 1973-1974 and 1979-1980, a number of developed countries established their own oil reserves. The US reserve has been at an 80 mt level, and during the 1991 Gulf War, the US reserve released about 150 000 tons per day to stabilize the market147. The need and use of the reserves have been questioned by many due to the high maintenance costs involved for their up keeping, and the limited possibility of a reserve in stabilizing oil prices. In the case of China, reserves not only ensure uninterrupted oil supplies to the security of the national economy but also in the event of war or natural disasters. It is in the light of this development, and partly to secure local supply, that what would become the world's largest tank storage-park is about to be built in Guangdong. With a capacity of 44 million cubic meter, the tank park will have to be split up and be located near two or three of the region's ports. Construction work has been initiated, with the building of a 2-mt facility in Zhuhai (CW 2004-08-27). The negative side of the increased oil handling is spills as seen in December 2004, when China faced its largest oil spill to date, when two ships collided at the mouth of the Pearl River and thus spilling 1 200 tons of oil (CW, 2004-12-15).

Companies From selected parts of the previous national monopoly two dominant vertically integrated companies, PetroChina Company Limited (PetroChina) and China Petroleum & Chemical (Sinopec) and some smaller operators were formed. The two biggest have been given not only a regional, but also operational focus. PetroChina has its activities in the north and west with crude extraction as its most important activity, while Sinopec has its regional base in the south with oil refining as its most important activity148. Two other important companies are China National Offshore Oil Corporation (CNOOC), established in 1982, to explore China's offshore petroleum resources, and The China National Chemicals Import and Export Corporation (Sinochem) that is primarily involved in imports and exports of crude oil, petroleum products and natural gas.

The two big, PetroChina, Asia's biggest oil company and Sinopec, Asia's largest refiner, have prepare to meet competition by increasing their share of retail outlets to over 50% and dominate the wholesale market to above 90%. A result of this is, the best locations for both retail and consumer sales have already been exploited by the two oil majors. Foreign companies will be allowed to operate limited retail business in China from 2005, and wholesale business from 2007, according to the Chinese WTO commitment. The increasing importance of retailing in petrol is clearly shown by the fact that in 2000 some 66 mt were consumed in the transport/car sector. In line with increasing car ownership this volume is expected to reach near 140 mt in 2010 and 260 mt in 2020 (MOFCOM, 2004-10-05). Meanwhile, other companies other than the four currently established state-designated oil traders have been allowed to import oil and oil

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- 222 - products outside state control. Such importation was based on a 5.5 mt quota set for 2003, and to be increased by 15% per year in the next 8 years, until the market will be set free.

Privatization has partly begun in the oil sector as shares to a value of USD 3 bn have already been sold in PetroChina, with BP as the largest investor, while Exxon Mobile, Shell and BP took a USD 2 bn of the USD 3.5 bn on offer in Sinopec. CNOOC has also been subject to a partial internationalization with Shell as its most important foreign investor. These foreign investments have neither given any of the foreign companies a seat on the boards in the companies, nor any say in how they are run, as the state continues to be the dominant owner in all three. However, all the major international oil companies that are entering the Chinese retail market have decided to do so in different partnerships with the big local companies. Only one new company, the private Dalian company, Shide Group, has so far been given the right to start a retailing operation of its own on the mainland (Xinhuanet, 2004-09-14).

Production, consumption and trade With oil continuing to climb in importance as energy source, reaching about 23% at the end of 2004, the focus of the energy policy has increasingly shifted towards oil. China's total oil reserves were set at 102 bn tons and with natural gas reserved of 47 trillion cubic meters. Out of this, recoverable oil reserves has been estimated to about 15 billion tons, with gas reserves at 10 to 15 trillion cubic meters, but with only 40% of oil and 20% gas reserves being proven (NDRC, 2004-05-02). There are over 700 oil and gas fields discovered in 25 of China’s provinces, on- or off-shore, and where just one extra percentage point extracted from the available resources would correspond several three years of energy consumption. During 2003, China was the world’s fourth-largest oil producer and the 24th largest gas producer. Production of oil has increased from a minimal 120 000 tons in 1949 to near 175 mt by the end of 2004 and with gas production having reached 41 bncm (PetroChina, 2005-01-13).

Domestic production has traditionally been concentrated in the Daquin area in northwestern China, but output here has been on the decline. Production in this area started already in the early 1960s and still some 50 mty of the national production originates from this region, with Liahoe, in the northeast, as the second most important area149. The Shengli fields have been the single most productive in East China, but the output here has also declined since the beginning of the 1990s, but still with a production of over 30 mt in 2003. Government policies have been set towards increasing production in the western parts of the country, mainly the Xinjiang region, and to build pipelines for the delivery to consumer regions in the coastal areas. Alternative production

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- 223 - areas can be found in offshore fields from the Bohai Bay in the north, off the coast in the east, to the mouth of the Pearl River and southwards to the Gulf of Tonkin (or Beibu Gulf). In many cases, offshore fields have been developed in cooperation with other foreign oil companies, than the small group of international oil majors that has moved in as minority owners in China’s big oil companies.

During 2003, China’s oil consumption rose by 11% in 2002 to 252 mt, making China second only to the US in oil consumption (IEA 2004-05-10). Increased domestic oil production that rose 1.5% in 2003 to about 169 mt was by far outstripped by imports that rose 31% to about 91 million tons to make up about 36% of consumption. Partly due to China’s rise in demand, world oil prices have been on an upward trend and the IEA revised its estimate for Chinese 2004 consumption to 300 mt. Rapid economic growth during 2004 has increased demand further and import of crude for 2004 increased by over 20% to reach near 120 mt for the year (SDRC, 2005-01-27). The foreign dependence is increasing and now corresponds to over 40% of demand, and will soon see the level reach half the consumption. The last five-year plan was perfectly correct in its estimations of domestic production in 2003, to about 170 mt. On the other hand, imports were a major misjudgment in the plan, expected to be 25 – 30 mt, but instead came to over 90 mt. This reveals the difficulty in making predictions, also for a controlling authority in a relatively controlled economy. From industry sources, it has been stated that the export is used not only to balance the domestic demand and not to increase earnings from higher foreign prices, but also because the configuration of refineries results in more gasoline than the market can absorb. As a result, excessive gasoline volumes are sold abroad, albeit at a considerable profit through higher prices in the international markets. Cuts in the wide Chinese export rebate system, for a large number of oil products are a part of a wide revision that has affected numerous export products150. To cope with the continued increase in imports, several new large reception facilities will be needed. Sinopec, as the dominant importer, has started to build large new terminals and storages. The most recent and largest outside the Cezi Island, off Ningbo, with reception facilities for VLCCs and storage capacity for 7 mt, to feed its nearby refinery (Sinopec, 2004-10-02).

Of the oil resource base of 15 bn ton (with 50% still to be discovered) it can be estimated that up to a third on the oil side can be recoverable. A share that can be expected to increase over time as the drilling technique improves. This could be ground for arguments against experts that set import needs over 400 mt per year of crude oil by the year 2020. In the tenth five-year plan, ending in 2005, it is expected that the volumes of accessible reserves will have reached about 3.5 bn tons of oil (NDRC, 2004-05-02)151. China has emerged since 2003 as the world’s

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- 224 - second largest consumer of petroleum products and consumption is expected to continue to rise from 270 mty in 2002 to an estimated 560 mty in 2025. Of the 2025 consumption, it is estimated that about 75%, or some 420 mty will have to be imported (EIA, 2004-05-18). New domestic estimations set the total demand figure as roughly 350 – 380 mt, and it could be expected to shrink further due to technological improvements. At the same time, domestic crude output is hoped to reach 200 mt by 2015, when it will reach its peak and then to fall off to about 190 mt by 2020 (SIC, 2004-11-06). Although predictions can be inexact over ten years' time, it remains undoubtedly so that China will play an increasingly important role in the international mineral market in the future.

In coming years, China both wants to, and probably needs to, widen the origin of it energy import, and one alternative is to increase its oil imports from Russia, Central Asia and Africa. As late as 1993, China was a net exporter of oil and oil products but during 2003 it also exported some 10-mt oil from its domestic production. Of the Chinese oil import, about 60% has its origin in the Middle East. This large dependence on a volatile part of the world is probably something that the Chinese leadership would like to reduce. Four countries delivered over 15 mt each during 2004 Saudi Arabia, Oman, Angola and Iran, with Russia supplying about 10 mt that was mostly shipped from the Black Sea (Bloomberg, 2005-01-08). Faced with substantial growth in domestic demand for oil, domestic production has been encouraged, but the big state companies have also been allowed from the political level to increase their efforts to secure new and stable sources of oil abroad. Recent visits by president Hu Jintao to the internationally unimportant but energy exporting countries, e.g., Gabon and Algeria could well be part of a strategy to secure future supplies. As China’s need to secure foreign supplies of energy has emerged much later than for most other energy dependent industrialized countries, it has been left to search, somewhat aggressively, among second tier suppliers. It is official policy to try to secure foreign supplies in strategic zones as the Middle East, the Caspians, and North Africa as well as in South America. The list of countries where Chinese companies currently hold oil interest, apart from the already mentioned, are Azerbaijan, Canada, Iran, Myanmar, Oman, Russia, Sudan, Syria, Turkmenistan, Venezuela and, until early 2004 UN sanctioned, Libya. China is also said to be considering investing in Canada and its large oil shell resources as future oil sources, it being the only long-term democracy on the list. As understood from the names of the other countries, this Chinese search for a new energy security has sometimes clashed with western geopolitical interests. Western countries have been reluctant, often due to public opinion to do business with governments that are suspected of large-scale proliferation of oil incomes or of human rights violations. The Chinese have so far not felt deterred by such arguments, as most other foreign companies are practically barred from doing

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- 225 - business in these countries. These are countries where China has emerged as among their top investors. China has also been a long-term partner of Iran, and imported near 15% of its oil from Iran during 2003, a country that is included in President Bush’s group - “axis of evil”152. This relation in October 2004 has been crowned with what is one of the larger oil and gas agreement that has been concluded as China’s Sinopec Group signed a USD 70 bn deal for oil and gas deliveries. The deal includes participation in the development of the new Yadavaran field and the deliveries of 250 mt of LNG over 30 years, including some 10 mt of oil per year at market value (CW, 2004-10-30).

China’s energy connections to Russia / CIS It was initially included in the Chinese energy plan that by 2005, the import from Russia in the cross-border pipeline from Russia should have reached about 25 mt. A memorandum of understanding was signed between Russian Yukos and CNPS already in June 2003 to build a 30-mty pipeline from Angarsk to Daqing with first deliveries scheduled in 2006. Despite t some construction work that has been done on the Chinese side, the project has been stopped temporarily. he Chinese interest remains high and energy deliveries topped the agenda during the visit of Premier Wen Jiabao to President Putin in October 2004.

China imported about 5.3 mt of oil from Russia in 2003, up by over 70% from the 3 mt imported during 2002 (Kommersant, 2004-09-20). Also during 2003, the Russian oil company Yukos tentatively agreed to increase its annual rail shipments of oil to China from 6.5 in 2004, to 10 million tons during 2005 and to reach about 15 mt by 2006. This suggestion to expand deliveries by railway could be looked upon as a way to compensate for Russian reluctance when it comes to building of a pipeline (CW, 2004-09-19). The seriousness of the agreement was put in doubt after the Russian Minister of Industry and Energy, Christienko, who lowered the previous figures, visited China. Instead, the delivery target for 2005 was set at about 8.5 mt and 15 mt by 2010, but with no state guarantees for the use of the railways (Kommersant, 2004-08-30). The Yukos oil company, under hard pressure to pay its tax debt, then made a statement that it could not continue to cover rail expenses for its deliveries to China, just two weeks before the visit of President Wen to Moscow. This created a serious complication to the relation, as deliveries had reached some 8% of China's imports during the first half of 2004, but already days later the Russian Railways declared that it will be compensated by the Chinese side (Vedomosti, 2004-09-24) 153. Also LUKoil will participate as supplier from 2005 to meet the full volumes agreed, but has declared that it will only continue if the export remains profitable after the first 400 000 tons have been shipped during Q1 2005 (Bloomberg, 2004-12-24). The complexity in the affairs related to the Russian oil company Yukos, long increased the insecurity (see also 2.4). In early 2005 state

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- 226 - owned Rosneft agreed to deliver the same volume. With Chinese money involved in the take by the Russian state of the resource base for the deliveries, the Yuganskneftegas company, supplies can hardly be allowed to fail again. However, the use of railways faces the complication that the rail-gauge is wider in Russia than in China and exporting already 6,5 mt/year will require the changing of 24 bogies/hour throughout the year from 60-ton wagons. In compensation for delivery volumes that are much lower than what a pipeline could carry, Russia is also said to have offered cooperation in space technology and to sell more advanced military goods. By the end of August, 3.7 mt out of the 2004 volume of 6.5 had been delivered by Yukos, while the railways stated that 10 mt for 2005 will be reached and this has been confirmed by a contract signed between the two ministers of railways (RZD, 2004-11-26).

The two biggest Chinese companies have also been active in the CIS and acquired a number of overseas assets, with the most important being the CNPC USD 700 million investments in the Aktobemunaigaz company in Kazakhstan. The company holds the right to explore the giant Kashagan oil fields in the Kazakh sector of the Caspian Sea. Already by the mid 1990s there were calls from China for the construction of a "pan-Asian continental oil bridge". This bridge, or rather pipeline, should consist of a network of pipelines linking Chinese consumers with the new oilfields in Central Asia and Russia, with a possible extension to Korea and Japan. Efforts to link Russian fields long looked more promising than the earlier plans for pipelines to Central Asia. However, plans presented in 1997 linked Uzen, Aktyubinsk and Kumkol field in central Kazakhstan with the Xinjiang in western China at an estimated cost of USD 3.5 billion. In September 1997, Chinaoil signed an agreement to conduct a feasibility study for this projected "pipe dream". Discussions to build a pipeline from the field to China has been on hold for a number of years, waiting for confirmation that the reserves in the region are large enough to make such an investment viable. In the early spring of 2004, the Xinjiang authorities finally announced that the construction of a pipeline to Kazakhstan was due to start in the summer of 2004. In July 2004, PetroChina started to build a new section from the border town of Alashankou to Dashanzi in Xinjiang, which will later connect to the existing 450-km Kazakh pipeline between Atyrau-Kenkiyak. The USD 2 - 3 bn pipeline, with a total length of over 3 000 kilometers and capable of transporting over 10 mty, is expected to be completed before the end of 2006 (IWPR, 2004-05- 18). For Kazakhstan, this is a volume that would correspond to about 40% of exports or more than the increase in production between 2003 and 2004. During 2004, Kazakhstan plans to produce 54 mt (5 mt lower than previously planned), 60 mt during 2005 and with production expected to reach 90 mt by 2010 (Bloomberg, 2004-06-02 & 08-16).

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- 227 - 4.3.2. Gas

Natural gas has never had a comparable importance in China to that in Russia and gas contributes only 3% of energy consumption compared to over 50% in Russia. This low share of natural gas in the total energy balance is set to at least double in China, and perhaps triple, until 2010. As all other countries China also would profit environmentally, especially if an increased use of natural gas could replace brown coal.

Production The available gas resources are estimated to be in the range of 50 tcm, of which some 75% still remains to be discovered, with proven resources estimated to be in the range of 15 tcm. Out of the gas resource base, under one third will be recoverable. This share can be expected to increase over time as techniques improve and if drilling is done deeper. Natural gas production is expected to increase considerably after having increased at a one-digit level over the last five years. Domestic production during 2003 was about 10% of the increase in the available reserves that was up by 340 bncm during the same year. The consumption of domestic gas in 2004 was under 40 bncm, with much of the basic consumption still being fertilizer production. The production is expected to reach about 80 bncm in 2010 and 120 bncm by 2020 (NDRC, 2004-11-28). As will be further discussed in the section about coal, there are also ongoing projects for the gasification of coal, although this is not expected to reach the volumes planned for the oil production based on coal.

China’s findings of natural gas are concentrated to the mid-north of the country, but gas is also being produced onshore and offshore as a by-product in some of the oil fields154. There are already a number of offshore fields producing gas for the mainland with several new findings having been announced in later years. Currently, offshore gas reserves are estimated in the range of 1 200 – 1 400 bncm, of which 700 – 800 bncm is accessible. Gas production in offshore fields along the coast is increasing rapidly, but the involved costs have questioned its efficiency. There have also been several pullouts by large foreign oil companies, that initially entered as partners, in these projects due to “commercial reasons”(Shell, 2004-09-28). This is similar with foreign partners who have pulled out of potential investments in the east-west pipeline project, after lengthy discussion, when good enough terms could not be reached (CD, 2004-09-30). International investors take their decisions on commercial grounds, while national long-term interest will probably influence strongly on what can be defined as “commercial” for a large state company like PetroChina and CNOOC.

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- 228 - Pipeline projects To put new gas findings into production and to connect them to consumers will demand a considerable extension of the existing infrastructure. Despite such extension, these new sources must be complemented by a considerable increase in imports. A sign that this work has been initiated is the gas network, that was already 11 800 km long in 2000, has since been extended by nearly 5 000 km. Also the construction of the Chinese West-East gas pipeline preceded much better than projected and is expected to pass the trial period by Q1 2005, which would be nearly one year ahead of schedule. The cost of this pipeline project has been estimated to USD 5.2 billion, although it is possible to use natural gas from Xinjiang Uygur Autonomous Region in the NW in as distant places as Shanghai155. Built by PetroChina, this near 4 000-kilometer West-to-East gas pipeline will lead gas from fields in the Xinjiang region and across the Gobi dessert, the Loess Plateau and the rivers of Yangtze, Huaihe and the Yellow River. The 1 600-km section of the pipeline that runs from the Shaanxi Province to Shanghai became operational in October 2003 and the remaining 2 330- kilometer western section from the Tarim basin in Xinjiang to Shaanxi was completed in September 2004 (Xhinhua, 2004-09-08). The pipeline will initially carry about 8 bncm per year, but with increasing shipments to 12 bncm per year, with possibly later 20 bncm. The Xinjiang fields that are expected to hold enough reserves to support this level of deliveries for at least 30 years. In the exploration of natural gas resources, the emphasis will be placed on the Tarim, Ordos and Quidam basins, and the Sichuan-Chongqing region (NDRC & CD, 2004-03-15).

PetroChina, as the major operator for the pipeline, has managed to find a market with a number of supply contracts signed in Shanghai for the near 7 bncm already a year before first deliveries (PetroChina, 2004-05-10). The city of Shanghai is also trying hard to diversify its energy base and to make use of cleaner energy where natural gas will play a key role. Natural gas is hoped to replace coal entirely in the long term, but to make up 10% of consumed primary energy by 2010. In 2003, Shanghai was the country' largest energy consumer with coal accounting for 60%, still down by 12% since 1994 (NDRC, 2004-03-31). Local gas consumption is expected to nearly double during 2004, from 500 mcm, and then jump to 1.8 bncm in 2005 and increase to about 8 bncm by 2010. During that time, a total of 600 000 to 1 million households in the city will have converted to natural gas instead of coal.

Just north of China, Siberia holds about one-fifth of the world's natural-gas reserves, which remains a considerable attraction to energy-hungry Chinese consumers. The first formal memorandum of understanding for a gas-pipeline connection here was signed between China and Russia already in late 1994. Preliminary studies covered the possibility of laying a 3 700-km pipeline between the large Kovykta fields some 400 km north west of Irkutsk and the

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- 229 - Chinese port of Lianyunggang via Ulan Bator in Mongolia. The pipeline was intended to carry 20 bncm of gas annually and include a possible underwater link to South Korea and Japan. The estimated cost of the project was USD 4 billion to Lianyunggang and in the range of USD 10 –12 bn if the links to Japan and South Korea are included. Still, ten years after the initiation of the first studies, it is debated if the fields in Kovykta hold reserves big enough to justify a pipeline. Moreover, another gigantic project has also been discussed, a 6 300-km Turkmenistan-China-Korea-Japan natural-gas pipeline. The costs here were estimated at USD 9.5 bn, where a possible extension to Korea and Japan would make the pipeline 8 500-km long, and lift costs to USD 22 bn. These pipeline projects are probably to be followed by several more suggestions for large and ambitious ventures in the near future. Although the vision of a pan-Asian continental hydrocarbon bridge from the 1990s has remained on the drawing board, it is obviously so that demand is located somewhat distant from the findings. Distance it what increases costs, but the Chinese East-West pipeline system is now completed, taking gas from the Xinjiang Province. As an indirect result, Turkmenistan has literally moved closer to China. What remains a major problem for such a pipeline is that it must pass two more borders before reaching China.

Liquefied Natural Gas - LNG To fulfill the government’s plans to increase gas consumption to about 8% in the total energy consumption mix by 2010, the local sources of gas will neither be accessible nor large enough. Although seemingly simple, LNG projects are still complicated. It would start in upstream fields to supply the gas and the infrastructure needed to get the gas delivered to an expensive condensation facility. The liquefied gas is then loaded onto, very expensive, LNG ships to carry the product to the market. The cold and pressurized gas is then to be unloaded at terminals that are under construction along the Chinese coastline, with the first to be completed by late 2005. At these technically not very advanced terminals, the gas is converted back into conventional gas at a pressure suitable for its consumers. The downstream market is the building of an infrastructure to distribute the gas to potential consumers, and to both find and make consumers turn to gas from their conventional sources of energy. Other aspects that must be included in the analysis when considering the use of LNG are partly the same as for any kind of foreign trade, like the fluctuation of foreign exchange rates, international political relations, transportation and security of supply. Briefly the LNG supply in the world market is widening, at the same time as demand is increasing, and it will remain a source of energy where it will take time for the market to find a balance.

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- 230 - The most difficult aspect for a new product like LNG is to build and extend its consumer base. If this takes too long, then the whole idea could be at stake before new projects have really taken off. So far there has been little indication that the Chinese government is about to introduce any stringent planning to coordinate the use and marketing, as well as pipeline building, for LNG and traditional natural gas. Reducing power shortages by using LNG could still be an insecure approach as a to rapid entry with large investments into a young and yet to be stabilize the LNG market could prove risky. If the energy market turns around and prices fall again, as it has done several times in recent decades, then investors are at great risks as the government has not given any support to gas consumption. If there will be a future glut in the demand for electricity, which has been seen as recently as 2000, the newly built, and expensive gas-fired power plants would be hard hit and will find it difficult to survive. With gas- based power plants being the most important consumers of the imported gas, the future of the idea with LNG projects could also be doubted.

The rush into LNG projects based on imports has allowed oil companies to participate in the development of gas fields in foreign countries to raise their reserves, like CNOOC in Gorgon fields in Australia as well as in Indonesia's Tangguh fields. If not all the grand plans will materialize, then the price to pay could be very high. The billions of dollars that will be spent on shipping contracts, the building of import terminals, the laying of pipe-lines and then to import the LNG to feed power generators as well as private stoves will all have to be paid for. These projects will import LNG using one supplier or, alternatively, source on the world market for an expected life span of 25 – 30 years. The main customers for the delivered natural gas are not only in all the approved project local power plants, but also residents and industrial users that are to be supplied by gas. This approved and proposed projects can be found in coastal areas, where few coal, gas or oil findings exist, and where LNG deliveries from large ships are possible. All regions with LNG projects hope to satisfy the demand from for energy from a brisk economy. Both the national and local governments aim to gradually replace coal with cleaner and more environmental friendly natural gas. All of these are an attempt to reduce air pollution, in addition to traffic and transport congestions, caused by coal transportation. It can be seen as an indirect support to the use of LNG that the State Environmental Protection Authority has banned the building and expansion of coal-fired power plants in many of the cities that are suffering from acid rain.

In the LNG market, it has so far only been CNOOC that has been given permission to build LNG terminals. Four LNG projects have been approved while another three to four are currently under discussion. If all projects are

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- 231 - approved China could have 7 – 8 LNG terminals built along its coastline before 2010. The building of the first started in Guandong in early 2002 (to use 3.7 mt LNG/year, in production 2006), the second in Fujian later the same year (3.7 mt, 2006) two more have been contracted during 2004, in Zhejiang (3 mt, 2008) and in Guangxi (3.7 mt, 2008). These LNG projects are all based on a gas-fired power plant as their main consumer. Like in the Zhejiang Province project that includes a USD 1.7 billion investment for a 2 800-MW plant, the Rudong project in the Jiangsu Province, will supply a 2.4 GW gas-fired plant from the 3.5 mty receiving terminal. This terminal is also intended to serve as a back up for the East-West pipeline. CNOOC holds a stake in first three of the terminals, while PetroChina holds the agreement for the other two. Other projects on the waiting list for approval are in Tianjin (CNOOC), in the Jiangsu Province (PetroChina), in Shandong (Sinopec) and in Shanghai, where the regions are discussing with all three domestic oil majors (CNOOCO, SINOPEC and PetroChina, 2004 various dates).

To fulfill the ambitious national plan for the expansion of natural gas usage, not only millions of family stoves must be connected, but also industry must be convinced to convert to gas on a large scale. Provinces with the strongest economic growth, but also badly hit by energy shortages during 2003 and 2004 have been leading in approving gas-based projects. One major argument for gas is reliability and its sufficiently to make industry in these provinces ready to pay for this relatively expensive, but clean, fuel. The mentioned CNOOC projects will be fed on natural gas from the huge Gorgon gas project in Australia and supplemented with gas from Indonesia. In Gorgon, CNOOC signed a framework agreement in 2003 to buy up to 100 mt over 25 years, in a deal, with an estimated value of USD 21 bn, making it the world's largest deal concluded, inside the LNG industry (CNOOCO, 2004-10-28).

4.3.3. Coal

China’s coal resources are estimated at 5 060 billion tons, but this enormous reserve not only include both high grade coking coal, but also large low quality brown coal findings. Most of the coalfields can be found in the north and in the northeastern parts as well as in limited areas in southwest China. It is only in the area south of the Yangtze River that is relatively scarce in coal resources. Coal is the most important source of energy in China, supplying about 65% of energy consumption. China is both the world’s largest producer and consumer of coal with a consumption of 1.4 bt in 2002, which was up nearly 19% over 2001. The production has witnessed a dramatic turnaround as a result of increasing demand, as the sector was plagued with over-production in the last years of the

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- 232 - 1990s. Demand has picked up again, and exports have also increased, at the same time as state reform of the industry has started to pay off. The consumption of coal is expected to continue to increase in the short term, although the share of coal in energy consumption should fall according to the energy plan. Consumption in 2000 was expected to increase to reach 1.7 bn ton in 2005, 1.8 bn ton in 2010 and 2.1 bn ton in 2020.

The rapid rise in demand for energy and coal, has surprised planners as production was up by 17% during 2004 to reach 1.9 bn ton, surpassing what was originally planned for. The estimate for 2005 has now set to over 2 bn ton (NDRC, 2005-01-31). To cope with increasing local demand, China had set a cap for the export volume to 80 mt for 2004. If this was followed, it would be a considerable reduction from an exports volume that stood at 93 mt for 2003, with 72 mt of that being thermal coal. This export volume makes China a competitor with South Africa for third place among the world's exporter after Indonesia and the outstanding exporter Australia that exported 213 mt in 2003 (Coaltrans, 2004-04-15). Also export prices for coal are higher than domestic prices and have risen considerably during over the last year. Export prices to Japan for 2003 was set at under USD 30/ ton, but has been renegotiated and came close to an average close to USD 50 for 2004 which gives Chinese coal producers good reason to export instead of selling to local consumers. Domestic prices also have increased and miners have also been reluctant to fulfill planned deliveries to the state, being paid prices clearly less than market prices, and instead focused on private consumers. Not only has production been strained by supply problems during the last two years, but also the transport of coal has been a limiting factor. Delivery problems have been so severe that the government has ordered the railways to priorities coal transports from mines and ports, but faced by a deficit in rail cars, and general organizational problems. These railway problems have not solved these problems (NPRC, 2004- 09-10).

The future level of coal mining much depends on the success of other energy sources that are set to somewhat eliminate coal. During 2005, all the state- controlled coalmines should have been merged into similar kinds of holding companies as in the oil sector, with the hope to increase efficiency and control. The country’s 28 000 coal mines, of which 24 000 are considered to be small, will be grouped into 13 major clusters (Coalinfo, 2004-12-10). As the vast majority are very small, and supplies the local market, it will probably be very difficult to introduce a basic form of control here. The reform is also intended for privatization of what used to be a loss-making sector. However, changes have been dramatic as a result of high prices and parts of the industry have instead become highly profitable. During the first ten months of 2004, compared to 2003, profits from state mines have tripled, with only one in every 32 mines not

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- 233 - showing a profit for the period (CD, 2004-11-24). Coalmining has not only been an economic burden it also generate serious waste and pollution problems, both during exploitation and in later stages of its utilization. Stricter supervision and management control over mines should be done to reduce the "three wastes"; control over the discharge of waste gas; control over the discharge of poisonous and harmful wastewater and control over harmful residuals produced in mines. Offenders against the regulations shall be severely dealt with. Another clear step towards improvements is to restrict the building or rebuilding of mines producing coal with a sulphur content exceeding 1.5%, and prohibit the building of mines producing coal with a sulphur content exceeding 3% (Xinhuanet, 2003- 12-23). The environmental impact of the coal industry was clearly demonstrated by the close connection between coal and where the most polluted cities. On a list presented by the Environmental Ministry, over the 113 most polluted cities, the coal-rich Shanxi Province was worst together, with three cities in the top ten of the list156 (SEPA, 2004-07-15). Most of the smaller mines are often run outside state control and do not only pollute, but is also disastrous since the record show a constant line of accident leading to over 4 100 deaths during the first nine months of 2004, with over 5 000 killed during 2003 (CD, 2004-08-10 and APN- BBC, 2004-10-12). It has been estimated that about 90% of the smaller mines should be closed for safety reasons, as mining work in China is three times as dangerous as the world average (CD, 2004-12-10).

In the US, coal extraction has started to convert to the relatively newly refined technologies of direct and indirect coal liquefaction or gasification. Through foreign investments, guided via the China National Coal Import and Export Corporation, no conventional energy production from Chinese coal is also on the rise. New techniques like coal bed methane production, coal liquefaction projects and long distance slurry transport has been introduced on what so far is small scale. One full-scale plant for coal liquefaction has been set up in the Inner Mongolia Autonomous Region. The Shenhua Group is the leading investor in this, the first large scale coal liquefaction project in China, with an investment value of USD 3.3 bn. The first production line at the plant is scheduled to go online during 2005 and is planned to produce 1 mt of oil products per year. By 2008, when all production lines are operational, it is expected to process 15 million tons of coal to produce 5 million tons of oil products. All investments in the plant are expected to reach USD 7.3 billion. According to the China Coal Research Institute major coal companies like the Shenhua Group and Shanghai Electric Group, have invested over USD 12 million in a new Shanghai based research centre to further develop this technology. Plans for two more coal-to-oil projects have been presented, one in the Yunnan Province and another one in the Heilongjiang Province, but permissions await a preliminary evaluation of the Shenhua project.

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- 234 - These projects, both the research institute and the full-scale liquefaction plant, should probably be seen as attempts of the Chinese Government to increase research efforts to avoid future energy supply shortage (Shenhua Group & CD, 2004-03-12). At a normal oil price, under USD 25/bbl, it has proved hard to make liquefactions projects cover their costs, but the development of energy prices during 2004 have provided considerable support to coal liquefaction. It must also be remembered that coal has also doubled in value during the 12 months since mid-2003, but in China, it is an abundant and domestic commodity.

4.3.4. Electricity Projects Electric generation, as was the case for the coal sector, has been marked by overcapacity during the later part of the 1990s and reform of the sector has closed many smaller and inefficient production units. In 1999, the Ministry of Electric Power was dissolved and its powers were shared between State Electricity Regulatory Commission and the State Power Corporation of China (SERC, 2004-07-01). A second round of structural reform in the power industry was enforced at the end of 2002 when the sector was reorganized under the State Power Corporation. Five new power groups were created including two power grid companies157. The intention of the reform was to commercialize energy production and to introduce competition into the sector (CEI, 2004-05-02). As in other transition economies, the separation of state and business has proved problematic as long as the ownership remains, especially so when it is an industrial monopoly split up into regional monopolies. Additionally, the reform created transmission companies independent from the group of generators, and it proved difficult to find a formula to share incomes between the two sides. A side effect of the reform was that many intended generation projects were put on hold, and not approved until the reform had taken effect. This has resulted in a number of new projects in coming on steam in 2004 – 2005, but it remains to be seen if it will be enough to cover for the large increase in demand.

The electricity distribution inside China is practically a duopoly with the market shared between two large state controlled companies. The State Grid Corp. controls the larger share of the market while the China Southern Power Grid Corp. is responsible for five southern provinces. Investments needs are very large at the same time as the controlled prices on electricity has left, and leaves, little room for increased profits to be channeled into power grid upgrades (SGCC & NIRA, 2004-04-10). The two companies have small chances to attract foreign investments in the current situation and their short history are far from ready to attract domestic capital through an introduction on the stock exchange.

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- 235 - Investment capital must largely be raised from own cash flow, which in the case of the State Grid Corp. has been estimated to be in the range of USD 4 bn for 2004 – 2010. At the same time, estimated investment needs in maintenance and upgrades, for just this company for the same period of time, exceeds cash flow by a factor of 1.5 (DRC, 2004-04-01). Another major problem has been to connect generation capacity with consumers, as existing distribution capacity has not coincided with what currently is the fastest expanding consumer region. China also faces a major distribution problem in connecting its central and western regions that are rich in hydropower resources with the economically more developed coastal regions in the east that are deficient in energy. For this reason, China will have to increase its efforts to transfer its abundant power supply from the central and western regions towards the coast and to enhance capacity in the parts of the grid connecting provinces and regions. To achieve this, the power grids need to be vastly expanded and/or alternatively expand generation by way of LNG or nuclear stations in costal regions. Despite of the need to increase prices China in relation to its income level as measured by the IEA “affordability index”, it already has the most expensive electricity among the larger economies in the world (IEA, 2004-05-13).

The generation of electricity The generation of electricity in China has always been dominated by coal. In 1950, coal was the base for about 90% of generation complemented by hydropower. By 1980, the influence from other sources was still marginal, but the share of hydropower had increased to about 20%. Currently the importance of nuclear power and gas has reached a level of 2 – 3% for each at the same time as hydropower has passed 25%, with coal being the base for the remaining 70%. At the same time, consumption has grown increasingly rapidly, from a level under 0.1 TWh in the 1950s, passing 0.3 TWh in early 1980s and reaching near 1.3 TW in the year 2000. Since generation of electricity has continued to rise in China, from 1.4 TWh in 2001, 1.6 in 2002, 1.8 in 2003 and has reached 2.1 TWh during 2004. Industry has remained the outstanding consumer over the entire period, consuming about 85%in 1980 and is still by 2004 consuming over 70% of the available electricity. Agriculture was the second biggest consumer in 1980, taking about 10%, but has falling to about 4% by 2004. It is instead residential consumption and the service sector that have seen an increase in shares from well under 5% for both in 1980 to over 15% and 10%, respectively by 2004. Despite the increasing consumption demand has been much larger than production, resulting in that smaller or larger areas in 21 provinces in China faced electric power shortages during 2003, and at least 25 during 2004 (Xinhua, 2004-09-09). The total shortage in electric supply for 2004 is estimated to have been in the range of 30 GW during 2004 and could increase further during 2005, or decrease slightly according to the NDRC (SERC, 2005-01-12 & NDRC, 2005-

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- 236 - 01-31). During the summer of 2004, a new record in electric consumption was set when daily consumption reached 6 500 GWh, with full year consumption increasing 15% to 2 200 TWh (Xinhua, 2004-08-05 and 12-20). Peak generating capacity by the end of 2004 had reached more than 6. 4 TWh, an annual increase of 15%, with consumption of electric power in 2005 forecasted to reach about 2 400 TWh (SGCC, 2005-01-20).

The development on the generation side has been as dramatic as for consumption mentioned above. In the 1950s capacity stood at less than 5 GW, to grow to about 70 GW by 1980 and near 350 GW by 2000. It is expected that shortages in later years should ease somewhat in 2005, as new plants of different kinds are reaching the production stage across the country. New capacity of up to 37 GW is hoped to be completed by the end of 2004, while total approved projects are estimated to add about 130 GW. Another 90 projects, with a capacity of over 80 GW, are in the process of feasibility studies (National Federation of Electricity Enterprises, 2004-04-01) (see also Three Gorges below). On the generation side, the state has set up a China Power investment Company, controlling 28 GW of mainly thermal generation capacity being listed in Hong Kong as one way to attract foreign investments to the sector (ZDT, 2004-08-07). The long-term growth in the consumption electricity has been estimated at 4.3% through to 2025. This figure, in relation to later years of exceptional economic growth, seems to be a very low estimation. In a future perspective much of the increase in production should come from generation based on hydropower, gas and nuclear (NDRC, 2004-07-12). It will take a Herculean effort to improve both production and distribution in China to be able to meet future power demands. There are still system reforms to be made and the conflicts among power plants, grid companies and coalmines over who should shoulder the responsibility for shortages have been numerous. While the coal price has been allowed to more or less float freely, in accordance with demand, the price of electricity has remained centrally controlled by the government. Power plants and distributors are squeezed in the middle between these two processes, and bound to be running loss-making operations. Limited price increases and differentiation of prices for different hours of the day has been allowed to bring some relief, also including controlled price increase of thermal power from early 2004 (CW, 2004-04-02). By December 2004, the government decided to allow the energy producer to pass on 70% of any price increases of the energy used over the next six months.

Alternative energy sources have also been greatly developed and planners expect it to generate about 10% of consumption by 2020. In northern China where e.g. the available resource of wind power is said to be 3.2 TW, with 253 GW of this being useable, which gives China the best position in the world in this respect. In remote areas with strong sunlight, solar-power, has come into

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- 237 - limited use for power generation, with about 60 MW installed capacity by the end of 2004 (NDRC, 2004-12-22). By the end of 2005, China’s largest solar power station, to produce 8 MW in the north western Gansu Province, is scheduled to be connected to the power grid, with a further 18 MW in smaller installations under construction. Another alternative would be to import electricity and where Russia is currently the only neighbor with spare capacity for export. Electric trade during 2003 reached 161 GWh, and for 2004 Russian exports are expected to reach about 235 GWh, which is still very far from having any significant influence on the market (Bloomberg, 2004-08-17 & RJ 2004-09-01).

Three Gorges An increased use of hydropower has been set out as a target by the government. This is a sector where the Chinese potential is highest in the world, but it is only being utilized to 24% compared to what is often 60% or more in developed countries. The reserve available from hydropower in China is estimated at 700 GW, and in the coming years hydropower resources will be developed rapidly (SDRC, 2004-10-28).

The largest single project, however, is the mentioned hydropower dam of The Three Gorges, in the upper reaches of the Yangtze River. Here, 26 separate 0.7 GW generators will produce a total of 18.2 GW. The first 14 of which were all delivered from abroad, while eight of the 12 that will be installed from late 2004 onwards. These will all be produced in China (CBW, 2004-03-29). The first turbines have already gone into production in a project that was initiated already in 1992 and should be finished by 2009. Near one million people have had to be relocated and large areas have, and will be, flooded by the dam behind the near 200-meter high and 2 km wide barrier. The energy generated by the project is said to replace, or at least correspond to, the burning of 40 mt of coal or 18 standard size nuclear reactors (Three Gorges, 2004-06-12). The dam, here, and often also elsewhere, serves two purposes; electric generation and flood control. Its first full scale test came during the floodings in September 2004, when the dam considerably reduced the damages in the river system, still letting through water at a rate of over 60 000 m3/sec (approximately twice the maximum flow of the Yellow River). It is not only in the upper reaches of the Yangtze river where large hydro projects have been initiated, but also further upstream prospecting is ongoing for a project even larger than the size of the Three Gorges. The Jinshajiang River projects will not force as many inhabitants to relocate, and is therefore expected to be much less controversial to carry through. Here, on the border between the Sichuan and Yunnan, four dams will be built at around USD 6 bn, and be in production by 2020. The two biggest, and first of the stations are expected to generate near 18 GW, which would nearly put them on terms with the Three Gorges dam (CBW, 2004-04-23). Resources are gradually being

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- 238 - transferred here as the Three Gorges project reaches its completion. However, Chinese preparations for the construction of 12 dams in a designated UNESCO nature reserve, in the upper research of the Nu River, in the Yunnan Province, near the Myanmar border, have come under heavy international critique (Wall Street, 2005-01-12).

4.3.5. Nuclear

China is also developing its own nuclear power program, and there are currently five plants, with in all nine units, that deliver electricity are all of pressurized-water power type. The effect generated has increased rapidly, with newly built reactors continuously reaching the production stage, from just over 2 GW in 2002 to 7 GW from five reactors by mid-2004, and to reach 9 GW when the next reactor in Jiangsu goes into production in 2005. Under the government’s long-term plan for the use of nuclear power, capacity by 2020 should have reached four times the 2004 level, or about 36 GW. With the production from the four reactors under construction, the share for nuclear generated electricity in total supply is expected to increase from about 1.5 – 2% to near 4%. During 2003, nuclear power plants delivered about 42 TWh to the national power grid.

The first nuclear plant in China, the Qinshan plant in Zhejiang Province, started to deliver electricity in 1991, followed by two more in Daya Bay and Lingao, both in the Guangdong Province, in 1994 and 1995 respectively (HKNIC, 2004- 10-10). The latest reactor being connected to the power grid in March 2004 was the second reactor of the Qinshan Nuclear Power Plant, in the Zhejiang Porvince. This reactor is a milestone in the country, being the first reactor that has been build by way of localized design and technology under Chinese supervision. This 0.6 GW reactor was a breakthrough because no important parts of the technology, as well as most of the know-how during the construction phase, were sourced domestically. Previous reactors in use in China have all been based on know-how and equipment imported from France, Canada and Russia (CBW, 2004-03-11).

The construction of the two most recent reactors at Qinshan started in 1996, with an investment of USD 1.8 billion. The two are now in production. The first reactor started commercial operations in 2002 and the second one in 2003. Both have been operating satisfactory, with each reactor designed to produce about 16 TWh during a 40-year life span (CW, 2004-10-01). Being located in one of the provinces most badly hit by power shortages during 2004, the Nuclear Power Qinshan Joint Venture Co Ltd has requested approval from the government, of its plans to building another pair of reactors. Chances for approval are

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- 239 - considerable as the government in 2002 endorsed the building of new nuclear reactors for the first time in six years. The construction of four new 1 GW reactors are ongoing, with two in Sanmen, in the Zhejiang Province, and another two in Lingdong, in the Guangdong Province. At least one reactor from each project is expected to reach the production stage in 2005. Additionally, six new reactors are planned for the costal city of Yangjiang, in the Guangdong Province, where land clearance has started for a USD 6 bn project that would make it the biggest in the country (GNPVJC, 2004-11-02).

4.4. Transport

The five-year plan for 2001- 2005 in the Transport and Communication sector gives the following description of the development planned for this time period:

“The long-term strategic goal for China's communications and transport development is to build an intelligent, comprehensive communications and transport system with thefocus on fast transport of passengers, freights and logistics”. (First sentence of the Five-Year Plan 2001 – 2005 in the Transport and Communication Sector, 2001)

Both foreseeing investments and adoptability becomes major factors of concern to make such an approach possible. At the same time, good planning for the use of available transport capacity becomes increasingly important when demand is high. In the case of China, the last decade has seen fundamental changes of both its economic system as well as on the production side. The transport sector has clearly struggled to adopt. Currently, the demand is in many regions and from commodity producers are considerably larger than the capacity of the overloaded transport system. The result is delays in deliveries of commodities not only coal, iron ore, fertilizer and grains but also of industrial goods. In modern time, the basis in the Chinese transport system has been the railways. Therefore railway congestion has led to dramatic effects inside the system as well as to knock-on effects in many other sectors. This has led to an undersupply of coal from China’s biggest coal region, the Shanxi Province and ports of imports, as it has not reached power plants according to schedule. This has, in turn, resulted in restrictions in power supply from these plants, adding additional pressure on an already struggling power supply system.

When changes in a country take place as rapidly as has been the case in China, especially on such a large scale, practically no transport system can cope with. Spare capacity should, in all economically effective systems be kept to a

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- 240 - minimum, as this generate costs for the operator when not being used, and the building of new capacity is only viable when it can be made more or less certain that there will be a stable future demand. "Railway construction (in the past) has failed to match the rapid development of the nation's economy, which has created a bottleneck for economic growth" (Railway Minister, Liu Zhijun, MOR, 2004-04-05). The daily demand for railway carriages has increased to 280 000 in 2004, an increase of over 60% from the 2003 daily average of 160 000 (MOR, 2004-08-20). The estimated capacity of the rail network, however, is less than 100 000 carriages per day. A change of this magnitude reveals one of the biggest weaknesses of a transport system – the need for adoptability. As investments in the railway system has, for many years, been on the 2% level while the economy as a whole has grown by 8 – 9%, it is feared that the situation will not really improve for many years to come (CW, 2004-11-24). Also, if investments were to increase significantly already in the next year, then it will still take years to build and upgrade infrastructure. In this situation, trucking could have been a natural alternative for shippers. China is trucking has increased in importance, as in all other economies in transition, but as a result of a government ordered crack- down on overloaded vehicles that begun late 2003. Capacity in the trucking sector has also been capped158.

In accordance with the market economic system, demand in the transport sector has come to rise sharply, as have prices (where not state controlled), which indirectly add an inflatory pressure on the national economy.

4.4.1. Railway

The railways in modern time have been the basis in the Chinese transport system, extending to cover practically all parts of the country, with the exception of Tibet159. Total mileage of the railway system has reached over 73 000 km, with double tracking on about 23 000 km and with 17 000 km being electric railway. These figures place China third in the world among railway nations, after Russia and the US. The network is still largely based on bygone needs as about 20 000 km was laid out before the founding of the republic in 1949 with an additional 20 000 km having been built before the 1960s (MOR, 2004-08-10). This imbalance, been observed and construction projects aimed at upgrading of trunk lines to access western region and to alleviate deficiencies in the north eastern part of the country has been launched. The needs are considerable with much technically outdated equipment in use, limited use of advanced IT applications and the railways have generally much to learn in the fields of marketing and distribution.

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- 241 - China remains, at least transport wise, a developing country, which is shown by the large importance of basic products, set to over 80%, in the total transport volume. Raw materials and basic products, like coal, constitute a considerable share of the rail volume. Other important products on the railways are iron ore, steel, non-ferrous metals, building materials and grain. The railways are in this way losing unnecessarily much in the competition against other modes of transport. Prospect for the larger parts of the system are bright, if changes can be brought in place and the railways can attract capital for the necessary investments. The railways, being such a large state run organization, has so far only seen limited foreign influence with its administration being integrated with the government. The administration of the railways continues to organize the extension and maintenance of the network practically without outsourcing. Foreign capital has still to find its way into the organization, with only one exception the private Guangzhou-Shengzhen Railway.

China's railway sector is funded through the government’s budget with incomes and expenditure being channeled through the Ministry of Railway (MOR). Funding for investments has largely been provided by the MOR itself and has been in the range of 50 bn per year from 1998 to 2003. As a result of these investments, 5 700 km of new lines have been constructed, 4 100 km new double tracking laid while 4 300 km have been electrified. New initiatives could be needed as seen in 2003. China spent almost 60 billion (USD 7 billion) on railway construction, which is only 20% of what was invested in road construction projects (China Youth, 2004-08-15). For 2005, the improved spending plan has lifted the investment target to USD 12 bn. Plans have been drawn up for a separation of construction and management from the operative parts under MOR. The idea is to establish a network company and then to have several passenger and cargo transport companies performing the transport operations. The three companies that currently operate on the railways, under the ministry, are specialized in the transport of parcels, containers and special cargo, respectively. All three are expected to be listed as share holding companies during 2005. Since the last years of the 1990s, there are also a number of private companies of embryonic size in operation for some special functions under the ministry (MOR, 2004-10-19). For future investments, the MOR is planning to allow private capital to enter as partners in infrastructure projects. High frequency lines and infrastructure operators also could become independent operators and be converted into shareholding companies, with a broad base for their ownership (CD, 2004-08-08). The reform builds on a similar reform to the road sector that has allowed private companies to work with construction and maintenance in the road sector, and to make profits.

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- 242 - As mentioned initially the railways for some years have constituted a bottleneck in the development of the economy. In addition to seasonal demand from e.g. farming, in spring and autumn and coal-fired power plants in winter, can deteriorate the situation further and cause aggravated congestions periodically. Federal decisions that have given priority to the transport of coal and grain on the railways over parts of the year, has filled up ports with imported raw materials like iron ore, alumina and soybeans (NDRC, 2004-04-12). Millions of tons of iron ore and steel had already been filling the quays at many ports, forcing arriving ships to wait offshore for several weeks before being able to unload their cargo. In Qingdao alone, in the Shandong Province, one of the largest ports in China, iron ore imports increased by 32% year-on-year in the first months of 2004. At the same time, the port is being serviced by fewer trains compared with the same period last year, as there are not enough empty wagons (Port of Qingdao, 2004-06-05).

As a way to counter capacity restrictions, technical upgrading of tracks has been continuous in later years to accommodate higher speeds of both passengers and cargo trains. Passenger trains should reach a speed of 160 km/h, with an operation speed of 140 km/h on the major lines, which should connect all larger cities of the country. This will also make it possible to increase the speed of the cargo trains carrying containers and finished goods up to 120 km/h. Of the tracks in use, about 13 000 km are considered to be express tracks, allowing for a speed of passengers trains of 140 km/h, while about 7 700 of these have a permitted speed of 160 km/h (CD, 2004-04-18). These speed increases have been adopted since the first one in 1997 and a sixth round of increases is set to take place in 2005 (CD, 2004-04-18). Increased speed not only cuts transport time, but it also increases capacity and frees slots on the lines for additional trains. Another aspect of upgrading that has been much discussed is to raise both the comfort and speed of passenger trains eventually by way of bullet trains. Although the Chinese railways transport the largest number of passengers in the world, it can only be hoped that investments for the future will lead to an improved security record. Hitherto the security record is appalling as during January through September 2004, accidents on the railways claimed the lives of no less than 6 100 people; i.e. 20% more than the much discussed coal industry accidents for the same period (APN-BBC, 2004-10-12).

To raise the rail standards between several of the larger cities in Eastern China tenders with a project valued at about USD 12 bn has been announced. This is a project that has been sought after by all major train and equipment manufacturers in the world. It was awarded to the Nanche Sifang Locomotive factory, in a joint bid with six Japanese companies. This project will construct five major existing railway lines, at a length of over 2 000 km, will be increased

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- 243 - to 200 km/h. This project will also see the first transfer of “low grade” Japan's Shinkansen technology to China and give trains with a top speed around 275 km/h. These improved lines will link e.g. Beijing and Shenyang with Qingdao and Jinan in the coastal province of Shandong (Xinhuanet, 2004-08-30). Special attention over a number of years has been paid to initiate the much-discussed high-speed rail link between Beijing and Shanghai. A line that is the most densely trafficked with passenger and cargo in the country, with utilization in the range of 5 – 6 times the national average. The two mega-cities that are 1460 km apart are in 2004 serviced by eight pairs of direct trains that, with a 160 km/h maximum speed, make the journey possible in 12 hours (Xhinhua, 2004- 04-18). A high-speed rail link here would cut traveling time by several hours and make the journey possible in just 8 – 9 hours. Estimated investments needed to make this reality are in the range of USD 15 bn, second only to the Three Gorges power project. The use of high-speed Maglev (magnetic levitation) rail link has been discussed. One of the crucial decisions still to be taken officially by the government is if it is a conventional wheel-and-track line that should be build, then using one of the long established French TGV or Japanese Shinkansen systems, or a Maglev line.

Several foreign consortia's are competing for the contract, linked to Chinese partners, German Maglev technology, Japanese Shinkansen bullet train technology and Alstom TGV of France with its TGV system. As often in this type of gigantic project financing often becomes of utmost importance. However, it is for the Chinese side to decide if it should be the most advanced technology that should be used or the lowest-cost that will count in the end. Fares must undercut airfares to make the investments viable, which will be more difficult with the maglev train that carry construction costs 50 – 100% above conventional technology.

If the maglev option is preferred, it will represent a new advance in technology and enable speed of up to 500 km/h and make the line less energy dependent, while conventional trains have reached a maximum commercial speed of 300- 350 km/h. The world's first complete maglev system has already been built in China, connecting the Shanghai Pudong airport with the 30-km distant city centre. A contract was signed in early 2001 and that probably improved the chances for a similar system to be used also for the Beijing – Shanghai line160. This relatively untested technique has long been discussed, but it has not yet been excluded as a Beijing – Shanghai option. At the same time, it has been decided to extend the existing maglev train line in Shanghai to the 170-km distant city of Hangzhou, cutting traveling time from the airport to Hangzhou to just 25 minutes (PD, 2004-11-27). The problem with magnetic levitation is that all technologies and much equipment will have to be imported while it would

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- 244 - probably be possible to source much of the equipment domestically, within a few years, for a conventional system. The need for a high-speed line as a whole has been questioned in the government, and especially so the higher construction and operating costs of a maglev system, which has kept the project on a hold for years. A fundamental problem with the Maglev technology is that it is not compatible with conventional technology, and that the other two alternative train systems are run on tracks separated from other traffic in both Japan and France. On the Beijing - Shanghai line, well over half of total train traffic is generated by trains with other destinations that could have a need for additional tracks. The general public is, probably, overwhelmingly against awarding the prestigious high-speed railway contract to Japan, which could leave the Alstom TGV concept in a very favorable position.

Large-scale transport links are often seen not only as generators of economic prosperity, but also demands increasingly large investments. Another such project would be the building of a new rail link “Euro-Asian land bridge” between China and Europe, initiated by the railway ministry in Kazakhstan. This project was valued at approximately USD 3.5 bn for over 3 000-km long railway. This line that would not only serve as a short-term injection to the local economies in western China and central Asia, but is also hoped to generate good flows with long lasting positive effects. Built according to European and Chinese standards, a Euro-Asian railway is expected to carry about 40 mt of goods per year and greatly reduce transit time for over two billion people living in the regions being linked (Eyefortransport, 2004-05-04).

4.4.2. Road

The Chinese road network is about 1.8 million km, connecting practically all towns in the country161. About 560 000 km of this was considered to be interregional roads while about 25 130 km of the network is considered to be major roads. The importance of roads in China has never been comparable to that of roads in western countries. Today, roads are not only important in passenger transport, but also for the quickly expanding private car ownership. The responsibility for the major roads remains federal while the responsibility for regional and minor roads falls on the provincial authorities. Of the existing road networks more than half of all roads can be found in the eastern parts of the country about one quarter in the central parts of the country and less than 15% in the western parts.

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- 245 - At the end of 2003, there were over 20 million vehicles in China, with some 4 million of these being privately owned. With the introduction of an additional 4.4 million vehicles on the roads in 2003, private car ownership also went up by about 50%. During 2004, an additional 5.1 million new vehicles were added to this stock, with production expected to have reached 10 million/year in 2010. As production volumes are expected to increase by 10 – 15% per year over the next 15 years from 2004, total production by 2020 could be in the range of 17 million (MOC 2004-09-20). The dark side of this expansion is that traffic education has not been able to cope with this increase and accidents on the roads are increasing, having claimed near 97 000 lives during the first nine months of 2004 (MPS, 2004-12-12).

Such a rate of increase in traffic also puts an extreme pressure on the network of roads. It has forced the government to start the construction of major national freeways to connect most Chinese cities and to cope with traffic volumes. This rapid increase has been met by rapidly increasing spendings on road construction in 2004, that will go beyond CNY 300 billion (USD 36 billion) five times more expensive than what was budgeted on railway projects. A total of investments of CNY 1.4 trillion (USD168 billion) have been spent on roads in the 1997 – 2002 period (China Youth, 2004-08-15). Still, the construction of highways among major provinces in western China, e.g., in the Yangtze River Delta and the Pearl River Delta in the south, is not expected to be completed until 2010 (CW, 2004-09-02). Although the Hong Kong - Shenzhen Western Corridor in the Pearl delta, which includes the Shenzhen Bay Highway Bridge, has been given priority, it is scheduled to be completed by mid-2006. Already by 2010, according to the ministry, China will have been relieved from its current tense transportation situation, which will serve to further promote the development of the national economy (MOC 2004-09-20). This prediction can doubt as at the same time it has been forecasted that by 2020 the road freight transportation will have more than doubled. In 2020, the number of vehicles on the roads could have risen to 140 million, which would be more than six times the figure at the end of 2003. Ownership in China is still under 20 cars/ 1000 inhabitants, setting the predicted 2020 figure to under about 100 car/1000 inhabitants, which would still be a low figure compared to international figures, but above the current world average of 120.

Motor industry production World automotive market has generally been relatively stagnant in recent years, with the largest markets being saturated. This has led to declining production and reduced investments in the industry. Global automotive production capacity is estimated to be some 30% above global demand. The situation is expected to deteriorate further due to the impact of a stagnant global economy

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- 246 - and the need of the automotive industry for readjustments. Backed by their technological strength and comparative advantages in R&D, the automotive industries from developed countries have instead began to focus on developing countries for growth. China is one of very few large markets in the world today where there has been a strong and persistent increase in demand for automobiles. Meanwhile, economic globalization is also accelerating in the automotive industry, and the control exerted over the automotive industry by multinational automakers is probably tighter than in most other industries.

Prior to 1994, China had no clear policies on foreign joint ventures in car production. However, it was decided that is should actively seek foreign capital for the industry that at the time had an annual output of no more than 150 000 vehicles. The maximum share of foreign investment in domestic producers is set to less than 50% and non-Chinese have not been allowed to head the management of car companies. Being an attractive market, the minimum investment was set at 2 bn, with at least 40% of that to be invested immediately, and with an additional 500 million to be set aside for R&D activities (Bofit, 2004- 24). With the authorities having been aware of the attractiveness of its market, foreign companies have not been allowed to introduce “old” models on the Chinese market. Foreign automakers, including their subsidiaries, have also been restricted in their establishment of production, as they can only set up a maximum of two JV’s for one type of car. Still it must still be made in co- operation with one of its already established local partners (CW, 2009-09-09). The aim has also been to influence the organizational structure of the industry, with a focus on large enterprise groups to better realize possible economies of scale in the industry. The state has also provided support for the development of the auto industry by stepping up the construction of some state- supervised technical centers, to strengthen domestic innovation capacity and technical product development. By 2005, the 5-year plan indicates that the share of the GDP generated by the auto industry should have reached about 1%, which looks increasingly realistic.

Authorities have played an important part in the reshaping the industry towards readjustment and upgrading of the product mix, with economy cars as priority. Many foreign producers are still reluctant to transfer high-tech knowledge as long as infringement of intellectual property rights are common, with a legislation falling short of protecting right holders. However, from the beginning, it seems to have been understood that the foundation for future development in the industry is based on the production of parts and components. The Chinese automotive industry has in an as short period of time as five years come to take a considerable leap from its previous stage of infancy, to its present stage of resemblance of a market economic situation. Automotives

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- 247 - did receive a certain amount of protection after WTO entry, but an exceptional inflow of FDIs has quickly lifted the competitiveness of producers, and not least important, of sub-suppliers. The import of car parts is still large as foreign manufacturers continue to source some 40 – 50% from foreign sources, despite the active approach to attract part manufacturers. However, the import level is expected to fall-off to about 30% by 2007. Practically all of the world's most renowned component producers have made considerable investments in China, with US Delphi and Germany's Bosch being such examples. At the end of 2003, there was already more than 5 000 car component plants, with over 1 200 of these with foreign involvement, in China (MOFCOM, 2004-04-04). The government has set an export target for auto component of USD 70 bn to USD 100 bn a year by 2010, increasing from an expected export of USD 8 bn in 2004 (CW, 2005-01-27). If the strategy will be successful then it is expected to account for 40% of total automobile and component sales at the time. China’s automotive industry has managed to sharpen its competitive edge considerably also in more advanced applications, although much of it remains the result of low costs.

With a sharp rise in car production and despite pressure from rising prices of materials, car producers have continued to lower prices and new models are hitting the market at an increasing rate. During the first quarter of 2004 alone, 10 new models of cars were introduced in the Chinese market and another 20 older models had their prices sharply cut (Xinhua, 2004-05-05). Total vehicle output during 2003 reached 4.4 million, with cars volumes jumping by 80% to just over 2 million (NBS, 2004-04-06). China overtook Germany as the world's third producer and market during 2004 and looks likely to catch up with Japan inside a few years' time. Many of the plants work round the clock', at the same time nearly all-major producers are announcing new large investments in China. For large automakers, it is important to maintain their position, both on the most expansive market and on the world market. China's imports in the sector are mainly luxury or rare goods, which are competitive and generally cannot be produced locally such as high-end sedans and other high-tech products. The car market in China is structurally different from other developing markets as about 30% of cars cost more than USD 30 000, which is extraordinary for a country on its GDP level. These products have found a strong demand and their prices have not been under the same pressure downwards as that of the low-end products. A fact that is confirmed by the most up-market producers, like Volvo, BMW, Cadillac, Mercedes, Audi and others, that have or are planning to set up a production presence in China. The market has now reached a stage when work is ongoing to improve the market environment, e.g. by reinforcing legislation, promoting fair competition and introducing a recall legislation of default cars (AT, 2004-03-12).

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- 248 - Being such a large country, China has a need for a large variety of different vehicles, and the output in the sector during 2003 came from no less than 120 different plants, but with a geographical concentration to Shanghai, Jilin and the Guangdong provinces (MOFCOM, 2004-04-04). It should also be noted that trucks and buses makes up a considerable part of vehicle sales on the Chinese market, with trucks up by 10% to 1.2 million trucks and buses by 12% to 1.2 million during 2003. During the first eight months of 2004, the number of trucks sold was 980 000 (+17%) with the number of buses sold being 800 000 (+10%) out of a total of 3.4 million, giving trucks a share of 28% and 23% of buses, which is still by 2004 more than half the vehicle volume. Total vehicle sales during 2004 saw a bumpy ride as it was up by 80% during February, fell by 10% during the next three months and then up by 20% in August, but –8% in October and up by 16% in November. Total vehicle production reached 5.1 million for the full year, up by 16% over the 4.4 million total for 2003, when cars constituting about 2.3 and 2 million, respectively (CAAM, 2004-09-13 & 12-13, CW, 2005-01-31). This volume is complemented by import of about 180 000 complete and CKD vehicles, mainly high price, during 2004, up only 3% over the 2003 figure, but a big rise over the 72 000 imported in 2001. China also exported 406 000 complete and CKD vehicles 2004, out of which near 70% was special-purpose vehicles (CW, 2005-01-27) (CW, 2004-01-27). Despite considerable price cuts by producers, near 15% during 2004 on average, sales increase has not stayed on par with the increase in production capacity. Sales have been further restricted by restrictions imposed by the government on credits and demand for larger down payments. Furthermore, in line with the WTO agreement, import duties on cars will start falling in 2005 and go down from 38-34% to 25% by 2006. The situation has led some producers to become increasingly cautious during 2004 and in some cases have come to postpone investment programs. Production for 2005 is expected to be about 5.8 million cars, a rise of 12%, while sales could go beyond 6 million (China.org, 2005-01-21). Increasing sales indirectly results in increasing oil consumption and the authorities are especially alarmed by the increasing use of petrol in the transport sector where cars, buses and trucks on average use 25% more petrol than in Europe. New compulsory fuel efficiency standards were issued during 2004 and will take effect from mid-2005, with the hope to increase overall fuel efficiency by 15% until 2009 (SAC, 2004-10-30).

The currently biggest vehicle producer in China, FAW Group Corporation of China was originally founded in already in 1953, producing its first truck in 1956 and the first Hongqi car in 1958. The FAW is an auto-industrial conglomerate controlling 35 assembly plants, with a total of over 200 other enterprises being related to FAW. Its most important foreign JV, the FAW - Volkswagen was established already in 1991, from a total investment of 11 bn. The Volkswagen group holds a 40% stake, with another 10% being owned by its subsidiary Audi.

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- 249 - FAW also co-operates as production partner with both Toyota and Mazda and produces the largest number of cars, with a total of 859 000 during 2004162.

The second biggest producer is the Shanghai Automotive Industry Corp. (SAIC) that includes 55 subsidiaries, listed as 461 of the world's 500 largest companies. This is a bigger company than the FAW, and in 2003 it showed a profit of USD 700 million from revenues of USD 12 bn, holding assets of 100 bn (USD 12 billion). SAIC has over 60 000 employees in China and SAIC sold about 800 000 vehicles during 2003, with car sales up 50% to 590 000 units out of the total (SAIC, 2004-09-02). The company is a partner of both Volkswagen and GM, with a production of over 400 000 and 240 000 respectively of the two brands during the year. SAIC has been lucky enough to see Volkswagen maintaining its position as the biggest selling brand in China for many years. The company aims to further increase its annual output to 4 million vehicles and to have become one of the world's six largest automakers by 2020. To generate the funds needed for its future expansion it is preparing for a Hong Kong listing that could raise some USD 1 bn. During 2004 the company has, like all car producers seen car sale rise over all. After two years when car sales have increased by over 50%, it could be understood that a slowdown would come, and in the second half of 2004 sales have stayed near or even below the 2003 figures. Consequently increased competition and falling sales have had a dramatic effect on the profit levels, which for SAIC contracted by 23% during the first nine months of the year (CE, 2004-10-26).

The third company in size, Dongfeng Motors Co., is also involved in a number of JVs with foreign producers, PSA Peugeot Citroen, Kia Motors and with Nissan. The list of companies in JV could be made long and has been turbulent, and difficult to keep updated, without following the industry closely. Some examples from late 2004 could still be given as Tianjin Automotive Industry Corp. works with Toyota; China Brilliance Group with BMW; Beijing Automotive Industry Co. with DaimlerChrysler, Hyundai and Mitsubishi; Chongqing Changan Group Corp. with Suzuki and Ford; Yuejin Automotive Group with Fiat, Guangzhou Automotive Association with Honda and finally the China National Heavy Truck Corp. is in JV with Volvo Trucks.

Of the producers in the NEA region, the Japanese producers entered early into the Chinese automotive sector. In later years Korean producers have also seen the potential and Hyundai Motor, the country’s biggest automaker, is about to compensate for its late start by building its third production unit in China. Hyundai has the aim of reaching a sales volume of 1 million units in China by 2008. In all new investments of USD 780 million will make it possible to produce cars, trucks, buses as well as engines at the new unit in the Anhui Province. Of

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- 250 - the previous two being located in Beijing and Jiangsu Province, it is the Beijing unit that will supply the bulk of the future volume. The subsidiary, KIA Motor’s JV, will be expanded considerably through an investment of USD 650 million to reach a production of 400 000 units by 2008 (Hyundai and KIA, 2004-09-15). The government plans to create 5 to 10 specialized export bases and both Japan's Honda Motors and its two Chinese partners have even formed a new small- sized car venture in Guangzhou (from where all cars will be exported). Total value of the Chinese car export in 2003 reached approximately USD 400 million. Ironically enough, the first large scale exports project to the US from China, from the Chery Automobile Co, is said to be based on a pirated Korean design information. The world’s largest car manufacturer, General Motors, has argued that the Cherry is largely based on pirated design information from its Korean subsidiary Daewoo’s QQ model, having sued Chery in December 2004 (New York Times, 2005-01-14). This is another example of the flood of patent infringement trend that makes it increasingly difficult for the US to accept the rising trade deficit with China.

4.4.3. Water transport

For natural reasons, waterway transport in China is concentrated to its coastal areas, but internal waterways nevertheless hold an important position for cargo transports. The basis of the importance of shipping comes from the fact that the country has navigable waterways that amount to some 120 000 km. Of the extensive inland waterway network, only 20% of the rivers and canals can be used by ships over 300 dwt, and it is still today the classical “djonk” kind of ships that perform the bulk of the transport work on the inland waterways. However, over 8 000 km of this network is channels that are capable of accommodating ships of up to 1 000 dwt. Well over 100 of the inland ports can be called at by ships over 10 000 dwt, located mainly along the Yangtze and Zhujiang river systems. The canals and the inland shipping routes are not only the important areas in Yangtze, Pearl, Heilongjiang and Huaihe rivers, but also the Beijing- Hang Zhou stretch (Grand Canal route), which has a potential to be substantially developed.

Also ocean transport is strong in the country’s waterway transport sector, carrying over 70% of the waterborne volume. In later years, some 80 - 85% of China’s foreign trade has been carried on ocean going vessels. In 2002, China’s volume of foreign trade stood at 760 mt, up by nearly 12% over the previous year. This volume was largely handled by China’s more than 60 larger coastal ports and reached nearly 2.7 bt in 2002, up by 12% over the previous year. By the end of 2002, there was allegedly over 3 800 berths of which about 700 could accommodate ships over 10 000 dwt. These coastal ports handled 1.7 bt, or over

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- 251 - 60% of the national total. Some Chinese ports, which in reality are often a number of different nearby ports, have an annual handling capacity of over 100 mt: Shanghai, Shenzhen, Ninbo, Guangzhou, Tianjin, Qingdao, Qinhuangdao and Dalian.

The handling of cargo in ports is becoming increasingly important due to China’s strong economic growth with increasing import volumes and the national export focus. Handling volumes in ports of import and export cargo have been increasing rapidly and has reached 350 mty in 2004. Especially the container sector has been booming, from 16 million TEU being handled in 1999, 19 million in 2000, 23 million in 2001, 27 million TEU was handled in 2002, to 37 million, which was lifted in 2002. The 2003 turnover of 48 million TEU already corresponded to near 25% of the world container turnover and a possible 55 million TEU for 2004 will make China the outstanding container handler in the world (MOC, 2004-08-10). In the port in Rotterdam alone, over 1.4 million arriving TEUs were handled from China and Hong Kong during 2004, delivered by the 35 shipping lines servicing China (Rotterdam, 2005-01-30). An MOC survey estimates that Chinese ports will be able to handle a total of three billion tons of cargo and 100 million TEUs by 2010. In the container segment the dominance of the coastal ports are large as they handle over 90% of the total volume. Of the current ports, eight are said to be capable of handling more than 1 million TEU per year: Shanghai, Shenzhen, Qingdao, Tianjin, Guangzhou, Ninbo, Xiamen and Dalian.

China's largest port, Shanghai, saw an almost 20% increase in handling during 2003 to reach 316 mt, including 11.3 million TEU. This container volume, according to the port authority, that was 134% above designed capacity. Despite this, it still increased near 30% to about 14.5 million for 2004 (CD, 2005-01-11)163. The 2003 and 2004 container volume ranked Shanghai as number three in the world behind Hong Kong (21.4) and Singapore (20.6), but before its closest competitor, Shenzhen. There will be approximately 10-km of deep-water berths available and capacity for about 15 million TEU after the completion of the Yangshan port project (located some 30 km outside Shanghai). This project appears somewhat risky, as it is located on an island with only one bridge that connects it to the mainland. In the container sector, the dominance of trucking is strong as international standard containers are normally not compatible with Chinese railway containers. If the 2004 growth trend continues, by about 20%, Shanghai could well be the world largest trade port already by 2005 as the volumes projected for 2004, 370 mt, could become larger than the world leader Rotterdam that handled 352 mt in 2004 (CW & Rotterdam, 2004-11-09; 2005-01- 12). As the country’s largest foreign trade port it handled USD 160 bn of imports and USD 120 bn of exports in 2004; up by 44% and 37%, respectively. Out of this

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- 252 - foreign-invested companies trade made up over 60% of the volume (Shiptimes, 2005-01-11). The second largest port in the country is Shenzhen in the Guangdong Province, with a near 40 mty turnover, and ranked fourth worldwide in container handling with 13.7 million TEU during 2004. The third largest port in China is located in the northeast, Tianjin, and had a cargo turnover of 160 mt in 2003. Tianjing is also showing impressive growth figures together with the other two, planning to have advanced to one of the top-ten in the world before 2010 (Tianjin Port, 2004-08-02).

As in other parts of the world, there are different kinds for bulk product that makes up a large share of the volume handled in the ports and rapidly adds up to large volumes. Coal, oil and oil products, metals and mineral ores, iron and steel and building materials make up a large percentage the handling. In 2002, they accounted roughly for 20%, 15%, 10%, 10% and 5% respectively of the total handling capacity of the bigger ports. The larger ports in China are generally well connected to their hinterland, both through waterways for inland navigation as with major trunk railways. However, in recent years, the reports have been numerous about severe congestion in many of the Chinese ports, due to the rapid increase in trade volumes. Part of the congestion problem in the sector is not only the widespread use of low capacity cranes and other handling equipment to unload and load vessels, but also a constant deficit of railway cars.

Expansion needs are considerable in the port sector and the Shenzhen port operators have announced that a “port construction charge” of about USD 10 will be added for each handled container units at the existing terminals. The money collected will be used for port construction in the region and can probably be seen as a first initiative that will be followed by similar initiatives elsewhere (SeaNews, 2004-09-08). With the difference in handling fees to its main competitor, Hong Kong, being about USD 300 per unit, the fee can probably be absorbed by its customers. The expansion of trade volumes in especially the last two years has practically exceeded capacity. As a result of the increasing pressure the Railway Ministry has announced that it will organize and reequip 18 major rail container stations, not only with one in each of the largest cities in the Eastern parts of the country, but also six in the Central and Western parts (Xhinhua, 2004-12-10). Additionally, the ministry will launch the construction of the biggest inland container port in the country, and Asia, by extending the Chengdu port to make it a distribution centre for the southeast of the country (MOFCOM, 2004-09-07). For this project and similar grand plans of the same caliber, there are many hurdles to pass to get the projects going. With only the construction phase involved taking several years, many of the prerequisites can change dramatically by the time such a project is approaching completion.

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- 253 - Shipping High sea shipping in China has been a rapidly expanding sector that despite this has been losing the grip over shipping volumes to and from China from that fact that it has been out-grown by demand. The government is still encouraging competition, especially now that oil shipments have been a sector completely dominated by foreign companies and the oil import has practically only been carried by foreign ships.

The largest Chinese shipping company, China Ocean Shipping Company (COSCO) is also the world's largest with an overall fleet under its ownership of 24 million dwt from near 800 vessels (COSCO, 2004-10-28). This indicates that its average vessel size, 30 000 dwt, is less than half that of the next five biggest owners in the world. COSCO is an example of how Chinese high sea shipping lines have been able to profit from the surge in demand for shipments especially from Asia to Europe and the US. It currently operates across different regions, sectors, and countries, and the company also has diversified its business into integrated logistics and terminal management, and with a spread ownership of many small vessels of all types. However, it is only for containerships that COSCO qualify among the ten biggest in the world with its 220 such ships. This fleet is also being expanded rapidly, having placed an order for five new 8 500 TEU ships at Chinese CSCL during 2004. When delivered in 2007 the ships will not only become the biggest in the fleet, but also the biggest ever built on the mainland.

COSCO has during 2004 adopted a new approach in signing strategic partnerships with some of the country’s largest companies; e.g., Baosteel, Sinopec, Haier and Huaneng164. Partnerships that are aimed to secure transport capacity in a tight market for the companies and in return COSCO have been promoted as the first choice carrier (COSCO, various dates). For COSCO, such deals partly secure a demand for its fleet, but at the same time forces it to globalize further. COSCO has e.g. agreed to join with a 25% share in a new USD 530 million and 3.5 million TEU terminal in Antwerp, Europe’s second biggest port (COSCO, 2004-11-16). A deal that will secure capacity to handle its ships arriving in Europe and expand the kind of service it can offer to both partnership and conventional customers.

The second biggest shipping company is China Shipping Group (China Shipping) from Shanghai, founded in 1997, which has grown into a shipping conglomerate. Its fleet currently comprises over 400 vessels with an aggregate deadweight of near 12 million dwt. China Shipping has been investing heavily into container shipping over the past few years and owns a fleet of over 100 vessels. China Shipping sailed, what at the time, was the world’s largest container ship with the departure from the homeport of Shanghai in July 2004 of

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- 254 - the 8 500 TEU, “CSCL ASIA”. During 2004, the company took delivery of its first VLCC, to be added to its other 80 tankers. The current fleet is not designed for long hauls of imported crude and it is of strategic interest to China to increase the percentage of imports that is arriving by domestically controlled ships. If the estimations presented in the petroleum part above are correct, indicating that China will come to import about 110 mty by 2010 it will take over 20 tankers of 300 000 dwt size to be able to handle less than 50% of that volume. That is if all the oil is carried from the relatively nearby Persian Gulf.

With booming world demand for shipping capacity during 2004 both COSCO and China Shipping Container Lines (CSCL) have been able to cash in considerably. Posted half-year result for the two companies for 2004 show approximately quadrupled net profits compared to the same period in 2003 (COSCO and CSCL, 2004-08-30).

Shipbuilding China has for nine strait years running been ranked as the world's third largest shipbuilding nation after Korea and Japan. When reforms started in shipbuilding, the controlling organization in the sector was China State Shipbuilding Corporation, from which related companies in the regions around Dalian, Tianjin, Wuhan, Kunming and Xi’an came to form a holding company named China Shipbuilding Industry Corporation (CSIC). The CSIC, founded in 1999, is currently the biggest of the shipbuilders and includes over 100 companies and research institutes with over 170 000 employees (CSIC, 2004-06- 25). China State Shipbuilding Corporation (CSSC) was also created in 1999 and is the smaller of the two holdings, that controls about 60 companies with near 100 000 employees. The company originally included several military yards that has converted to civil production and has its geographical focus in the eastern and southern parts of the country (CSSC, 2004-06-29)

The two big shipbuilding groups controls about two-thirds of the sectors' capacity and have, during the first half of 2004, absorbed about 75% of orders in CGT placed at Chinese yards. As mentioned above, this does not necessarily mean that it is so in order value, as the price of a VLCC, measured in USD/CGT, is much lower than most other ship types. The diversity is considerable as there are about 600 shipbuilders in the country. However it has remained an industry with a very low level of profitability over the last few years. The shipbuilding sector with its directly related supporting industry includes no less than 17 000 companies all over the country (CANSI, 2004-09-10). The sector has been hit by rapidly increasing steel prices and augmenting energy prices, and in China, also by energy cuts. Shipbuilding has survived some complicated years that have included both reorganization and expansion, as there has been a sharp increase in demand for its products (CANSI, 2004-09-10)

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- 255 - During 2004, the delivered tonnage is expected to grow by about one-third, from the 6 million CGT delivered during 2003, to approximately 8 million CGT. If so, this would lift China’s world share to about 15%, but still well behind Korea and Japan. The main restrictions to continue expansion would probably be a combination steel prices and energy shortages. In 2002, the Chinese order book for ships numbered 384 and by the end of 2003 had increased to 574. This from orders of near 10 million CGT during the year, or near 20% of the world total, which lifted the national backlog to 32 million CGT. Development in shipbuilding has been phenomenal, as both the kinds of ships have become increasingly advanced and size of ships has increased to the very top of the scale. Starting from the construction of smaller and conventional freight carriers to the top of the scale with the most advanced large LNG carriers. The difference in know-how needed to build the two is and ocean to bridge for a shipyard. Additionally, it takes a different kind of infrastructure at a yard in the form of dry docks to be able to compete for the largest of the tankers. Despite this, the first order for a VLCC came in April 2000, from Iran, to the Dalian New Shipyard, which included no less than a series of five 300 000 dwt tankers. Also for container ships the size is increasing and the COSCO orders for five 8 500 TEU ships and for two jumbo size, 9 600 TEU ships, brings capacity on the containers side into world class. Of the same importance as the first contracts for a VLCC’s ship in 2000, a jumbo containerships in 2003, was the signing of a contract in August 2004 for a late 2007 delivery of a 147 000 cubic meter LNG carrier. With COSCO as leading partner in the group that placed the order, the delivery of two LNG vessels, valued at USD 400 million, with options for a third, was signed with CSSC. This indicates that the production capabilities of Chinese yards, if it comes out well, will soon be regarded as among the technically advanced in the world (CSSC, 2004-08-11). The biggest yards in 2003 was the two in Dalian, Dalian New Shipyard Heavy Industries and Dalian Shipbuilding Heavy Industries, with the next two being Hudong Zhonghua Shipbuilding Co and Guangzhou Shipyard International. These four, clearly larger than the other, generated over 30% of the value add in the industry for the year (Maritimeindustries, 2004-09-29).

4.4.4. Aviation

A major reform of the aviation sector was conducted in 2002 by forming the Civil Administration of Aviation of China (CAAC) that controls three new aviation holding companies. A considerable lack of funds for continued reform in the new organization brought opportunities for nongovernmental business. This has made possible the emergence of both foreign and national private business to access different aspects around civil aviation and airport management. In 2002 airport management was transferred to the local

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- 256 - authorities. The new organization has also led to that prices, for both passengers and cargo, has better come to correspond to costs and opened up for competition.

The effectiveness of the reform was shown by the economic result posted by the CAAC for 2004 of 8.7 billion (USD 1 bn). This is four times the losses incurred in previous years and was attributed to the effect of reforms and a turnaround in tourism as passenger figures were up by 38%, to 120 million, with airlines contributing 72% of the profit, airports 17% and other activities 11% (CAAC, 2005-01-14). Air cargo is still a small sector, but with increasing import and export of high unit, value cargoes the sector has shown strong growth. Shanghai is the biggest and fastest growing cargo destination, handling about 1.1 mt during 2003, well ahead of Beijing with 0.7 mt (Airports, 2004-10-12). Still handling volumes are relatively small and highly concentrated to the largest cities like Shanghai, Beijing and the Guangdong region. On the passenger side, a 15% increase is expected during 2005 and over 20% on the cargo side (CAAC, 2005-01-14).

China National Aviation Holding Company was formed in 2002 and included the civil aviation sector, with Air China as the main body. Air China International Corporation in 1988 became the first operator of civil aviation in China to be organized as a company, and was reorganized into Air China Limited in 2004. Being listed in Hong Kong Air China has set in movement an international public offering (IPO) that was initially for USD 500 millions. However, as a result of strong interest, the IPO has been increased to USD 1 bn and has been presented to investors in London. The IPO includes a near 10% takeover of Air China by the Hong Kong, based airline Cathay Pacific, with the entire company being valued at USD 3.7 bn (CW, 2004-11-24).

China's first private airlines, Okay Airways Co., could be ready to fly at the beginning of 2005, with two more, United Eagle Airlines and the Air Spring, being said to be just behind in the process of obtaining approval from the CAAC. All companies, based in Beijing, Sichuan and Shanghai, respectively, are expected to use rented aircrafts in their start-ups. When, or if, they get off the ground it will be the first time that China will see a fully private competition on domestic lines (CW, 2004-10-17).

China is not only a very big passengers, market, but is also expected to be a market growing by several percent faster than the world average. Consequently, it has been estimated that there will be a need to acquire about 2 400 new jet airplanes over the next 20 years. Chinese airlines are, by 2010, expected to fly approximately 2 800 passenger and cargo planes (CD, 2004-09-03). Chinese

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- 257 - airlines are consequently introducing new aircrafts at a grand scale to increase efficiency, and to attract passengers. China Southern Airlines Northern Company (CNASC) can be seen as an example having ordered, by way of a leasing deal, 23 new Airbus A320. This is in addition to the 14 Airbus that are already operated in the fleet of the Shenyang-based carrier. CNASC is a subsidiary of China Southern Airlines (CSA), based in Guangzhou, which over the last decades has been the largest airline in China. In addition to about 260 domestic destinations, CSA also fly to some 90 overseas destinations (China Southern and Airbus, 2004-09-09). China Eastern, based in Shanghai, is also operating about 60 Airbus planes, and has placed orders for another 20. In all, there are currently 230 aircrafts from Airbus in use in China, up from 29 in 1995, with an additional 36 being ordered during 2003. As for Boeing aircrafts, there are about 400 in use with an additional 30 on order. Around the turn of 2004 a boom in Chinese aircraft orders added five of the new large A380 Airbuses, 20 A330-200 from Airbus and 60 of the new mid-range Boeing 7E7. China National Aviation Holding, signed the contracts at official prices worth over USD 12 bn, and will later distribute the planes among the national airlines (CD, 2005-01-28). The internationalization of the aircraft fleet has resulted in an increasing shortage of pilots. All Chinese airlines already have a number of foreign pilots, while Shenzhen Airlines has been the first airline that, on a large scale, has focused on hiring foreign pilots, with already near 60 Brazilian pilots in its staff (Shenzhenair, 2004-09-08).

Not only has the Chinese aviation market seen a large influx of foreign made aircrafts, it has also seen investments in the manufacturing of aircraft parts. The Chinese aviation industry has been organized in two major aircraft manufacturers: China Aviation Industry Corporation I (AVIC I) and China Aviation Industry Corporation II (AVIC II). The two have no larger planes in production, with AVIC I developing an ERJ145 regional jet while AVIC II has began assembling ARJ21 family jets in a joint venture Brazilian producer Embraer at its Harbin facility (CD, 2004-09-03). Exports from the aviation industry has so far been limited, and the export order to Xi’an Aircraft Company for 20 of its 60 passenger MA60 aircrafts to undisclosed buyers could be a major breakthrough in this field (CATIC, 2004-12-20). In the production of the new Airbus 350, the AVIC I company has been included as producer of up to 5% of components, i.e. wing parts, when the manufacturing is about to start in late 2005 (CD, 2004-12-17).

China has collected a fee since 1992 for airport construction, maintenance and to upgrade the airports; 90 Yuan for international flights, CNY 50 for domestic flights and CNY 10 for branch flight routes. This was previously paid separately by passengers, but has since the summer of 2004 been included in the ticket price

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- 258 - (China Avia, 2004-09-07). As a result of these funds many of the larger airports have been given considerable face-lifts and have increased both their technical and passenger-handling capacity.

Despite the increase in passenger volume, China has only seen one major construction effort in this field: the Guangzhou Baiyun International Airport. After four years of construction work the new airport opened in mid-August 2004. It will become one of China’s three largest airports, being located in the middle of the Pearl River Delta, just outside Guangzhou. The old city airport was the largest in China in 2003, handling over 15 million passengers and 550 000 tons of cargo, while the new airport has been designed to handle up to 25 million passengers and 1 million tons of cargo by 2010. Terminals, and the two full-size runways, have all been designed for the requirements of future 500 passenger aircrafts. The new airport not only has a rail link to the city, but is also directly connected to two passing highways, and in line with the new Chinese transportation pattern, it features a passenger carpark for over 5 000 vehicles (China Southern, 2004-09-08).

4.5. Other

4.5.1. Natural resources

As China is one of the world’s largest countries, the total quantity of resources is relatively big with a fairly complete variety of minerals. Both the quantity and the quality is very high for tungsten, tin, rare earths minerals, molybdenum, antimony, talc, magnetite and graphite, while in the case of e.g. iron, manganese, aluminum, copper, and phosphorus there is also an abundance, although much of this is low-grade ores. China is also a large exporter of minerals, e.g. lead, zinc, tungsten, tin, antimony, rare earth metals, at the same time as large quantities of iron ore, manganese ore, fine copper ore and potash fertilizer are being imported. It is estimated that there are about 140 000 non-state-owned mining enterprises which are mostly very small and inefficient. About 400 of these mines have been supported by FDIs, with about half of these investors from Hong Kong, Macao and Taiwan and the other half from the far abroad.

Over 400 promising potential production sites were indicated when the results of a five-year national mineral survey were presented in 2004. These could serve as a foundation to somewhat relieves the country's hunger for different kinds of minerals. Most important are new copper findings that have been reported to hold reserves of more than 12 mt in the Xinjiang Uygur Autonomous Region, Yunnan Province and in Tibet165. Reserves could be extensive enough to

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- 259 - dampened negative prognoses, but more detailed information from further testing is needed to set the specific reserves volumes. Statistics shows that only about a fifth of China's rich solid mineral resources are actually being developed.

Also a number of less frequently discussed minerals are mined or produced in very large quantities, being considerable transport generators as well as serving as inputs in other products. Such examples are the production of copper that in 2002 stood at 1.4 mt (with 1.7 mt of expected output 2005), 2.9 mt of aluminum (3.5), 1.1 mt of lead (900 000) and 1.1 mt of zinc (1.7). In 2005, the volume of copper in concentrate is expected to be 500 000 tons while the production of aluminum in concentrate should reach 6 mt. Also in 2003 231 mt of iron ore were mined, 23 mt of phosphorus ore as well as another 10 non-ferrous metals of non- refined quantities had a production above 10 mt for the year. Two other products are also produced in large quantities, phosphorus, that has a production in the range of 30 mt while the production of ferrous sulphide is about 15 mt (MOFE, 2004-10-10) 166.

4.5.2. Iron and steel

Despite the fact that China shares much of its ideological history with the former Soviet Union steel making was never given anything near an as strong symbolic meaning. Crude steel production has instead slowly but steadily been on the increase. As recently as in the late 1990’s there was a serious overcapacity problem of steel production in both China and abroad, but dramatic changes and a strong recovery in the world market have occurred since. Demand from China that consumed 36% of the world's steel during 2003, has been the most dramatic (Metal Bulletin, 2004-08-26). China’s steel industry currently plays a very important role in the nation, providing much needed steel as one of the basic raw material in the economic expansion. The sector has progressed rapidly since the 1980s, with steel output passing 100 mt as recently as during 1996, giving China the rank as the largest producer in the world, and having doubled that during 2003. Since 1974, the production increase has practically remained unbroken, with the increase from 2000 to 2003 alone corresponding to nearly the total production of Japan, the world’s second largest producer. In 2004, China produced a volume that corresponds to more than twice the Japanese volume and near three times the US volume; the world's second and third largest producers. Despite this enormous increase, China has shifted from a production volume more than 20 mty above consumption in 2001 to what was a slight deficit for 2004. Chinese steel supply is, and will for the near future remain, below demand as a result of the country's strong economic growth and a

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- 260 - continued construction boom and a general increasing demand for steel (Chinaesteel, 2004-03-02). Average production costs for basic steel products in China are estimated to be at the lower end of the scale among major producer countries, but still above Korea by some 5%, but 20% below that of Japan (combined from IISI and WSD, various dates).

When China entered into the WTO, domestic steel enterprises were placed at a disadvantage as wide-ranging promises were made regarding tariffs, non-tariff barriers and trade rights. Since 1994, China has not had any import quotas and licenses for steel products, and only a limited import registration system. Therefore, before entering the WTO, China’s tariff rate for steel products almost met WTO requirements and saw relatively few changes. The WTO entry, as a result of this, has had a relatively limited impact on most steel products, but the sharp rise in imports still has seriously challenged the industry and the national trade policy. It is in the segments of high value-added products and for special- steel products where imports have had a substantial impact on the steel industry. Segments where the China’s government neither had time nor the resources to take appropriate measures to maximize the benefits and minimize the problems from the full opening-up to trade.

However, China still lags far behind the world’s leading steel nations in terms of technology and equipment, product variety and quality, and by all means, in labor productivity. As much of the production comes from smaller smelters, the difference in both production costs and productivity inside the Chinese market can be expected to be much larger than in other major producer's nations. With strong domestic demand, there has been little incentive for domestic producers to diversify into more advanced product niches, which is probably needed to maintain their long-term competitiveness, rather than depending on a continued high demand. Making the best out of the available domestic and foreign resources will be the long-term strategy of the Chinese metallurgical industry. China must combine inland raw material resources for the domestic industry located far from the coast and make use of foreign suppliers for industry located at suitable locations for import, using domestic resources only as a compliment. In recent years, and for the future, domestic production cannot fulfill the needs for raw materials such as iron ore and coke, which restrain the domestic industry's output capacity. Despite this, China holds a domestic iron ore resources of near 40 bn ton, over 97% of this is ores with an average mineral content of 30 - 35%. Compared to a typical open cast mine in e.g. Brazil or Australia that often mine findings with some 55 – 75% ore content. In 2002, the production volume of domestic iron ore reached about 190 mt, while imports amounted to just under 70 mt. In 2003, production of iron ore reached 231 mt with imports for the year adding another 148 mt. Chinese imports of raw

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- 261 - material have increased dramatically in later years and the long-term resolution has been attempted to sign long-term iron ore deals. As the iron ore market has relatively few suppliers controlling a large part of supplies, this has not been easy for the mostly small Chinese consumers. The country’s largest producer, Baosteel, has managed to buy into one of the world’s largest producers, Rio Tinto’s, Australian mines, where the USD 65 million will be used to initiate production (CBW, 2004-04-27). Buying into mines and create joint ventures with major suppliers from Brazil, Australia and its new big supplier India, and securing future supplies are expensive ventures that can only be financed by the biggest steel producers. This will place many of the smaller domestic producers in an increasingly troublesome situation in the near future. China still imports vast quantities, with Australia supplying nearly 40% of the total, Brazil with 26% and India with 22. The size of the country also contributes to a pattern where both the import and export remains considerable in the same categories as overland distances from raw material supplies to customers, can in some cases make import the favored alternative.

Chinese steel production reached 241 mt during 2003, up by 24% over 2002. During the same year an additional 37 mt was imported, up by 52%, predominantly in the higher value quality categories, setting local production to about 85% of total consumption. China imported 24 mt of steel in the first 9 months of 2004, down by 15%, while exports jumped by near 70% to near 9 mt (Chinaesteel, 2004-12-12). September was also a special month for the steel industry as the export exceeded imports for the first time, reaching just under 2 mt for the month. The development of international prices during the year has made it ever more profitable for Chinese producers to export their production. This could well be what the trade statistics are reflecting. As long as the current situation with a strong increase in demand continues, prices of steel products are not expected to drop dramatically. Production is expected to reach about 280 mt of steel during 2004 while consumption will probably reach beyond 280 mt. The steel industry has been showing clear signs of being "overheated", after excessive investments in the steel industry in later years, but so have the aluminum and cement industries. New investments in especially these three sectors have been examined with extra care from central authorities, but continued national growth has managed to somewhat ease the situation, at least for the time being (NDRC, 2004-09-12). The risk for a major overcapacity crisis as soon as demand would fade was a bit eminent as investments in the steel industry was up by near 90% during 2003. These investments were mainly used to upgrade production facilities to increase the share of higher value products. Investments in the steel sector have continued to grow, by over 50% year-on-year during H1 2004, but still only half of the 100% increase during H1 2003, to near USD 10 bn (CD, 2004-09-02). Parts of the industry are doing extremely well and the

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- 262 - combined sales for China's 66 major steel companies, during the first 7 months of 2004, came to USD 64 bn, with profits reaching USD 5 bn; up 60% and 75% respectively over 2003 (Chinaesteel, 2004-09-05). As prices for steel have risen practically uninterrupted since the beginning of 2003 the industry is currently harvesting record profits. However, prices in the steel sector seem to have rebounded somewhat in the latter part of 2004, and could be flattening out during 2005.

Baosteel is currently China’s largest steel company, formed in 1998 by a merger of Baoshan Iron and Steel (Group) Corporation, Shanghai Metallurgical Holding Group Corporation and the Shanghai Meishan Group Co., Ltd. During 2004, it produced 21 mt of crude steel, with its 2010 plan indicating a 30-mty production (Baosteel, 2005-01-17). Despite its short history, it was classified during 2004 as among the very best companies in the world inside its line of business, with Baosteel being upgraded to third spot (WSD, 2004-06-24). The company also became the first Chinese company to be included on the Global 500 list ranking of the world's 500 biggest company by turnover, at number 372 (Fortune, 2004- 07-12).

Chinese steelmaking is one of the big transport and import generators, with not only much iron ore, but also coal and coke needed in the process being delivered from both domestic and foreign suppliers. Steelmaking is also a process that is highly energy consuming, additionally older steel-making processes are severe generators of pollution and with the whole process being a large consumer of water. It is not fair to generalize the situation for the industry based on this, as China is such a large country. Especially so as some producers are considered by leading experts to be world-class in both size and operation, but with most producers being small using largely outdated equipment. At the same time, there are producers that source practically all their raw material from nearby domestic suppliers, while others do the opposite, but are instead likely to be located near the large consumers in coastal regions. That the industry will at some stage face major restructuring, when the current demand growth will fall off, is quite obvious. There will be no attempt here to predict how severely such a change will affect production volumes and how thorough such a restructuring period will reshape the industry in both China and other nearby nations; but it certainly will.

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- 264 - 5. Korea

5.1. Introduction to Korea167

Korea was one of the world's many underdeveloped countries by the middle of the 1960s, which largely depend on agriculture. Korea has been transformed into a modern industrialized country due to its export-oriented industrialization, within an as short period of time as three and a half decade. Assisted by its rapid growth, which averaged near 8% per annum during more than thirty years, its national GDP soared from only USD 2 bn in 1961 to USD 520 bn by 1996. At the same time, the per capita GNP jumped from USD 82 to USD 11 385 (BOK, 2004- 03-17).

Based on this remarkable development, Korea emerged on the world stage as one of the front-runners of the four Asian Tigers. Korea was also adopted as a member of the OECD in 1996 as an important newly industrialized economy. This outstanding economic achievement was truly remarkable, considering the poor endowment of natural resources and the limited domestic market. For these reasons, the economic development strategy of Korea has been widely promoted as a possible model to use for other countries on their road to development.

However, structural weaknesses during the process of concentrated growth fractured abruptly toward the end of 1997, due to the transformation of the external economic environment. Consequently, the Korean economy experienced a currency crisis and faced severe internal difficulties. Soon the development changed for the better and already in the first years of the new millennium, Korea, along with practically all the Asian economies, had managed to largely cure the weaknesses that had led them into the currency crisis. Korea for its part, supported by loans from the IMF, had pressed ahead with thorough structural reforms of its economy.

On the listing of the world's economies by the World Bank for 2004, the Korean GDP is tenth in the world, slightly before countries like Mexico, India, and Australia 168. In per capita terms the GDP for the same year reached USD 16 400. This figure placed Korea near 50 of the world's about 200 economies, behind e.g. Cyprus and Greece or about 65% of the per capita GDP of Singapore and just over half that of Hong Kong (MOCIE, 2005-01-31).

Approximately ten years ago, Korea looked like developing into one of the economically strongest Asian countries, while Japan seemed to have started to fall off, and appeared to be catching up with Japan. Japan was urged to learn

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- 265 - from Korea how to handle non-performing corporate loans in the banking sector during a financial crisis. The situation is more uncertain today as some analysts warn that the future of Korea could lead to a situation similar to that of Japan, and its stagflation in the 1990s, while others say that this is not at all the case (Morgan Stanley and Standard & Poor’s, 2004-09-02 & 2004-07-30). The negative perspective, issuing warnings about a possible long-term slump, is increasing finding support, and most importantly so from the head of the Bank of Korea in official speeches (CI, 2004-07-24). Korea, in 2004, finds itself in a new post- industrialization situation with relatively high wages, low domestic demand, and lower yields on investments. It can neither profit from latecomer advantages in its current situation, not can it start to protect the domestic market behind trade barrier.

Korea has seen more political conflicts during the last few years, despite the economic comeback from the 1997 crises. From the time of taking office in late February 2003, the newly elected President Roh Moo-hyun’s administration stated that they would attend problem areas of the economy. But the view on which areas that are problem areas and what measures to apply are far from shared by all Koreans. Policies that tackle issues like social reform and wealth distribution, could well be very important indeed for the long term development in the country but the shift in focus has unsettled the business community. Opponents say that the presidential administration set out that it would not to use short-term policies to support the economy. However, by the end of 2004, the economy had seen about 20 different stimulation measures (CI, 2004-10-08).

Opposition mounted early on in the Roh presidential term, but after a long and turbulent process, the president, in the end of March 2004, faced impeachment from the parliament. That was after only 13 months in office, out of his five-year term. This came about after a parliament vote could finally take place, followed by near riot looking scenes in the parliament. This vote put the president out of office for nine weeks. However, on May 14, the president could return to his position after the Constitutional Court had reinstated him, by overturning parliament's decision to impeach him (Reuters and CD, 2004-05-14). The court did not see Presidents Roh’s violations of the election law, when expressing support for one of the political parties as grave, neither so with his call for a national referendum in support for his policies. The scheduled parliamentary elections were held during the weeks the president was out of office, resulting in a new parliamentary majority supportive of the president. Although the majority for the ruling Uri Party is slim, it holds 151 seats out of the 299 in the single-chamber parliament. The prospects of having a majority in parliament, and a supportive president, looked sure to allow for a strong showing of the party during 2004. Instead, reality has been grim and stubborn opposition both

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- 266 - inside and outside the party has resulted in fewer proposals that have moved forward in the parliament than expected. As a consequence, the entire central committee of the party resigned after much criticism in the first days of 2005 (KT, 2005-01-10).

Under the term of Roh, the largest business groups have been set under pressure to increase transparency, to reduce cross-unit transactions and family control. The market is generally expecting, or fearing, tougher measures from the administration, which has somewhat dampened the business sentiments. One such social reform is the highly controversial issue of the enforcement of the proposed five-day working week that should be gradually introduced in the near future. Another such government decision was to bailout the nearly bankrupt credit card company, LG Card in 2003, against market principles. The government should let the market decide the fate of a defaulting credit card firm, and ask them to pay back debts in the same way as militant workers have been forced to pay for Il legal strikes. The critical fractions have argued that the government has also promoted a national vision of making Korea a regional business hub in Northeast Asia, without a detailed action plan how this should be achieved. Worse yet, the repeated use of the word “hub” has come to irritate its neighboring countries, such as Japan and China, as both have difficulties understand both how and why Korea should fill this position.

Another goal that has been set out for the Korean economy was to reach a GDP level of USD 20 000/capita. Prior to the 1997 crises, this looked possible to reach in perspective, but for which prospects has faded since. One way to achieve such a goal would be the appreciation of the Won that has started to happen during 2004 and will lift the USD measured GDP. The drawback of such a development is that it would hurt the competitiveness of the Korean export, but the government sees the USD 20 000 mark as achievable by 2008 (MOCIE, 2005-01- 31). Korea's current uneven performance, with low consumption and investments while maintaining high exports is partly a result of economic uncertainty. Confusion over economic orientation and frequent market interventions has been cited as some of the reasons for the economic policy failures in recent years.

5.1.1. The Korean Economy

After the deep crises in 1997 – 1998, the Korean economy recovered fast in 2002, when GDP grew by 6.3%. The turnaround can be explained by strong exports and increased government spendings (MOCIE, 2004-01-17). Despite the positive trend during 2002, 2003 also became a turbulent year as growth fell off and into

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- 267 - the negative in the beginning of the year, but again gained momentum later in the year to reach a GDP growth for the full year of 3%. The export performance during 2003 was positive and compensated enough for the depressed domestic demand and low corporate investments, to lead the GDP growth169. The problem for the economy has, for some year, been to uphold consumer spendings that increased by near 8 % during 2002, and then increased by only 1.4% during 2003. In the same way, the fixed capital investment by the corporate sector have grown by near 7% during 2002, but has since fallen back to only 3.6 % in 2003, and has continued to decline during 2004 to 2.5% for the first six months of the year (BOK, 2004-08-22). Measured in economic weight, the dominating sector in the economy is the slowly increasing service sector that generates 57% of GDP, while the slowly declining manufacturing sector generates 27%, construction about 12%, and agriculture the remaining 4% (BOK, 2004-10-12).

The Korean GDP reached USD 667 bn during 2004, in a year when Korea sets a new export record reaching USD 254 bn and when imports came to about USD 224 bn. This resulted in a record trade surplus of USD 30 bn, three times of what was expected in the government’s budget for 2004 (MOCIE, 2005-01-31). Over the last year, Korea has also been badly affected by falling prices for its major export products, largely caused by increased competition. At the same time, import prices have gone up, prices of energy has also gone up. It has been estimated by the Korean International Trade Association that every USD 5 in increased oil price over USD 30/bbl hurts the Korean economy by a lowered GDP of 0.9% and a USD 5 bn reduction in exports (KITA, 2004-05-10).

In 2005, the new state budget foresees a growth rate of GDP of 5% and inflation to remain around 3% for the year. The state also intends to raise its incomes by 7%, largely by increased taxes that will reach a per capita level of 3.4 million, but with the relation of tax to GDP to remain at 19.7% (MOFE, 2004-09-23). Two months after the 2005 budget was presented, and after the economy has shown clear signs of stagnation, the government launched the “Korean New Deal”. This will take full effect from the second half of 2005 and is expected to increase growth by 1% by initiating new projects valued at around 10 trillion. It will draw on the resources not only from the National-, Private- as well as Civil Servants Pension Funds, but also major state corporations like the electric power utility to finance investments in social infrastructure (MOFE, 2004-10-07). Critics say that the “deal” has no concrete plan for the financing and that it could make funds increase their deficits. Independent but company- funded researchers warn that the Korean economy could come to see a short-lived recovery during the beginning of 2005, to be followed by a longer decline. Worse, it could lead it into a situation where the economy could become stagnant if not backed up by increased employment and increasing real incomes (Samsung ERI, 2005-01-31).

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- 268 - The insecurities in the economy are again the insecure development of energy prices, possible appreciation of the Won and the low consumer confidence. Other institutions have adjusted their opinion about the Korean economic future during the second half of 2004, with the IMF having downgraded its prospects for GDP growth for 2004 from 5.5% to 4.6%. As for 2005, the IMF, the World Bank and the Asian Development Bank have lowered their estimations from 5.3% to 4%, 5.3% to 4.4% and from 5.2% to 3.6%, respectively (IMF, World Bank and ADB, 2004-09-30; -10-08; -09-29). Citibank in Korea sets out much lower expectations, predicting growth for 2005 at a level well under half that of the government, 2% instead of 5%, as the economy is unlikely to improve significantly during the year (CI, 2004-11-24). At the same time, there is a danger for increased government debt if consumption is assisted by generous state spendings. The probability for this increases as the economy during Q3 of 2004 showed a growth of just 4.6% and with expectations of a continued downward trend for the rest of the year and on into 2005 (BOK, 2004-11-14). To make the economy grow by 5%, as suggested by the government, is seen as futile by its critique, as Korea should learn from the Japanese experience where stimulation led to little more than an increasing deficit. A high economic growth rate requires an optimal use of the labor force and capital, but without increasing inflation. In higher income countries with a GDP over USD 30 000 per capita, growth generally remains below 3%, for countries in the interval above USD 20 000 at 4%, while in countries with incomes in the range of USD 10 000 or under can maintain a 5% or higher growth (KDI, 2004-09-14).

The above-mentioned problems are destabilizing the foreign rating of the Korean economy and contribute to the volatility of stock values, thus risking a large withdrawal of foreign capital and increasing the cost of foreign loans. The tense relations on the labor market, and its relation with the US where a strained relation is seen to increase financing costs, increases the insecurity (KIEP, 2004- 07-07). US investors are sensitive to analysis presented from their own government, which makes political relations with the US extra important. For a fresh take-off for the country, basic political stability must first be achieved, offering a clear vision for unification and a clear idea of a lasting diplomacy not only among its most important partner, the United States, but also with its two big neighbours, Japan and China. The need to support growth, create generally market-friendly policies and to improve relations on the labor market will need strong domestic political support, but the real existence of this support is seen as insecure (Morgan Stanley, 2004-07-17). The Roh government started off with changing the political and social landscape, but realities have forced in place a number of stimulation packages. It has been controversial inside the government, which measures to take, and during just over two years, Korea has seen three ministers of Economy resign from the post. The political agenda has

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- 269 - also run into problems as the leadership of the ruling Uri Party resigned in mid January 2005 due to its failure to move forward on its political reform agenda. In line with the controversial political agenda, an unprecedented initiative by the Korean Economic Association (KEA - an association of university professors) 400 professors of economy and business leaders concluded in a public statement that “the economic policy of the Roh administration has been a failure, not only in regard to implementing reform but also in promoting stability’’170.

The sentiment of the general public, small companies and large corporations for the economic future has become increasingly negative having reached a 43- month low by August of 2004 (NSO, 2004-08-05). The index for expectations for six months ahead in living standards and consumption stood at 89.6 in July 2004, which was the lowest since December 2000, with all income brackets of the population being negative. Still, the business confidence of manufacturing companies for the economic future has become increasingly negative, reaching a 46-month low by December of 2004 (BOK, 2005-01-04). At the same time the Business Conditions Survey stood at a very pessimistic 86.4, with service-related businesses being more negative than manufacturing (FKI, 2004-08-06)171. Figures that are well in line with the Bank of Korea index, published one month earlier, that points to a falling increase rate in exports for various of the most important items and generally growing pessimism for the future (BOK, 2004-07-16). The situation for many small- and medium-sized companies is problematic with struggling home demand at the same time as the large export-oriented companies are doing very well. Exporters are doing well at the same time as the global economy, while domestic consumption is holding back the economy from showing strong growth. Companies have, over the last two years, been importing more machinery from abroad, while buying less local products. Another important tendency is the declining export of consumer goods at the same time as imports in this sector continues to increase and has practically done so monthly for over a year. It will be difficult for domestic consumption to revive as long as imports continue to increase, despite strong export (BOK, various dates). By the end of the year the Bank of Korea indicated that consumption could have passed its “rock-bottom” and should lead to a recovery (BOK, 2005-01-20). By the end of 2004, China accounted for 45% of Korea’s outbound FDI, and 40% of Korean companies with plans of expansion abroad considered China. This rapidly increasing focus on China could become dangerous for Korea and should be handled cautiously not to become too dependent (KIEP, 2004-04-29). Although the manufacturing industry is most positive about the future, or least negative, its productivity level in 2004 stood at 60% of that of Singapore and Hong Kong. The low figure was due to the lack of technology, breakthroughs and sluggish investment in research and development (BOK, 2004-08-12). According to the same study, Korea's

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- 270 - productivity, using the same amounts of capital and labor in manufacturing, would reach 50% of that of the United States and 66% of Japan. A leading annual international economic competitiveness ranking conducted in Switzerland placed South Korea at 35th among the 60 economies surveyed (IMD, 2004-05-04). The problems that are highlighted are the often-strained labor-management relations, difficulties in attracting FDIs and problems originating from government bureaucracy. In the classification among the world's 30 biggest economies Korea is placed as 15th, as the previous year. A number of its closest competitors are placed well ahead of Korea, like Taiwan (4th), Malaysia (7th), Japan (9th) and China (10th).

This could indicate that the Korean economy is approaching a non-convergence trap situation, and to break this tendency, it might be forced to invest further in R&D to come up with more innovative technologies172. In Korea, it has been the companies that have funded most of the research and the state’s contribution in the R&D sector in 2002 came to only 26%. Companies investing in R&D in Korea seem to focus on memory semiconductors, as in all other sectors investments are below the average of the other G7 countries. The ratio of overall R&D spendings to GDP in 2000 stood at 1.43%, just over half that of the G7 average of 2.63%, with the same proportion seen in electronics and telecommunication where R&D investments stood at 3.7% compared to the G7 average of 8.7%. With 60% of Korean investments in manufacturing devoted to electronics and telecommunication, being far above the 20% average for the G7, the focus could be set dangerously narrow for the future (BOK, 2004-09-22). It could well be so that the outbound movement of manufacturing and investments do hurt the relatively small Korean economy, at the same time as the domestic market is becoming increasingly open for competition.

In an attempt to lift the domestic spendings on R&D, the government has increased support for research connected to foreign companies using high-level domestic staff from the end of 2004. In order to attract such companies, assistance will be given to these companies covering up to 80% employment costs for foreign staff coming to Korea (KT, 2004-05-20). The Government has also approved stem cell research for the possible cloning of a human embryo, which has been a highly debated subject, typically postponed by reluctant governments in other countries (DowJones, 2005-01-12). The Ministry of Environment has also been set to sponsor research for “future technologies” and will invest 130 bn in technologies to reduce the emission level from cars and in the processing of wastewater up until 2010. For car exhausts, the goal is set to surpass the European Euro 4 standard by at least 30%, which is to be introduced in 2005. It is also expecting wastewater treatment research to reach a level where water quality is good enough for swimming (NIER, 2004-05-30). If what has

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- 271 - been mentioned are the positive and offensive initiatives in this field, then the new regulation demanding advance approval from the government for the transfers and sale abroad of advanced technology, is the defensive ones. Especially so as informers reporting violations will be rewarded by up to USD 90 000 (CI, 2004-09-21).

Investments Since the financial crisis in 1997, policies have focused on attracting FDIs and have restrained the outflow of domestic assets. FDIs in Korea peaked at slightly over USD 15 bn for both 1999 and 2000, but have since dropped during three consecutive years to just USD 6.5 bn for 2003. During 2004, FDIs nearly doubled over the previous year to USD 12.8 bn, with USD 11 bn expected during 2005 (MOCIE, 2005-01-05). During the 1999 – 2003 period, the origin of investments has been volatile, with the US investing three times the EU level in 2002, but with the EU investing more than double the US in 2003, USD 3 bn and USD 1.2 bn respectively (MOCIE, 2004-02-03). Of total FDIs made from 1962 to 2003, all European countries were found to have invested 0.1% more than the US. As for the accumulated figure, the EU and US investment total, USD 27 bn for each, slightly more than double that of the number three investor, Japan. European investments have continuously been dominated by manufacturing, while US investments has, in later years, shifted towards real estate and the service sector. Generally, FDIs have been used to buying into existing companies, with little new manufacturing being the result. European investors regard the Korean skilled manpower highly, its technological level, its well-placed geographical location and developed infrastructure system. Europeans also call for stable labor relations and more consistent government policies (AsiaEuro, 2004-08-10).

The largest Korean companies, often called conglomerates (chaebol’s), have long been tightly controlled and not very open. In later years, the transparency in Korean companies has improved, but companies have generally also improved their financial reporting while having clearly broadened their board representation (BOK, 2004-10-15). Still, the government has pushed legislation limiting voting rights to enforce the right to trace transactions at bank accounts by the Fair Trade Commission (FTC, 2004-12-03). The FTC has shown that to conduct control over a Chaebol needs very low levels of ownership as it is conducted through a network of companies. The average level of ownership by the president in the 36 biggest companies was 1.95%, but through stakes in affiliated companies, the real level of control was near 49% (FTA, 2004-12-29)173. Voting rights for Chaebol-controlled financial institutions are to be maximized at 15%, instead of the current 30%, by 2008. The critique is strong from the most influential lobby organization, Federation of Korean Industries (FKI), voicing concerns that this will undermine investments and in the longer run, also job creation.

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- 272 - It is important to understand that the biggest companies in Korea are very big in relation to most other companies, with the Samsung Group as the number one174. At the end of August 2004, the value of the four biggest groups, including subsidiaries, stood at USD 84 bn for Samsung, LG Group at USD 29 bn, SK Group at USD 23 bn and Hyundai Motors at USD 22 bn (KSE, 2004-09-19). In the top 10 Korean companies, foreign investors have been aggressively building up their ownership enough to account for nearly 50% of their market capitalization 175. This is up by over 10% in one year, and up near 70% from the below 30% share held in 1998, to make the Korean economy the most internationalized in Asia (SG, 2004-08-28). By mid-2004, foreign ownership in Korea’s biggest company, Samsung Group, had reached 57%. In the same mode of economic openness, almost all Korean restrictions on foreign investments, both for direct investments and portfolio, have been lifted. Foreign management openness also prevails. Foreign ownership has also increased in the local real estate market by opening up to foreigners in 1998, where 17% of all higher than 10 floor-buildings in the country have foreign owners, investing another USD 1.7 bn during just H1 2004 (CI, 2004-10-13). In the stock exchange, foreign investors are the most active in buying and selling shares, but far from always taking the money out of the country. During 2004 the stock prices were very volatile indeed, having even had a minor “Black Monday”, on May 9, when the Korean shares index fell by 5.7%. This was triggered not only by a combination of the announcement about the cooling of the economy in China, but also indications of rising oil prices and a possible interest hike in the US (KSE, 2004-07-05). Share prices during the second half of the year have seen both dramatic new highs and lows, to reach another relative high by the end of the year.

Still a general suspiciousness on foreign companies has probably led to excessive control and tax audits on foreign companies operating in Korea. The tax authority has set up a program to provide a fairer tax environment for foreign businesses in relation to domestic companies to compensate for this, but indirectly also to prove more attractive to foreign investors. The new tax act will also include less frequent investigations into "transfer pricing" and states that follow-ups will, in the future, be included in the regular corporate tax audits (NTS, 2004-02-09)176. Authorities are getting gentler with the foreign companies because over 15% of production comes from foreign-owned companies (MOCIE, 2005-01-05). This group of companies generates 10% of employment and accounts for 13% of exports in the manufacturing sector.

The development of total outbound FDIs by Korean companies during 2003 showed a negative tendency, and fell by over 10% to USD 1.5 bn (MOFE, 2004- 01-29). Investing in China has become increasingly popular and has already been established as the most important FDI destination for Korean companies. Their

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- 273 - relation has developed extraordinary well, as seen in the establishment of diplomatic relations as late as in 1992. This is already the second year that Korean companies have preferred to invest in China, with USD 2.5 bn during 2003, up by near 50% over the same FDIs in 2002. Many of the projects initiated in China by Korean companies are relatively small-scale, with a total of 22 208 by the end of 2003. In late 2004, the approval-free level for individuals who want to invest abroad for business purposes was increased to USD 1 million. As a result, the already large number of relatively small-scale investments will probably continue to increase in the future. Total Korean investments in China had, by the end of 2003, reached a value of USD 28 bn, with USD 16 bn (57%) of that sum having materialized (CD, 2004-02-07). The trend during 2004 was an increase in outbound Korean FDIs by about 40%, to over USD 2 bn, but still with a record 50% going to China, 15% to the US and 10% to Japan (MOFE, 2004-09-08 & 2005-01-25).

In theory, it is said that the more economic freedom a country has, the more investments and economic growth it is likely to record. In support of this, it can be pointed out that the countries with a high economic freedom rating are generally the world’s richest nations, while the poorer countries are often being rated low. In relation to other countries Korea is just average in overall economic freedom, with a score of 7.1 out of the maximum 10 in 2001, but on a steady rise from and index of 5.4 in 1980177. The Korean figure is the same as for Japan and Taiwan, but with a score of 8.6 it is Hong Kong topping the list, followed by Singapore at 8.5, with the New Zeeland, the US, UK all scoring 8.4-8.3 (Fraser Institute, 2004-04-10).

Domestic investments Not many years ago, the situation for domestic investors was quite different as the competition was then about funds for investments while in 2004, it is lenders who look for sound projects to invest in. Additionally, the rate of interest is low, down on the one-digit level. The interest rates investments should be booming, but it is becoming ever more evident that the relative direct control of the market that central banks used to have, by way of monetary policies and control of interest rates, appears to be fading. In late 2004, market rates in Korea are at the lowest ever and liquidity is high, but this still has not been sufficient to push up consumption or investments (BOK, 2004-10-15).

The government is well aware of these problems, and two major projects are the building of infrastructure and the facilities needed for two economic free zones in Busan and Jinhae. By 2020, an estimated USD 54 bn should have been invested in these two projects. According to the plans, the two new zones and their surrounding areas will generate USD 70 bn worth of production per year and create over 1.5 million new jobs. One of the largest projects is to increase the

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- 274 - container-handling capacity of the port in Busan that is being upgraded from already being one of the largest container ports in the world. The largest of all domestic state investment projects so far was the High Speed Railway between Seoul and Busan. The line started to operate in 2004 with near 20 trillion (USD 17 bn) having been spent over a 15-year construction period. The largest state project ever discussed was to relocate the nation's capital, Seoul, but this was finally scrapped in late 2004 due to lack of political support.

Though Korea and China now often work as two closely interlinked business partners, the balance looks likely to tip over in the favor of China in the near future. If Korea will not be able to increase its competitiveness, along with its growing dependence on China, then the nation may eventually, and slowly, turn into something like a Chinese satellite. The most important export destination for Korea, being more important than the US, is China. At the same time, the advantage when comparing the technological level, that used to be many years, has constantly been shrinking and is by mid-2004 estimated at the range of 20 months (Business Week, 2004-05-15). In a similar Korean study, the advance in ten technologies designated by the government as future growth engines, including digital TVs, intelligent robots, next-generation of semiconductors and mobile communications the advantage over China, was set at only 36 months (MOST, 2004-10-02). Both studies expect existing advantages to have evaporated five years from now, if current trends remain more or less stable. Considerable investments into Korean R&D will be needed to avoid this and to somewhat maintain the current advantage. Seen as a kind of development outlined here, it is recommended that the internal political problems in Korea should be addressed, for the sake of the future position of the nation.

In the private sector, it is again the largest companies that are the most important. Samsung, the country' largest company, has stated that it will increase its domestic investments by 18% during 2004, reaching near USD 7 bn, and with another 20% for 2005 (Samsung, 2004-06-10 and 12-06). The LG Philips company, considered world leader in the TFT – LCD sector, started the construction of the world’s largest TFT - LCD industry complex in Paju City in Korea in March 2004 that will manufacture the next and future generations of TFT - LCD products. The company already had 21% world market share during 2003, and a considerable part of the production volume from the new plant is scheduled for export. LG Philips plans to invest about USD 2.5 bn over a ten- year period, building another 170 hectare plant, and expects to create 25 000 jobs (LG Philips LDC, 2004-03-17)178. However, competition is fierce and margins are small, as another company in the LG group has instead closed what was the world’s largest microwave oven plant in 2003. Production here will move from Newcastle in the UK, to China to avoid yearly losses of USD 25 million (ic-

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- 275 - Newcastle, 2004-06-02). The reason given for the move is the low value of the ovens, on average around USD 50, and the high wages in the UK, over USD 10/hour, being more than five times the wages that will be paid to the workers at the new factory in China (CI, 2004-09-03). Korea was not an alternative for the company as wages in Korea are, in some sectors, already on par with both the US and the UK, despite the fact that Korean manufacturers are generally less productive.

Banking and monetary policies Korea has undergone considerable financial reform since the 1997 crises, with a number of changes forced upon it by international institutions in exchange for restructuring loans. The reforms have been largely successful and resulted in a financial system that in 2004 is considered as considerably more stable than before, and as further supported by increased foreign ownership. Of the 33 banks that entered the crises, 19, and only 60% of the previous staff were left, three years after the crises (BOK, 2004-10-15).

Domestic savings are necessary for the long-term availability of investment resources, which have to be found outside of the country as a burden for the national finances. At the time of the financial crises in 1998, the savings ratio in relation to available income reached 23% In the following years, it has continuously been falling, e.g., 16% in 1999, just over 10% in 2000, 6% in 2001, 1% in 2002, restored to 5% in 2003 and up again to 9% by mid 2004 (BOK, 2004- 10-18). However Korean banks also hold bad loans and have not been able to entirely overcome this since the financial crises in 1997. By the end of 2004 the ratio had fallen by 25% during the year to a new low of 1.9%, from 13% in 1998. At the end of 2004, all the 19 banks met the target of holding less than 3% of non- performing loans (FSC, 2005-01-31). The banking sector in Korea has generally prospered not only during the economic slowdown as outstanding loans have increased sharply during 2004, generating increasing interest earnings, but also lowering the share of bad loans. For the first half of 2004 the banking sector reported its highest combined earning ever, surpassing profits for the same period in 2003 by nearly four times (Korean FSS, 2004-08-20). The difference between the interest given on deposits and loan interest rates at Kookmin Bank, the nation’s largest lender, was about 4.4% in the first half of the year. The profitable market has attracted international attention and by the end of October 2004, foreign banks held near 22% of deposits, to be compared to just 4% after the crises in 1997 (FSC, 2005-01-09).

The inflow of capital remains record strong for Korea, despite the negative development of several economic indicators discussed above. The current- account surplus in 2003 came out a surplus of USD 12.4 bn, which was nearly

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- 276 - twice the 2002 surplus of USD 7 bn (BOK, 2004-02-26). The Bank of Korea in 2004 had predicted a current-account balance surplus of USD 6 bn and an increase in consumer prices by 2.9%. Already by the end of Q1, adjustments had to be done as the current account had already surpassed the predicted level for the full year. The consumer prices' prediction also had to be adjusted upwards as it stood over 5% by the end of H1 (BOK, 2004-09-10). For 2004, the current account surplus came to just under USD 28 bn, again more than double the previous year, but still well behind the record of USD 40 bn in 1998 (BOK, 2005-01-28). The prediction from the government for trade during 2004 set a target for a trade surplus during the year of USD 10 bn, but was already surpassed after five months. Instead, predictions for the full year were doubled by mid-May (MOCIE, 2004-05-25)179. Neither was this somewhere near the correct figure as the full year resulted in a surplus of a USD 30 bn, in a year of a 31% export growth; second in the Korean history only to the 36% recorded in 1987 (ibid., 2005-01-02). As a result of the positive development and the government’s purchase of dollars to stabilize the foreign exchange rate, The Bank of Korea’s foreign exchange holdings reached USD 160 bn by the end of H1 2004. South Korea at the time, held the world's fourth largest forex reserve, only behind Japan (USD 820bn), China (USD 440) and Taiwan (USD 230) (BOJ, 2004-07-20).

The Korean Won has been on a slight rise in relation to the US dollar during 2004, supported by its large current-account surplus. By April, it had reached above 1 140, its highest value in more than three years, and by October it reached 1 129, to break through the 1 100 psychological barrier on November 15 to reach 1 092; strongest since November 1997 (Seoul Times, 2004-11-15). The value of the Korean Won has previously remained in the band of 1 160 – 1 175 to the USD, although it has practically been floating freely (KT, 2004-10-25). According to the government policy, it should not intervene in the currency market “but it must take steps to correct market failures” (BOK, 2004-05-12). Indirectly any intervention by the government in the currency market becomes a way of supporting (subsidizing) the nation's export industry. After the Won had appreciated by near 10% in just one month, a few percentage points more than the Euro and the Yen, the Bank of Korea started to increase Won circulation and to buy Dollars to defend the exchange rate (BOK, 2004-11-23). Total appreciation of the Won against the US dollar during 2004 came to 13%; starting the year at 1192 and closing at 1035. The Won is expected to continue its slide in 2005 and could stabilize near the 1000 Won to the US-dollar mark (ibid., 2005-01-25 & KCIC, 2005-01-11).

Interventions are probably not only about the USD, but also to offset an increase for the Chinese Yuan. The government would not let the won appreciate too sharply as that is likely to lead to falling profits and job-cuts in domestic

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- 277 - companies. The sudden fall in the value of the USD is expected to deal a sharp blow to Korean exporters, on which the nation’s economy largely depends for its recovery. Much also depends on other countries, and especially Korean trade rivals, if they intervene to support their currencies, then it could become unwise to allow the won to float “too freely”. As long as the Chinese Yuan is pegged to the dollar, some smaller currencies could become subject to speculation, and among them the Korean Won. The government’s foreign exchange policy has contributed to price increases, thus it should accept a drop in the foreign exchange rate to ease the price burden (Samsung ERI, 2004-08-03). From a Korean perspective China got a mixed reaction during the G7 meeting in October 2004. This is a sign that China could be revaluating its fixed exchange rate of the Yuan to the US Dollar. Such a measure could indirectly raise the value of most Asian currencies and would have the strongest effects on export- dependent countries. As an immediate result, the stock prices for export dependent Korean companies fell by 10% on the day of the news (Kopsi, 2004- 10-04). Foreign companies that are strongly export-dependent, including the biggest Korean businesses, will face increased difficulties on two of their most important markets through the continued slide of the dollar, and indirectly the Chinese Yuan, in relation to the Won. Additionally, other export contracts are often concluded in USD, and as a result, profits will be eroded when measured in Won. If the Won continues to get stronger, exports may falter, while the advantage of a stronger Won is that it makes imported goods cheaper and will indirectly dampen inflation. Although this is a medium-term effect it is also immediate, and the slow ongoing appreciation has held back inflation to around or below 5% during most of 2004 (FSO, 2004-08-30). Still, this has not helped to lift consumer spendings, that has instead been trailing, which is badly needed to make a struggling economy recover. In line with this, the Bank of Korea followed suit on the US Federal Reserves adjustment of the US interest rate by +0.25%, to lower the base interest rate by the same amount, -0.25%, to 3.25% (BOK, 2004-11-08).

The government's many initiatives must be paid for and Korea’s national debt reached a record 166 trillion by the end of 2003 with an increasing amount of public funds of about 14 trillion, which could not be recovered. This corresponds to 23% of 2003 years GDP, at 721 trillion, and as a result, the Korean national debt for the first time exceeded 20% of GDP. Korean debt/capita also increased at the same rate to reach 3.4 million (MOFE, 2004-04-27). During 2004, the debt has continued its slow increase and at the end of August totaled USD 169 bn. The rise in the foreign reserves during the year proved been even more rapid, and already in September, it became bigger than the debt for the first time, and by the end of November it totaled USD 196 bn (Yonhap, 2004-09-08 & 2004-12- 22). Since the BOK started to intervene in the currency market to offset the fall of

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- 278 - the dollar, the reserve grew by about 10% in one month. If that is a lasting phenomenon remains to be seen as the estimates for the debt points to a continued increase for several years to come and to be in the range of 300 trillions by 2008 (MOFE, 2004-10-10). These predictions have been based on a 5% GDP growth in coming years and a higher value of the USD; two basic assumptions that, only months later are developing differently.

A possible redenomination of the Won has long been discussed in Korea, and has been evaluated by the BOK as highly profitable. That would take off at least two or perhaps three zeros from the Won. The profit from such an undertaking has been set at 5 trillion (USD 2 bn), despite costs for new software, printing, and minting valued at 2.6 trillion. The positive side is savings from reduced time when counting, easier handling, less exchange of old bills and reduced controls at banks. The last point alone, over three years, would give savings of approximately the same level as the total minting cost (BOK, 2004-09-20).

Employment From a Korean perspective, its workforce is one of the most productive and dedicated in the world, and its international companies are among the most profitable within their respective groups (KOTRA, 2004-06-10). Although such a state promotion agency statement appears somewhat contradictory to other facts presented above. The total working population in Korea stood at 22.7 million in 2004, with an average education of 11.7 years. The average worker at that time was just under 44 years old, working nearly 59 hours per week and had been for nine years with the same company (MOE, 2004-08-20). In the 30 biggest listed companies in 2004, the employees' average time working for the company was just over 11 years, having increased by nearly two years since 1999.

The large generation born in the 1960, now in their 40s, has already seen fierce competition at all stages of school and university and this has continued in the work market. As one of many signs of an aging population, the number of employed persons in their 40s was 6.2 million in May 2004, surpassing for the first time the number of people in their 30s. People born in the 1960s, standing at 8.8 million, are the biggest economically active group in Korea. At the same time, the number of workers in their 60s account for over 10% of the workforce, with the economically active in the 20s having fallen to under 20% (NSO, 2004- 07-29)180. The last two groups have passed these critical marks for the first time, and clearly indicate that there is an aging workforce that is carrying the economic burden in Korea. With an aging population, the functioning of the Korean retirement system, first introduced in 1961, comes into focus. The existing system has been covering no more than 40% of retirees, as job changes and joblessness from bankruptcy has so far meant that the person has lost his

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- 279 - benefits. Despite being a burden to companies, the system has not worked well. From 2006, there will be personal accounts that will assist in making it easier to change work and from 2008 the system will also cover, for the first time, companies with less than five employees (BOK, 2004-10-15).

In Korea, as elsewhere, increasing exports has a tendency to create ever fewer new jobs, indicating a “jobless growth” trend. Despite the registered increase in production during 2003, employment decreased, indicating a relatively new economic phenomenon: the negative elasticity of employment. Job creation in the Korean economy has fallen dramatically and stood at - 0.05% during 2003, compared to + 0.41% in 2002 and 0.5% in 2001(BOK, 2004-05-26). The difference between elasticity in the service sector and in manufacturing is clear with +0.52%and -0.08%respectively for 2002, with +0.11 and –0.18 for 2003. These figures are supported statistically by that 1 billion in increased exports in 1990 led to 46 workers being hired, while the same increase in export volume in 2000 added only 16 new workers (MOFE, 2004-07-10). More capital-intensive products not only have contributed to this development, but also increasing imports of parts has reduced the share in the total value generated by domestic manual labor. It follows that a focus on increasing exports has largely failed to deliver as a major generator of employment. Employment generation is one of the most important issues on the government’s agenda, and to compensate for lost jobs, some 500 000 jobs per year needs to be created in Korea. As pointed out by the deputy Minister of Finance, Lee Hun-jai : “To create 500 000 jobs, Korea’s economy needs to grow 5 percent annually, and to do so, corporate investment and establishment of new enterprises are essential”(CI, 2004-05-05). The government believes that if only the growth is high enough, then the employment elasticity is expected to break away from the negative rule that was indicated above.

It might be so from the minister's point of view, but in times of severe price competition from industrializing countries that can offer lower wages, like China, Malaysia, Thailand and India, many basic manufacturing industries have relocated away from Korea. Aiming to reduce labor costs, many smaller- and medium-sized factories have moved abroad. It is more alarming that the number of larger factories that used to be the source of much employment, are decreasing rapidly in Korea. In December 2003, the 1617 large factories that employed more than 300 people down by 409 from the December 2001 total of 2026 (-20%) this is equivalent the closure of one factory every other day (KICC, 2004-03-26). Employment in manufacturing from 2001 to 2003 decreased by 62 000 to 4.2 million (-1%) (NSO, 2004-04-25). The difference in reduction between the two figures indicates a trend of mergers at remaining factories.

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- 280 - During the same period, another 150 000 jobs have been lost in larger manufacturing companies, but have to some extent been absorbed by smaller upstarts inside the same sector. There is not much that can be done to prevent firms from moving production abroad to cut costs and for reasons of structural adjustment. The big problem for the governments' side is that if this process occurs too quickly, then it will cause widespread employment insecurities and indirectly social problems. As shown above, the speed of the process with the employment effect received from all the new upstarts inside different sectors should be kept under control to give this time to happen. Few counter measures are available for a state, as long as wage reductions are not acceptable, which they would seldom be, apart from easing regulations and reducing other non- economic barriers, like employment issues. This is actually supported by statements from the biggest companies during 2004, when the car manufacturer KIA planned to add over 2 500 employees in its 13 overseas factories, up by 20%, while employing less than 1 000 in Korea. Not only KIA, but also other carmakers will hire considerably more overseas workers than domestically during the year, thus worsening the exodus of employment from Korea. Similar statements have been made by other large manufacturers, like Samsung, LG and Hyundai, that all will create about twice as many overseas jobs as they will do in Korea (KEF and KNSO; 2004-05-10)

What helped to keep South Korea's jobless rate relatively low during 2003 and 2004 was exporters' investments. Total registered unemployment stood at 3.5% at the end of H1 2004, still indicating that there are some 780 000 unemployed. Unemployment in the youth is about double the general level, at 7.3% in November (NSO, 2004-12-22). The age segment with the largest increase in unemployment during 2004 is in the +50 group where unemployment in the latter part of the year has been rising by some 30% per month over 2003. In the midst of serious levels of youth and “older age” unemployment, it is often among the mid-sized companies that unfilled positions can be found. Though the official number of open job positions in mid-size companies, in June 2004, stood at 140 000, it is estimated that up to 50% more jobs are available. That the two figures do not match is partly caused by the strong preference among college graduates for employment in large conglomerates. The same relates also to other unemployed as surveys have shown that unemployed practically never turned down a job offer from a large company, while over 70% had done so, at least once, from a smaller company. At the same time, as the unemployment rate remains high among younger workers, over 20% of all newly employed quit their jobs within a year, with over 65% of these are in their 20s (Joblink, 2004-08- 27). Workers who quit are not satisfied with the pay, working environment and that the company generally falls short of expectations. Young employees also show an unprecedented desire to work abroad, as near 97% of respondents to a

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- 281 - survey said that they would like take up a position abroad, with the US, not surprisingly, as first choice for over 50% of the respondents (Korea Recruit, 2004- 09-06). The work market is getting ever more difficult for the young generation as only 60%, lowest ever, of 2003 university graduates in Seoul had found work by September 2004 (CI, 2004-10-04). As a result of the continued stagnation of the economy, companies have become increasingly reluctant to hire new employees, leading to continuously increased job competition during 2004. In a survey of 180 major companies it is revealed that it has been electric and electronic companies that have taken on new staff during 2004, while companies in the local service sector have not employed them (CI, 2004-12-23). In another survey of 57 major companies, the number of applicants for announced positions had increased to 101 to 1 in September, up 35% on the same period 2003 and up 45% in 2002 (CI, 2004-11-22). Of the new jobs created, an increasing share is for irregular workers with little job security, i.e., part-time and on limited time contracts, the number is estimated to have reached 5.4 million, jumping by over 0.8 million in one year and near 2 million in four years (NSO, 2004-12-14). This group of employees could well be as large as over 8 millions, and has changed dramatically in the sense that these irregular jobholders used to be relatively unqualified, but in 2004 the share with an academic background had risen to just under 30%. Also the fact that the increasing share of irregular and part-time workers earn less than 50% of regular workers, contributes to the unfairness. This is the largest difference among the OSCD countries with the average in e.g. the EU being 70% (KT, 2004-08-23).

By mid-2004, just under 190 000 received financial unemployment support, which was just 5% less than during the crises in 1999 and nearly twice as many a one year before (Korean MOL, 2004-07-15). A person that has lost his job due to restructuring or business closure is normally entitled to 50% of previous salary for a period of between 90 to 240 days, depending on length of previous employment. The costs for the state to support this program are increasing dramatically in line with the increasing numbers of people enrolled.

In the summer of 2003, the Korean government legalized the status of 186 000 Il legal immigrants, out of an estimated stock of 300 000 Il legal workers. The remaining 124 000 were offered voluntary departure incentives at the same time as crackdowns were launched on companies using Il legal workers and followed up by forced deportations. This system was much criticized, and especially so after a handful of immigrants, under the threat of forced deportation, committed suicide (Base21, 2004-05-25). The measures were aimed at reducing the numbers of Il legal foreign workers in the country ahead of the August 2003 implementation of a new worker permit system. During 2004, the situation on the labor market has deteriorated, along with an increase in the number of Il

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- 282 - legal workers. It had proved that a large number of the workers were given permits and remained in the country after that permits had expired, lifting the total well above the level at the time of the 2003 crackdown. A status quo of the current situation is encouraged because there are a large number of small- and medium-size companies that are eager to hire this kind of workers. Il legal workers currently do much of the “3D-work” in Korea (being Dirty, Difficult and Dangerous) that the local workforce is reluctant to do (Asian Migrants, 2004-05- 05). This new legislation, put in place in August 2004, was intended to help smaller companies to find the kind of workers they need if they cannot find Korean nationals. The law is also intended to give foreign workers (holding a work permit) proper legal protection. Last year, bilateral agreements have been signed with the Philippines, Mongolia, Thailand, Vietnam, Indonesia and Sri Lanka, who’s nationals will be allowed to work legally in Korea, but all foreign workers must be registered by the authorities. Employers found to employ Il legal workers will be heavily fined and barred from the right to employ foreign workers (CI, 2004-08-17). The increased crime rate among Il legal immigrants, with the number of convicted having risen by near 100% in just one year, is at the same time eroding public support for their presence in the work market, and the country (KT, 2004-10-06). On the other hand also Korean’s overstay in other countries in even larger numbers, with their number being estimated to 350 000 (ibid.). Of the Koreans who work Il legally outside Korea, 180 000 of these are to be found in the US and about 50 000 in Japan.

A silent and slow restructuring of the Korean labor market has also been ongoing as more and more women work. However, it is not only the number of women that has increased, but also women who are also entering into fields that previously were practically reserved for men. The number of women studying technical subjects at universities and institutes has risen by over 25% from 2002 to 2003. At the same time, as several surveys have shown, up to 70% of female students do not see it as necessary to get married and that a marriage will discourage her chance to work and studies (CI, 2004-05-05). The former rules that used to ban married females from Korean universities have been lifted since 1998. Still today, there is a big difference between the number of females with higher education that are active in the labor market, 56% compared to the 91% of men with higher education. On average, 60% of working age women really works, which is lower than among neighbor countries, as the same percentage for China stood at 83% and Japan at 66% (Globewoman, 2004-05-27). The problems for female workers are still considerable as, e.g., the availability of public childcare is under 15% compared to the number of children under six. When women do find a job, the average wage level is at 62% of the average male level, to be compared to Sweden, Norway and Finland, where the same level in 2002 stood at over 80% (Korea Insight, 2004-10).

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- 283 - The Korean labor market has also been be affected by the opportunities that the ongoing globalization has given companies. As a result Korean companies have also started to take advantage of low price-foreign labor outsourcing, made possible by way of improved communication technologies. Ethnic Korean labor is available in nearby China where, e.g., Internet-related work can be preformed at about 25% of the costs in Korea. Although productivity is clearly lower, the huge margin of savings can often make up for this. In the Chinese Shenyang province, where a lot of ethnic Chinese Koreans live, this kind of establishment are being encouraged by the local authorities. Low-cost foreign language knowledge, e.g., in English is in the same way available to Korean companies in India or in the Philippines.

A low domestic consumption level has been blamed to hold back the economy, which is unexpected as a large share of the population saw their earnings fall during 2003. During the year, money earnings for the population fell for the first time in seven years, at the same time as the income gap in society widened. The bottom 10% earned 782 000 monthly, a fall of 6% in one year, while incomes for the top 10% earners increased 2% to 7 000 000 (NSO, 2004-02-15). Not only is the difference between rich and poor growing with the richest 20% earning nearly 8 times the poor, having increased with 0.5 from 2002, but also between urban and country dwellers (KNSO, 2004-06-10). Increasing income inequalities in the population will simultaneously reduce the likelihood of a recovery. Such in- equality could be shown by the commonly used Gini coefficient, measuring economic equality in a society, has increased from 0.30 to 0.36 from 1996 and to 2000. In these terms Korea is badly positioned if compared to the OSCD group of countries, just behind the US and Mexico. It is expected that the executives at large companies earn the highest salaries with a 6.2 million average, almost four times the national average of 1.7 million (KT, 2004-08-23). Richest in Korea is the Hyundai chairman Chung Mong-koo, with shareholdings worth USD 1.2 bn, just ahead of the chairman of Samsung, Lee Kun-hee, controlling holdings with a value estimated at USD 1.1 bn (CI, 2004-12-07).

The share of the population living in poverty has, during the 1998 - 2003 period, increased to 11.5%, with another 5% living on incomes just above the domestic poverty line181 (KDI, 2004-06-09). To somewhat maintain living standards, many have obviously decided to live off debts as 32% of families in 2003 (4.6 million out of 14.3) consume on a level above disposable income. As a result, household loans in September 2004, for the first time ever, exceeded the volume of corporate loans from banks (CI, 2004-10-04). Especially the 20% with the lowest incomes, having a disposable income of on average 621 000 (USD 550), consume a value of near 1.1 million, i.e., 70% above incomes. Low interest rates and very generous credits have resulted in a flash back from 2003, in the form of defaults.

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- 284 - As a result, the number of credit defaulters had, by mid-2004 reached 3.7 millions, but still with less than 0.1% having applied for individual bankruptcy (CI, 2004-08-09). Despite the willingness of consumers to go into debt to maintain consumption, supermarket sales have fallen for over 22 straight months, which is several months longer than during the financial crises in 1998. At the same time, the average household debts are constantly growing, having reached an all time high of 30.4 million per household (USD 27 000) after Q3 2004. This figure has doubled since 2000 (BOK, 2004-12-05). It is estimated that 80% of the household debt is invested in real estate in the form of housing and apartments.

It is not surprising that the Consumer Sentiment index, measuring consumer confidence in economic conditions, has been falling during 2004. Logically, Koreans have been restricting domestic consumption, as they hold a negative view of the future, and in August, confidence fell in all age groups and in all income brackets, for the first time. The year has continued in the negative, when it comes to consumer confidence, and from a value of 94 in March, the figure had fallen to 87 in August 2004. This is the lowest value since 2000, with the inflation reaching 5% (NSO, 2004-09-09). In contrast, to all these negative tendencies, companies listed on the Korean stock exchange registered record net profits during the first six months of 2004 with combined net profits reaching near 27 trillion (USD 23 billion) (KSE, 2004-08-18).

Other related issues in brief Tourism is one sector where Korea has a large and dramatically expanding deficit. Tourism abroad has seen cost increases, which include payments for foreign studies, reaching about USD 12 bn in 2003. During 2004, outbound tourism rose by 23%, with one in every five citizen going abroad; or 9.1 million (KNTO, 2004-05-02). Positive though is that during 2004, the number of visitors have turned upwards again, after a 12% fall during 2003, and could surpass even the numbers from the football World Cup 2002, when 5.4 million visitors were registered (ibid., 2004-11-21). Asian tourism is increasing the fastest. This is especially positive for the neighboring relations, with Japan where e.g. tourism is going up rapidly and has surpassed 40% of the total.

On the world corruption ranking, Korea finds itself behind most competitors as it ends up as number 47 in the world, with a position between South Africa and the Seyshelles Islands, with only China of the four just mentioned behind in the listing (Transparency, 2004-12-11). In the Korean Independent Commission Against Corruption, the state and community agencies the Ministry of Planning and Budget came out as the most “unclean” (KICAC, 2005-01-04). The largest problems can be found in the agencies issuing licenses, but the tendency of the yearly KICAC investigations is a general improvement in later.

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- 285 - 5.2. Trade

In 2004, WTO Trade Policies Review, released every four years in the case of Korea, voiced concerns on the increasing and worryingly high dependence on exports and external economic factors. The WTO argued for further economic reforms to compensate for this and continued restructuring to reduce the imbalance between consumption and exports (WTO, 2004-09-17).

Export In 2003, the Korean terms of trade index deteriorated further and came to end the year at its lowest level since 1988, and continued its decline during H1 of 2004. According to the terms of trade index that stood at 138 in 1996, has since fallen uninterruptedly, as it stood at 95 in 2002, 89 in 2003 and reached 84 by the end of 2004 (BOK, 2004-08-24 & 2005-01-27) 182. The reason behind the sharp change during the year was due to increasing global raw material and oil prices, products that constitute a large share of Korean imports, and falling prices for export products, especially for semiconductors. The current index series was introduced in 1988 with the index standing at 117, later to peak at 138 in 1995, but has since more or less shown a constant downward tendency 183.

In 2004, total export came in at USD 254 bn (+31%), having passed USD 100 million in 1964 and USD 100 bn for the first time in 1995, with 2004 imports valued at USD 225 bn (MOCIE, 2004-10-21). Already by mid June the 2004 trade surplus had reached USD 15 bn, surpassing the total for the full year in 2003 (MOCIE, 2004-07-04). The strong export was due to the international demand from several of Koreas biggest export markets like China, US, Japan and Hong Kong. This is especially true for Korea’s most important export products: semiconductors, automobiles, computers, and mobile phones184. The export growth of some important export categories, like semiconductors, reached 45% with exports for telecom equipment, computers, cars and ships seeing growth from 40 to 33%. Of all items it is PDP TV panels and mobile handsets that show the largest increases with near 100% for both. The destinations that grow the fastest are China with a 43% increase, the EU with a 40% increase and both Japan and the US with 25% over the previous year. The government had forecasted that overseas sales would rise by 12% in 2004, after having increased near 20% during 2003. Exports were expected to drive the economy to sustain Korea’s economic growth, but both assumptions were proved wrong. For 2005 most forecasts have indicated that export growth for the year will stay on the one- digit level, while the official forecast is projecting exports to rise by 12% to USD 285 bn and imports to increase by 14% to USD 257 bn (MOCIE, 2005-01-05).

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- 286 - Korea had a USD 24 bn trade deficit with Japan during 2004 while earning a surplus of near USD 14 bn with China. For Korea, this indicates that the money earned in China is being spent in Japan, while Japan is spending the money it earns in Korea on imports from China. However, in this triangular drama, Japan is improving its trade balance the most, from having had a USD 20 bn deficit vis- à-vis the other two, in only three years the deficit has contracted to USD 1 bn. This improvement can be traced back to Japanese companies that earlier invested more in own factories in China. Korean companies, that entered China later, continued to trade with their mother companies and have been late in expanding their own facilities on the Chinese market.

Imports On the import side, prices for raw materials and intermediate goods have risen sharply during the last few years and have reached their highest level since the crises in 1998. The import price index in September 2004 stood at 114, having increased by 16% in one year, with 100 as the base of the index from 2000 (BOK, 2004-10-15). This tendency is expected to transform into inflation as a 10% increase in import prices has been estimated to result in a near 2% increase in consumer prices and near 3% for producer prices. These price increases for raw and intermediary products will, sooner or later, result in rising consumer prices that are likely to put further strain on domestic consumption. During 2004, much of the 26% increase in imports, to a total of USD 225 bn, was due to higher raw material prices (MOCIE, 2005-01-05).

The sharply raising international prices of raw materials and energy and low domestic demand has contributed to low profits for domestic businesses and a focus on exports185. In this respect, the Korean situation shows a number of similarities to the Chinese situation. Financial knowledge inside small- and medium-sized companies to handle price fluctuations of this kind is relatively limited, which has made the effects of the crises considerably worse. The situation had probably been less dramatic if companies had made better use of derivatives and other risk-hedging techniques (LG - ERI, 2004-05-10). The Korean government has, during 2004, taken a string of new measures to support domestic business and ensure the supply of raw materials to industry in light of soaring international prices.

In March 2004, import tariffs on imported raw materials were lowered as their share often weighed heavily in the production cost of typical small- and mid- sized Korean companies (MOCIE, 2004-02-08). The government has also started to release, e.g., electrolytic copper and nickel, from the national reserves and to provide 230 billion (USD 200 millions) in loans to small businesses. A decision was also taken to crack down on speculative stockpiling of raw materials, but no details were given on how this measure should be followed up. Few market

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- 287 - economists would have anything to argue against the fact that an actor who is willing to take the risk of speculation should be rewarded if successful; but also made to carry the burden if unsuccessful.

Trade with China Total trade between Korea and China reached USD 57 bn during 2003, but after a 40% increase during 2004, the total reached USD 79 bn. This was enough for China to move up, with a USD 8 bn margin, to become, Korea’s most important trade partner (MOCIE, 2005-01-05). Trade with China during 2003 generated a surplus of near USD 14 bn, and increased during 2004 increased to USD 20bn, from USD 50 bn in exports (36 in 2003) and USD 30 bn in imports (22). At the same time as China has emerged as Korea's biggest export market, 30% of exports to China are destined for just one province: Guangdong. Korean exports to Guangdong surged by more than 38% in 2003 and over 40% in 2004, amounting to nearly USD 11 bn and USD 15 bn. The demand in the Guangdong region for semi-manufactured goods, from its quickly expanding electronic and IT-related industry, was particularly strong during the year (KITA, 2004-02-11 & 2005-01-31).

The trade surplus with China is projected to shrink to USD 7 bn by 2008, and could at the present trend turn negative by 2011 (KITA, 2004-02-04). At the Korean – China presidential meeting in 2003, the goal for bilateral trade was set to USD 100 bn for the year 2008. The Chinese government encourages Korean companies’ investments, especially in projects to develop the lagging behind industry of western and northeast China, which is hoped to also benefit from Korean economy. KITA, however, expects exports to China in 2008 to have reached beyond USD 75 bn, with imports of USD 68 bn the same year, and to have equaled out at around USD 105 bn by 2011.

Korea is rapidly becoming ever more dependent on China, that became the largest Korean FDI destination in 2002 and export market in 2003, overtaking the US on both accounts. Increased dependence on one market is always worrying and the growth rate in the relation to China is impressive with exports increasing by near 50% during 2003 and 40% during 2004, to reach 18% of total export. Yet more important is that the trade with China accounted for 2/3 of the national trade surplus for the year.

Surveys have shown that Chinese youth consumers see Korean products as better designed and more innovative, although Japanese products are seen as having good quality (Hakuhodo Inc., 2004-04-09). The “cool products with good sense” answer was given by 32% to Korea, with Japan 30% and US 28%. More than 2/3 of respondents (68%) replied that “high-quality” referred to Japanese products with only 26% said this about Korean products.

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- 288 - The trade relation with China is not rosy due to 19 current cases of dumping against Korean exporters. In June 2004, the first preliminary Chinese dumping charges against foreign optical fibers exporters was introduced, with Korean exporters being forced to pay a dumping margin of 7 – 46% (KITA, 2004-06-17). The importance in the charges against the optical fiber producers is that this is the first dumping charge set by China on a high- tech product, which makes it likely that more of this kind will come in the future.

Trade with Japan Since diplomatic relations with Japan were normalized in 1965, trade, investment and individual exchanges have increased dramatically. However, trade and investment between the two countries stagnated throughout the 1990s and fell further during the Asian currency crisis in the summer of 1997. The crises spread to Korea, which came to suffer a severe economic stagnation, while Japan had to live through a prolonged recession in the 1990s, with both countries showing a negative growth rate in 1998.

At the same time, as trade with China is extremely profitable for Korea, trade with Japan displays an ever widening trade deficit. Korea remains dependent on Japanese chips as inputs in its own export products, but also on steel and petrochemicals as the most important product groups. This is a mutual dependence as Korea is Japan’s third biggest export market. The imbalance in trade is increasing rapidly, with imports for 2004 having reached nearly USD 46 bn while exports reached just USD 22 bn. As a result, the trade deficit came out larger than the Korean export, or nearly USD 24 bn, more than doubling from the USD 11 bn for the full year 2000 (MOFE, 2004-10-29 & MOCIE, 2005-01-05). The Korean trade deficit with Japan is even USD 1 bn bigger than the trade deficit with the combined group of countries in the Middle East; in a year of record high-energy prices. The accumulated Korean trade deficit with Japan since 1960, including 2004, stands at no less than USD 240 bn. Precision machinery, industrial electronics goods and steel products from Japan are the most important items among Japanese exports in 2004. Noticeable products imported from Japan are equipment for the manufacturing of mobile communications goods and semiconductors nearly doubled during the period; all used in the production of the most important Korean export products (KITA, 2004-09-06). Korean goods constituted 4.7% of the Japanese imports in 2003, and this has only changed marginally over the last ten years.

Trade with the US In 2003, Korea exported products to the US to a value of USD 37 bn, corresponding to 2.9% of total US imports, but still small in relation to the four biggest; Canada, Mexico, China, and Japan supplying an 18%, 12%, 11% and a 9% share each of US imports186. Similar to total Korean exports there are just a

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- 289 - handful of major products that dominates in the exports to the US market, with just three products making up 57% of the value; vehicles, mobile phones, and different electronic communication parts. Other major exporters to the US, like China, Taiwan, Mexico and Japan showed a much lower dependency for their five most important products: 36%, 26%, 33% and 44% respectively. At the same time, the Korean growth in export is alarming low, compared to that of China, 4% and 22%, respectively (KOTRA, 2004-03-03). China overtook Korea as exporter to the US in 1992. While the Korean share in US trade has stayed around 3% since, the Chinese share has increased to over 10%. With its relatively small share in the imports of the world’s largest importer, the Korean dependence on just a handful of products could prove to be a dangerous strategy. That is from both the point of view of innovations in these fields as well as if there would come up restrictions on the import side. Worrying from a Korean point of view is the increasing penetration in the market of high price segment by goods produced in China, where much of the above-mentioned growth is taking place. China is emerging as a serious competitor, during 2003 about 63% of Korean exports was competing with Chinese products in its potential export markets (KDB, 2004-01-28). One such sector is textiles where Korean export to the US market could be hard hit from the abolishing of the textile quotas from 2005 when Chinese exports are expected to make prices fall by 20 - 80% for different products (KOTRA, 2004-09-30). It is feared that the Korean textile export to the US market will be hit hard, due to an expected fall in prices of cotton and wool products, which will lead to a reduction in the number of workplaces. For 2004, total exports grew by 25% to USD 43 bn, with imports increasing by 9% to USD 29 bn, resulting in record surplus of USD 14 bn (KEIA, 2004-09-10 & MOCIE, 2005-01-05).

Trade with others Korean exports to ASEAN members came to nearly USD 24 bn in 2004 (20 in 2003), while imports from the ASEAN region nearly balanced exports coming to USD 22 bn (18), constituting approximately 10% of ASEAN’s total trade. At the same time, Korea’s trade surplus with the ASEAN group, in over just 8 years, has contracted to just 20% of the level recorded in 1996, from USD 8.2 bn to USD 2 bn for 2004. During the same period, the Korean share of ASEAN trade has been more or less stable around 5% while the Chinese share in the same period has grown from around 6% to over 9%, with Japan’s 16% being the largest (ASEAN, 2004-10-10 & MOCIE, 2005-01-05). In principle, the Korean surplus has dropped because of increased competition from cheaper Chinese products and high-quality Japanese goods. Korea should strengthen the marketing of products with comparative superiority to not lose out further, or at least maintain its markets. However, is should also push forward with the signing of free trade agreements with the more important of the ASEAN countries (KOTRA, 2004-04- 06).

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- 290 - Trade with the Europe is rising strongly and has gone up from USD 40 bn in 2001, to USD 71 bn in 2004, from USD 45 bn in exports and 31 bn in imports. With the extended EU 25, the trade volume had go well beyond USD 60 bn for 2004 (Eurostat, 2004-10-29 & MOCIE, 2005-01-05). Out of Korean trade with European nations, the EU takes over 80%, with Germany as the largest single market, with a balanced trade of about USD 8 bn in both export and import.

Trade between Russia and South Korea is also developing very positively, having nearly increased by 80% from 2001. In 2001, the value stood at about USD 3 bn to nearly reach USD 6 bn for 2004. Trade between the two has, in later years, relatively and persistently seen the value of imports from Russia constitute about 2/3 of the trade value (MOFE, 2004-08-02 & 2004-01-05).

Total inter-Korean trade, according to the Ministry of Unification, fell by nearly 4% during 2004 to just under USD 700 million. Imports decreased 11% to USD 258 million while exports were up by 1% to USD 439 million. South Korean imports has seen much of the worth of goods being textiles and agro-fisheries while a large share of the export has been constituted by steel and chemical goods. The fall in imports during 2004 is attributed not only to the bankruptcy of some major textile manufacturers, but also to falling domestic consumption.

Miscellaneous products Korean exports have remained strong despite global downturn. However, there are still growing domestic concerns that Korea needs to break away from, e.g., its reliance on just some few export products, topped by semiconductors, cars and wireless communications equipment. Semiconductor exports was, in 2003, the most important item for the 12 years in a row. During the year, shipments of non-memory chips alone totaled just under USD 20 bn, up 18% over 2002, making up slightly more than 10% of total exports. Meanwhile, chip imports were up by 22 % to 21 bn. This translates into a trade deficit, for the third consecutive year, of nearly USD 2 bn for the countries most important export item187. Cars and wireless communication equipment has been the two items behind semiconductors in importance, and the mentioned three products, together with the next two, computers and ships, are becoming increasingly important. Together, these five accounted for 43% of Korean exports in 2003 and by the end of July 2004, approached 45% (KITA, 2004-09-09). A level of dependence on these five products that is on the rise, as the product among the five that rose the slowest increased its export volume by 36%, while semiconductors increased by 53%. The dependence has increased by nearly 6% in just three years, which could make the country alarmingly vulnerable to fast changing market conditions in these segments. The result of competition has already shown in the export of several important products. The negative

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- 291 - tendency of prices in high tech sectors was initiated in 1999, when average export prices fell by 19% during the year. Export prices for items like DRAM chips and television-related good, weighing heavily in the Korean export, was down by 19% and 14%, respectively during 2003, and the trend has clearly continued during 2004. Prices for flash memory chips, LCDs and for DRAMs have all been falling during every month of the year (BOK, 2004-08-15).

According to a Korean survey, China is catching up with Korea in terms of technological advancement. The technological level of Korea's export items will be equivalent to that of China by 2010. Currently, China is only 2 years behind Korea in the mobile handset industry, 8 years behind in the TFT - LCD industry and 7 to 10 years in the petrochemical sector (MOCIE, 2004-05-05). The same kind of estimations from a large-scale survey among Japanese manufacturers indicates that China will surpass Korea and reach the level of Japan, within ten years (Nihon Keizai, 2004-07-29). The scores for “technological power” registered by the news agency survey placed the US first at 4.6, out of 5, with Europe and Japan at 4, Korea at 3.3 and China at 2.6. What is worrying about these kinds of figures is when foreign trade for the NEA group of countries is compared with each other an increasing overlap of products can be identified. As observed in Korea during Q1 2004, 14 export items out of the 30 most important, overlapped with those of both Japan and China. How rapidly markets are changing is clearly indicated when considering the overlap for the same period just one year earlier of just 6 products. In 1998, just five years earlier, only 9 out of the top 30 Korean products overlapped with any Chinese or Japanese product (KITA, 2004- 05-30).

According to the Korea Chamber of Commerce and Industry (KCCI), the number of internationally acknowledged first class products made by Korean corporations amounts to 53 products in 2003. This is only 6% of that of the US, that had 954, and 7% of that of China’s 753 products. In 1994, the same figure was 82, i.e., decreasing by 29 products over 10 years, while the number of US “first class products” has increased by 178 products in the same time period. In 1994 China had 383 products on the list and managed to nearly double its number, while Japan, showed a slight decrease (KCCI, 2004-04-13). As other surveys have shown, Korean technological level is only 60% of that of developed countries. The declining number of first class products is perhaps no surprise. Increasing the number of highly rated products is a priority in strengthening the long term Korean competitiveness (KCCI, 2004-04-13). Although competition is generally increasing on the export market, the situation could still be favorable for individual products. As analyzed by the Korea Export Promotion Agency, 77 products dominated its export and was number one in world sales in 2002; five more products than the year before. The US dominated the world in this respect,

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- 292 - being the leader with 884 items (KOTRA, 2004-08-11). For Korea to maintain its competitive edge in key sectors in relation to China in the future it must develop more high-tech components, cut manufacturing costs and further differentiate its products. Along with these efforts, Korea must cooperate with China, as both a supplier and as a market to achieve win-win situations. A problem for Korea is that China has been more stringent than other developing countries in demanding investors to transfer new technology. China has therefore managed to bring in relatively advanced technologies from abroad inside just a decade, in a way that practically no other country before China has managed to do. A development process that has included the promotion of mergers among Chinese companies as well as acquisitions by foreign newcomers.

There are two major worries connected to this development as it is becoming increasingly difficult for Korea to remain an important exporter of several products. Not only has China generally low costs, but Korean producers are rapidly building new production units in China. Eventually, this is bound to reduce the demand for parts from Korea’s biggest market in the future, but Korea also runs the risk that these new production facilities will be the ones used by the Korean parent company for future exports to overseas markets.

5.2.1. WTO and (free) trade agreements

Only during 2003, it has been estimated that Korea lost USD 600 millions in exports because neighboring countries' favor their FTA partners (MOCIE, 2004- 02-07). The successful conclusion of future FTAs has a great effect on the Korean export, currently being concluded or negotiated between USA – Singapore, Japan – Chile and Thailand – India, could mean an additional loss of the same amount. This development aggravates the potential negative effects from further delays in the negotiations of FTAs with other countries. Korea should therefore take urgent steps to its efforts in negotiating FTAs, as soon as possible. The number of existing agreements, at the end of 2004, was worryingly low, just one, with Chile. As a result the government has, under the Foreign Affairs and Trade Ministry, decided to set up a special FTA Bureau to better coordinate the national efforts in this field (CI, 2004-12-21).

For a relatively small actor as Korea, it remains important to keep up with the global economy as closely as possible as trade conflicts are still very much present. Korean manufacturers were estimated to be facing a total of 140 safeguard measures in some 19 nations as of the end of October 2003. In neighboring China alone, the import of Korean products were restricted by 18 safeguards, while there were 24 active measures in India (KITA, 2004-02-19).

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- 293 - With the Korean government's increased emphasis on free trade, it has also actively started to promote negotiations with Canada, Mexico, Mercosur and India for future FTAs. India is a market with over 1 billion people, Canada and Mexico are members of the NAFTA and Mercosur being a common area for the southern part of South America, they are all important future trade partners. Other countries on the FTA agenda are the European Free Trade Area (EFTA) members, (Switzerland Norway and Iceland). A group that is closely associated with the EU and will serve as a very good test case in preparation for possible future FTA negotiations with the EU (MOCIE, 2004-06-10). Both the EU, and especially the new EU members, has been rapidly expanding markets for Korean exports. With the EU expansion, the Korean side is fears that there could be a considerable trade diversion inside the EU in favor of the new members. Making the negotiations for a possible future FTA even more urgent. Practically all major Korean companies have already established production units in the new member countries, profiting simultaneously from low wages and membership.

Negotiations with Singapore have been ongoing for almost a year with a draft for a final agreement being signed by the two parties in the final days of November 2004. At the same time, an agreement is also being discussed with the ASEAN group ten countries that saw Singapore as one of its founding members. There has also been positive advancement with several delegation meetings having been held during 2004, and with the two sides planning to start real negotiations in 2005 to sing a final draft in 2005 (CI, 2004-11-24).

The relation with Japan In the course of the recovery from the economic hardship in 1997 - 98, the leaders of Japan and Korea found the time to re-examine the bilateral relationship. This has advanced to stage where Korean and Japanese officials held the first round of official FTA talks in December 2003 with what, at the time, was a hope to conclude a free trade agreement by the end of 2005. High level talks between the two with the intention to find a basic direction towards a mutual FTA has advanced positively, but slowly, so far. During subsequent meetings on minister level the work to sort out details has been organized in committees. Subcommittees have been set up to hold meetings concerning six important subjects: trade in goods, non-tariff barriers, investments and services, other trade issues, economic cooperation and settlements of disputes. The next issue to be negotiated is mutual recognition of product testing and standards. The two parties in 20044 agreed on a custom pact to facilitate mutual assistance and harmonizing procedures (JT, 2004-12-14). Sharply rising Japanese investments in Korea during 2004 could be interpreted as occurring in anticipation of a future agreement. During the first nine months of 2004, investments had reached USD 1.6 bn, up from USD 340 in 2003, lifting the Japanese share from under 10% to just above 20% (MOCIE, 2004-12-01).

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- 294 - The negotiations between Korea and Japan preparing for a future FTA are difficult, which is indicated by the fact that 73% of Korean exports compete with Japanese products on international export markets. Competition between the two is apparently escalating as the same figure stood at around 65% in 1998 (KDB, 2004-01-28). Examples of fields where the competition between the two is full-fledged and fierce are shipbuilding, automobile and steel. With a rapidly increasing Korean trade deficit with Japan that reached USD 24 bn during 2004, it could well become increasingly difficult to find local Korean support to a further opening of its market. In late 2004, the Japanese Ministry of Finance officially warned against premature expectations of an agreement being reached in the near future.

The relation with the US The trade relation between Korea and the US is currently being strained by a few bilateral issues, which have proven very difficult indeed to resolve. Korea has banned the import of American beef since January 2004, due to domestic concerns over mad cow disease, while Korea has been put on the US priority list due to intellectual property piracy. As Korea is the US sixth largest export market, the Korean failure in meeting international standards in protecting US music and films against piracy is indeed serious. The Korean requirement of a 40% minimum of domestic films to be shown in local cinemas is another constant issue of discussion (CI, 2004-11-15).

As a large agri-product exporter, the US concerns over the Korean market is not only limited to beef, but also to rice that currently is imported under what has been named the Minimum Market Access Quota. Several rounds of talks have been held to shift this system into a tariff system, while Korea wants to maintain the quota system. Under a 1994 agreement, Korea has been allowed to protect its rice market for ten years, and will have to bring in changes during 2005. The import quota is currently set under 4%, with no imported rice being sold in the retail sector (US Agri. Dept., 2004-08-18). Changing food habits, with instant food like noodles and bread becoming increasingly popular, has meant that per capita rice consumption in Korea has fallen by nearly 1/3 over 15 years; from 112 kg/year/capita in 1990 to 82 kg in 2004. This puts increasing pressure on remaining farmers and indirectly on the Korean government. Other key issues in the relation to the US, apart from rice, are US countervailing duties on Korean memory chips as well as Korea's stringent customs clearance regulations on other agriculture imports from the US.

To add to the tense relation between the two, Korea was among the countries that were given the right by a WTO ruling to retaliate against the US “Byrd Act”. The US actions are estimated to have caused damages to about USD 29 millions

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- 295 - over two years to Korean exporters (WTO 2004-09-01, CI 2004-09-02). The actions to be taken in retaliations from the Korean side are very sensitive towards a long time partner (see also the chapter on WTO under Japan). A persistent problem for Korea, as for its neighbours, is the US visa policy that is making not only conventional traveling more difficult, but also spills over to business contacts. In an attempt to resolve mutual problem the two have since years staged quarterly meetings (Korea Insight, 2004-09).

Despite ups-and-downs in the relation, the US is said to have indicated unofficially that negotiations of an FTA with Korea could be a possible option in the near future, because the US rather wants few major agreements with large partners than a large number with smaller trade nations. However, any hopes of that this could become reality was ruined by the US Trade Representative that see it as impossible as long as the Korea keeps it agricultural market practically closed for US products (USTR, 2004-09-21). If such an agreement could have been reached, it then had been forecasted to give gains 12 times larger to Korea then eventual losses from trade under a US FTA. Again indicating that rice and farming gets, what from the outside looks to be, disproportionately much attention (Samsung ERI, 2004-12-15).

The FTA with Chile The Korean FTA with Chile that took effect in April 1 2004, was not only the first for Korea, it was also the first one for an Asian nation across the Pacific, although soon to be followed by the one between Japan and Mexico. Being the first FTA concluded by Korea, it shows that Korea has so far had difficulties to distinguish between the advantages and disadvantages that are at stake, resulting in the conclusion of only one FTA agreement.

After three years of negotiations, Korea and Chile signed an FTA in October 2002. The resistance to the agreement has been especially strong from Korean farmers, fearing that cheaper products from Chile would force farmers out of business. Agricultural issues were the main stumbling block that kept the FTA stuck in the Korean parliament for 15 months until it finally passed its third and final reading in February 2004. An additional farming support fund of 1.2 trillion, over four years, had to be established to make the approval possible in Parliament.

Although an agreement was signed with Chile, the 20-month ratification period, from the signing in October 2002, until it took effect in April 2004, saw many Korean products lose out to EU and US products for just that reason. The EU signed an FTA with Chile in February 2003, which rapidly came to increase its car and car parts exports to Chile, often at the expense of Korean producers. The US FTA with Chile was signed in June 2003, ratified quickly by both parties and

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- 296 - took effect on January 1 2004. China has recently proposed an FTA with Chile, and if such an agreement comes in place, Korean exporters will be facing severe price competition. Chile is a part of the Mercosur customs union together with Argentina, Brazil, Paraguay and Uruguay. Through an FTA with Chile, some Korea products and Korean production in Chile gets tariff-free access to large parts of South America.

In its agreement with Chile, Korea, on the day the agreement took effect, abolished tariffs on 87% of all industrial goods and most agricultural products, fish and forestry products imported from Chile. Tariffs have been lifted on 224 Chilean agricultural products where there are no or very limited competition from Korean producers. An increased import of Chilean pork is expected to lower the price of pork in Korea to under USD 6.50 per kg. Prices for red wine will go down by 2.5% per year during 5 years. Fruits like apples and pears, which are also harvested in Korea, have been excluded from the agreement, as well as rice. Chile, on its part, has sharply reduced fees on 42% of some 2 500 Korean items, including cars, mobile phones and computers. For other products, like tires and vacuum cleaners, fees will be reduced over ten years, while some other home appliances, like refrigerators and washing machines, have been excluded from the agreement (KITA, 2004-04-01).

It could be seen as a warning of the difficulty to foresee the effects of an FTA, as the Korean deficit in its trade with Chile has, five months after the FTA took effect, reached the level of the full year 2003. Chile has continued to export copper, paper and wine to a market that is one of the quickest expanding wine markets in the world (KT, 2004-09-07). Prices of, e.g., copper have been rising dramatically during the year and it is not clear from preliminary statistics if the souring trade with Chile is generated by a trade diversion effect due to the FTA agreement (in favor of Chile), or by just increasing prices, on copper. For the full year 2004, trade with Chile reached USD 2.6 bn, from exports of USD 0.7 bn and imports of USD 1.9 bn, resulting in a deficit of USD 1.2 bn (MOCIE, 2005-01-05).

In a world with an increasing number of global trading alliances being formed, Korea continues to lag behind in this respect. The necessity of establishing FTAs with potential export markets has increased in importance as a form of indiscrete discrimination towards non-FTA nations. Mexico is just one example, out a number of such examples, where tariffs for imported cars and related parts from nations not holding FTAs, like Korea, have been raised significantly. Malaysian steel import is another such example, EU textiles, newsprints in Vietnam, and car tires in Brazil are all other such examples. A market of great concern is India, where an FTA with Thailand is being negotiated. If concluded, foreign producers that manufacture in Thailand will be able to export freely to India, which Korean-based producer will not.

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- 297 - 5.2.2. Neighbor relations

North Korea At the June 2000 summit in Pyongyang, Kim Dae Jung became the first South Korean leader to visit North Korea since the peninsula was divided in 1945.

The northern neighbor has caused much concern in later years with its suspected nuclear program, but it also holds an army of about 1 million. The initiation of talks have improved the international rating of the Korea debt by the Moody’s agency, after having been down rated in February 2003. The change is due to that the valuation of a future conflict on the Korean peninsula is seen a considerably reduced as a result of the six-party talks and a future that includes a “complete, verifiable and irreversible”, nuclear-free zone being created (KIS- Moody’s, 2004-06-10). A warning is also being issued that US troop withdrawals will not only reduce military capabilities but could also considerably weaken the links to the US. The US announcement of troop withdrawals of about 1/3 of its troops from Korea is feared in the south to send the wrong signals to the North. As this has been one of the several demands from the North, the refusal to dismantle their nuclear weapons has informally been accepted, or at least given them a favor.

On the micro level, the relation is slowly improving with a continuing exchange of people between the two. During 2004 about 2 000 people were given the possibility to reunite with relatives and about 80% of the 1 600 contact applications were approved during the year. The construction of a special family reunification centre has long been negotiated and construction work is expected to start during 2005. During the year, 29 000 visitors were granted visas to North Korea, which was up by over 70%.

The US The US is not exactly a neighbor to Korea, but as the US, in 2004, holds about 37 000 soldiers in Korea, and have had a strong military presence since the Korean war, the US must be looked upon as a “neighbor”. Despite being close in the defense field, Korea still holds a very complicated relation with the US as shown in the field of trade above. These problems were again demonstrated in June 2004 when the US unilaterally declared that it will withdraw 12 500 of its soldiers from Korea by the end of 2005. The US suggestion was later renegotiated and the troop reduction will go ahead, but at a much slower rate. This could be seen in the light of the Korean public opinion that is divided on the advantages and disadvantages of the large US military presence in Korea and especially so about Korea’s participation in Iraq. Still, this large military presence contributes considerably to the local economy, apart from the security aspect.

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- 298 - China Korea has kept a low diplomatic profile in its relation with it big neighbor, but especially one historic issue has clearly broken that near silence. In recent years, Chinese scholars have come to claim that the ancient Koguryo Kingdom, (or Goguryeo) was a regional government subject of China. The Chinese Foreign Ministry has made these claims official by posting this change on its homepage. The two current nations on the Korean Peninsula have no doubt that the two kingdoms are part of their history and see the Chinese position as a bid to distort early Korean history. To make the issue even more sensitive, the UNESCO in 2004 included the Koguryo tomb mural paintings on its World Heritage sites list (UNESCO, 2004-08-10). The positive result that could come out of this tragic- comic discussion is another reminder of the common history of the two Koreas. This debate on history has developed into something like a diplomatic row between South Korea and China. Soon after the diplomatic row broke out in the open, the Chinese ministry erased all information on pre-WWII history of Korea (and Japan) from its site (FMPRC, 2004-08-10). North Korea has also opposed to the Chinese claims of historic sovereignty over Koguryo and Balhae, but has been considerably more reluctant to officially criticize the Chinese position than it southern neighbor. North Korea has avoided mentioning China as the country distorting history and has instead referred to it as “foreign nations”(KT, 2004-09- 14). However, the Korean position against China has generally been low profile and “quite diplomacy” has been the rule. This has not been the case when similar protests have been forwarded to Japan (KT, 2005-01-14).

Koguryo, or Goguryeo, was a kingdom that stretched from the upper Korean Peninsula into what is Manchuria today, in the years from 37 B.C. to 668 A.D. The kingdom of Balhae was established by a former Koguryo general 30 years after the fall of Koguryo. In the Korean version, the people of Koguryo formed Balhae and its territories were almost identical. This époque played a great role in developing early Korean history with Balhae existing for more than 200 years from 698 A.D. to 926. Historians have given the kingdom of Balhae a reputation of having had an advanced political and military system affecting the neighboring regions. Balhae is also given the reputation of having had a considerably more developed culture and economy than its neighboring kingdoms (Korea.net, 2004-08-01).

Japan Also in Korea it has caused concerns among ordinary people, and hurting mutual relations, when the Japanese Prime Minister Junichiro Koizumi has been visiting the Yasukuni Shrine, which also honors Class A war criminals. With this in mind, it is difficult from the Korean side to understand the Japanese request for “respect for each other’s position”. In Korea, the memories of the victims after the Great Kanto Earthquake in 1923, the tragedy of the young Korean men who

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- 299 - were conscripted into the Japanese military only to be executed and the women who were forcibly taken away as “service women” during the Pacific War, are especially strong188. The above-mentioned feelings are not pacified when the Japanese side has continued to impose the same distorted view of the common history to the next generation. It is not only in China that the so called “text book incident” has again come to initiate a debate on the Japanese sincerity and its will to correct mistakes in the past (further discussed under Japan and China).

Russia Having established diplomatic relations in 1990, Korea and Russia have not seen any major bilateral crises since the shooting down of the Korean Air Flight 007 Boeing 747 airliner in August of 1983, killing 270 people. There is also an ethnic connection to be found between the two, as the Russian Far East holds a Korean minority. Emigrants that started to settle there in the 1860s, of which 150 – 200 000, under the years of Stalin, were moved by force to Central Asia. During transition years, many in this group have made their way back to the Far East. With President Roh’s visit to Moscow in September 2004, the improved relation between the two was confirmed in the form of a declaration of “mutual trust and comprehensive partnership” including and agreement to hold regular talks in the future (Kremlin, 2004-09-22). The current day relation with Russia revolves around three issues: energy, transport and the North Korean stand off.

On the energy front, Korea has not given up hopes to one day be connected to Siberian gas, and possibly oil findings. This issue has been discussed for years. During the president's visit to Moscow in 2004, a memorandum of understanding was signed (not a contract) for Korean companies to participate in the pipeline construction and oil field exploration in both Siberia and Sakhalin. As for transport, there is the intention to connect the Trans Siberian Railway with the Korean network, which would ultimately make it reach all the way to the port of Busan. This issue depends on the results of the six-party talks and a future acceptance from North Korea. The third issue, the nuclear problem, is the key question in making it possible to realize both the two first mentioned on any larger scale. Russia and Korea have both argued for large-scale aid program to be suggested to the North in compensation for a secured cancellation of the nuclear program. The two have also agreed on the goal of a nuclear-free Korean peninsula.

Generally, the two countries ought to be very complementary indeed in the economic field and trade between the two should hold a considerable potential for a future increase.

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- 300 - 5.3. Energy

Korea is not a country endowed with any larger domestic energy resources. Of natural energy resources, Korea originally only processed limited coal, hydropower and wood resources that can contribute to the energy supply, but in 1987 the first gas findings could be added to this list of domestic energy sources.

In the energy sector, Korea has a history similar to that of Japan, with a strong oil dependence that turned into a major problem in line with the 1973 and 1979 oil crises. From the point of energy use, the industrialization process in Korea that took off prior to the first energy crises, still came to be much based on energy from oil. Somewhat surprisingly, oil dependence, having stood at 47% in 1970, had increased to over 60% by 1980. Total energy consumption in Korea has grown very rapidly and slightly more than doubled from 1970 to 1980, and again so by 1990 and once more until 2000. At the same time, as total energy consumption increased ten times during this period, oil consumption increased by a factor of 12. Small growth figures compared to the increase of per capita consumption of electricity during the same 30 years that shoot up 22 times (MOCIE, 2004-08-15). From the time after the energy crises, the use of imported coal was expanded, only to be complemented by the introduction of nuclear power as an additional source of energy. Over the last few decades, the base of energy has been widening with the growing importance of LNG. This energy resource was added already in the early 1980’s, but consumption jumped by more than 600% during the first five years in the 1990s. Exploration for oil and gas on land and at sea has continuously been conducted since 1980 by the Korean National Oil Company (KNOC) but still part of the continental shelf has still not been surveyed.

In Korea, it is currently the Ministry of Commerce Industry & Energy that formulates the overall policy for energy and coordinates the basic plans for electricity generation. In preparation of an “age with high oil prices” the government has initiated the work with a three-year energy conservation plan from 2005 - 2007. Energy efficiency in Korea is generally seen as low, with its industrial energy efficiency having been estimated to be 40% below that of Japan (KITA, 2004-05-12). Among a list of measures, large companies will be obliged to yearly diagnose energy efficiency, enhance energy conservation, intensify the use of recycled energy and plan the compulsory usage of high efficiency electric motors (MOCIE, 2004-08-10). To make matters worse, recent research has indicated that 11% of total electricity consumption in 2003 was wasted by active standby of electrical appliances (Kemco, 2004-10-11). With, e.g., the US state organizations having decided not to buy equipment using more than 1 Watt at

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- 301 - standby, which conventionally is near 10 W, something still has to be adopted by manufacturers in Korea.

When oil prices started their latest dramatic rise in the beginning of 2004, stringent measures were prepared by the government to meet the need to restrict consumption in the country. At that stage measures like, e.g., the banning of traffic with cars with number plates with a last digit that corresponds to the date, were discussed. However, this has not come about as high prices have, by itself, made consumption, as well as petrol sale, fall to its lowest level in years.

The expansion of electric generation capacity that is currently under construction will increase available capacity by near 30%, although some of this will replace low efficiency older capacity. The plans for the next five years include a considerable expansion in nuclear capacity, followed by a near as large expansion of capacity from coal, 6 GW compared to 5 GW, or together over 75% of the total. It is slightly unconventional that the capacity of hydropower pumped storages will be extended by as much as 2.4 GW, which if the equivalent of three nuclear power units. The basis for this is the nuclear power that can feed these stations at non-peak hours.

However, Korea remains highly dependent on imported energy, as it has limited coal and gas resources that, together with its hydro power make-up some 15% of consumption. With a wider definition, nuclear energy can also be included in the calculation, and then the share rises to about 40%, as such a definition will make it possible to include the pumped storage capacity into the calculation. As a security measure, the government, in cooperation with commercial companies, normally stockpiles about 100 – 110 days' worth of emergency oil reserves, with a day estimated at near 300 000 tons (KNOC, 2004-03-21).

5.3.1. Petroleum

Trade statistics show that Korea is probably the most severely affected by higher oil prices among the more important Asian nations, due to its high dependence on foreign energy. During 2003, Korea even spent more on crude imports than China, USD 23 bn and USD 20 bn, respectively (KITA, 2004-05-12).

During 2004, oil consumption has been falling dramatically, by 10 – 15%, and total consumption per month has been the lowest since 1999, with industry consumption having fallen even more dramatically (KNOC, 2004-04-05). With constant high prices for oil in later years, the dependency on oil as source of

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- 302 - energy has fallen and by July 2004 it reached its lowest level since 1990, at 46% (NSO, 2004-08-09). Back in 1970, the dependence stood at about the same level, 47%, but reached its highest degree at 61% in 1980, and then fell to under 54% in 1990, but to again grow above 60% in the strong growth of 1996. The dependence has constantly been downward and was back at 47% for 2004, and this trend is expected to continue in the medium term (MOCIE, 2004-09-12 & 2005-01-31).

Korea is, through KNOC, actively trying to reduce its strong dependence on the Persian Gulf by finding alternative suppliers. In line with these ambitions, KNOC has signed a USD 250 million agreement with Russian Rosneft for exploration efforts in Sakhalin and explorations in Kamtjatka for oil reserves of estimated to 240 mt (RIA-Novosti, 2004-09-21). Putin and Roh also discussed possible South Korean investments in oil refineries and gas pipelines in eastern Siberia. Still, it is Saudi Arabia and Dubai that has long been, and remains, the biggest suppliers of oil for the Korean market. Contacts between Korea and these two are well established and regular meetings are being held where not only supply, but also bilateral business exchange and investments, are on the agenda.

During President Roh’s state visit to Kazakhstan in September 2004, a deal was signed with KazMunaiGas as the state oil company in Kazakhstan. It will give a Korean Consortia, lead by KNOC, the right to develop a capacity of about 15 000 ton per day. The aim of the deal is to widen the geographical base for the Korean oil import, but how the oil will reach Korea remains to be settled.

5.3.2. Gas

This sector has, in its 30 years of history, been dominated by the state-owned Korean Gas Corporation (KOGAS) that was set up in 1983. In 1997, it was converted into a government invested-organization, to prepare it for future privatization. The first natural gas came into use for domestic consumers, as well as for heating/electric generation, in 1986, and has been made available in most of the country. The introduction of gas came as a reply to the need to further diversify the energy base and as a result, the mainline gas network has since been extended to over 2 500 km (KOGAS, 2004-06-28). The single biggest consumers are the five energy stations that have been build, which together holds over 50 generation units. The share of gas/LNG in the Korean energy consumption has been increasing since its introduction, reaching the level of 5% in 1994, then 10% in 2000 and has just surpassed 15% during H1 2004 (NSO, 2004-08-09). The generation is still some 30% below the capacity installed in the

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- 303 - sector. Surprisingly, the new project under construction or planned by the major energy companies include only two LNG stations with a combined capacity of 1.4 GW (CEPCO, 2004-07-07). If the current projects will be carried through as planned, then the share of LNG will be falling in the near future for the first time in some 20 years. Still, 2004 was an important year in the history of Korean natural gas, as the first domestic gas was finally, near 20 years after offshore prospecting started, taken ashore from the Donghae-1 gas field. With a production of 400 000 tons of LNG/year, the field is expected to last for about fifteen years. This production will correspond to the energy consumption by over 300 000 households, in first of all the Ulsan province.

During President Roh’s visit to Russia in 2004, it was also indicated that KOGAS will actively participate in the development of the Siberian Kovykta gas field, controlled by TNK-BP. This gas field is expected to connect a pipeline to China in the near future and perhaps, in perspective, onwards to South Korea. Additionally, another long-term contract for LNG supplies has been said to be under way for 2.5 mty from the Shell-led Sakhalin-2 project (Interfax, 2004-09- 20). The expansion into a foreign market, like the Russian, is not new to KOGAS that already holds a long-standing business interest in its main Qatar supplier. Other major gas projects in Vietnam, India, Myanmar and Nigeria over the last 30 also have seen large Korean investments (KOGAS, 2004-06-28).

5.3.3. Coal

Coal has for a long time been an important source of energy in Korea, as there are local anthracite findings that have been explored for a long time. Until the industrialization started to develop, coal used to be the most important source of energy. From then on, the importance of oil increased and later coal also came to be imported in large quantities. The basis of the current generation comes from imported thermal bituminous coal. Coal used to be the most important source of electric energy with an installed generation capacity of near 15 GW. Still, local anthracite coal is used at four different plants that generated about 1 GW in 2003, which corresponds to 7% of what is generated by coal, or 2% of total electricity produced.

For the near future, the capacity that is under construction continues to be based on imported coal, and is nearly as large as the nuclear capacity, which indicates an increasing importance of coal for the future. Any loss in confidence in nuclear, or problems in the ambitious construction plans of nuclear reactors in the coming years is probably to be compensated by coal plants for electricity (Coaltrans, 2004-08-02).

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- 304 - 5.3.4. Electric

The generation of electricity in Korea is dominated by the Korea Electric Power Corp. (KEPCO). In 2001, KEPCO’s holdings were split up into sex different production companies, in preparation for a full privatization in the future. Although these are now operating as competitors, the group controls the majority of the generation capacity in the country with an installed generation capacity of 51.2 GW. The most important among the six is Korea Hydro and Nuclear Power Company (KHNP), operating the country nuclear industry that delivers about 40% of all electricity in the country. The other five, basically covering different geographical area of the country, are practically equal in size when measured in generation capacity, and fairly similar to the energy base they use for generation.

Coal used to be the most important source of electric energy with an installed generation capacity of 14.7 GW. This has largely been based on imported thermal bituminous coal. On top of this, local anthracite coal is used at four different plants that together generate about 1.1 GW.

LNG is the other major source with a capacity to produce 12.2 GW. This is the latest of the energy resources and has been expanding rapidly since the mid 1980s. Oil, on the other hand, has been falling in importance and its present capacity come to 4.4 GW, or 9% of capacity. The increasing use of LNG has pushed the share of oil in electric production under 10% for the first time in decades. During 2003, the most important generator was nuclear power, contributing about 40% of the electricity with coal making up 37%, LNG 12% and oil 8% (KEPCO, 2004-09-12).

The southern part of the Korean peninsula does not have the topography that is normally considered to be suitable for hydropower generation. Hydropower generation has the least installed capacity of 2.9 GW, but still generates about 7% of the electricity. Capacity in the sector is relatively concentrated to dams on the Han River, with several having been built already in the 1940s. Generally, hydropower dams are as important for the regulation of water flow and for flood control as for power generation. Somewhat exceptional with the Korean hydropower sector is that it is not conventional units that dominate, but over 80% of the power is being generated from pumped-storage units.

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- 305 - 5.3.5. Nuclear

The nuclear power age in Korea started in 1978 when the first station was completed in Koori in the southeast of the country. This was followed by five more units in the early 1980s. Since then the use of nuclear energy has expanded rapidly and by 2004, there are a total of 18 units in operation.

The regulation of nuclear energy use in Korea is summarized in the “The Atomic Energy Policy towards 2030”. This was first outlined in 1994, and adjusted in 2000, and emphasizes the safe and peaceful use of atomic energy in Korea, with the spirit of a better life harmony with nature189. Its first objective states that the use of nuclear power should be promoted as a major domestic energy source, ultimately to improve the economy and to strengthen the international competitiveness of domestic industries. This will include future self-reliance in nuclear reactor and nuclear fuel cycle technology through research and development. One opening for a sudden change in policy is however given: “unless an epoch-making alternative energy source becomes available in the foreseeable future” (Nuclear Energy Policy, MOST, 2004-08-02).

The state-owned Korea Hydro and Nuclear Power Company (KHNP) operates the four nuclear reactor sites in Korea with a total capacity of 15.7 GW, which corresponds to about 30% of national generation capacity (KHNP, 2004-07-10). During 2003, generation reached a total of 130 TWh, or over 40% of Korean electricity generated during the year. In addition to the existing capacity, four more 1 GW units are under construction, of which two are expected to become operational during 2005. Four more reactors are being planned around 2010 and another six by 2015. If construction is fulfilled according to the long-term program, this would lift the share of nuclear generated electricity by nuclear to near 45% by 2015 (MOST, 2004-08-10).

The nuclear sector has been developed into a major domestic industry over the last 20 years, with the last 10 of the reactors being based on domestically designed technology. The performance of some the later reactors has proved world class in both capacity and availability. Also on average availability, Korean nuclear reactors have been in use 10 - 15% above the world average, or above 87% annually since 1993. The KHNP imports its uranium needs, some 500 – 600 tons/year from Australia, Canada and Russia. In Korea, spent nuclear fuel is currently stored at each of the four sites, and will be so until a central storage, scheduled for completion by 2016, has been build. The last proposed site in Buan, was voted against by near 95% of local residents, adding to the insecurity over the future handling of spent nuclear fuel (MOCIE, 2004-02-16).

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- 306 - 5.4. Transport

Due to the geographical location of Korea and its focus on export-based economic development, its transport infrastructure has to be developed accordingly. The current Korean ambition, under president Roh, has included the broad idea of developing Korea into the key logistic hub of NEA by 2020. This plan includes large-scale improvements and investments into a number of fields of transport infrastructure, including railways, roads, ports and airports. Such plans would probably find it difficult to take off without a near future reunification or at least a peace accord between the two Koreas. However, the idea is not really unique, especially many of the other large ports and airports in the NEA region will probably want to play an as important part in the future of the region as their Korean competitors. The carrying through of such a “hub- vision” includes a large number of pieces to the jigsaw puzzle that must be settle before making development project somewhat self sustainable to avoid exorbitantly high costs.

5.4.1. Rail

April 1, 2004 is one of the most important dates in the history of the Korean railways. At 05.05, after 12 years of construction work, delays, endless controversy and construction cost increases, the first high-speed train entered into service on the new Seoul – Busan line190. The new train link makes traveling between the country's two biggest cities, which are 410 km apart, possible in less than three hours, compared to six with a conventional train. The building of the Korean Train Express (KTX) line has seen numerous delays not only caused by cost overruns, but also by route and design changes. The price for the line, including trains, has been in the range of 20 trillion (USD 12 bn), but is expected to support a new takeoff in the Korean economy. It will now be possible to do day-trips between the two cities and the Korean Railways estimate that the business society will be able to save over 2 trillion yearly in logistics cost in 2005 (Korean Railway, 2004-05-10). The launch of the new train is also hoped to ease the chronic traffic congestion for this connection where over 50 trains per day in both directions has been far from enough to meet up with demand. The designed capacity for the high-speed train-line is set as high as near 500 000 passengers per day.

In 1989, when the government announced the high-speed train program, total costs were expected to be in the range of 6 trillion. The cost estimation was raised to near 11 trillion four years later, and then again to over 18 trillion in 1998. The figure has not been revised since, but it is widely assessed that the

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- 307 - final figure will exceed 20 trillion (CI, 2004-07-25). The problem that has emerged, after just a few months of operation of the KTX, is that the number of passengers, and as a result of that also the profit level, has come out far under expectations. The average number of passengers per day on the KTX has, during the first three months, been just over 70 000, which is only half of what was originally estimated. If this level is maintained for a longer period of time, the KTX will not be able to cover even the interest on the loans, and it becomes highly likely that taxes will have to cover future deficits (CI, 2004-07-25). At the same time there has been an ongoing development on the KTX project since 1996. A breakthrough was the newest version of the KTX that broke the 350- km/h speed barrier in December 2004. This achievement makes Korea the fourth nation in the world to have broken this speed barrier reached with a new version of the KTX that holds a local content in parts of 87% (CI, 2004-12-16).

As Korea has long been an established market economy, as well as a geographically small and compact nation, cargo transport by rail has been largely out-competed by trucking. Of the transport work, trucking constitutes over 90% and with trains and costal shipping sharing the rest.

Linking the Korean network with the Trans Siberian Railway so that it reaches the port of Busan has been discussed for several years. This would make over 9 000-km Trans-Siberian railway to continue beyond Vladivostok through North Korea and on to the South. This USD 3 bn project has only been initiated, but would, if or when completed, allow for faster freight access to Europe than by conventional shipping. At the meeting between President Roh and President Putin in September 2004, the idea to link Russia's Trans-Siberian Railroad with South Korea's rail network, via North Korea, was again on the agenda. If it would prove possible to create a fast and cheap route for South Korean exports to Russia and the rest of Europe, then Russia would profit considerably not only as supplier of most of the transport service, but also through transit fees from goods crossing its vast territory.

In line with the agreement signed as a part of the Korean summit between the two Koreas held in June 2000, (where the South Korean leader symbolically arrived by train) both the South and the North have started to build two railways, including parallel roads, across their common fortified border. Once completed, this will, in principle, allow transports from the south to connect to the Trans Siberian Railway. However, with an as infected history in the background as on the Korean peninsula, it is far from enough to have built the infrastructure to get a project of this kind rolling.

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- 308 - 5.4.2. Road transport Road As in most developed countries, the road network in Korea is its most important transport infrastructure, where over 90% of the domestic transport work is being generated. In all, there were 88 000 km of different roads in the country in 1999, which is three times the 1950 figure. The first expressway in the country was opened between Seoul and Incheon in 1968, and by 2004 has been extended to include 21 routes and over 2 000 km of expressways. The expansion of expressways is to serve as the backbone in the development scheduled for the coming 15 years with over 6 000 km more to be build. In 2020, there will be a total of nine expressways running east west and seven more running north souths. The full implementation of the intelligent transport systems (ITS), which will be used to optimize the flow efficiency on the roads, will also have been completed by that time (MOCT, 2004-06-23).

The Asian highway project that was first mentioned at a UN conference in 1959 is still being discussed in the region. More than 30 countries have been discussing ambitious highway projects to support regional exchange in the Asian continent, under the United Nations Economic and Social Commission for Asia and the Pacific. These projects have not progressed due to political tension among the involved nations (UNESCAP, 2004-08-10). At the 60th congress in Shanghai in 2004, the program was once again born, and its participants reaffirm their intention to participate. In the case of Korea, this could mean two links where Route 1 would stretch from Japan, over the Korean peninsula, China, India and then on to Turkey and Europe. Route Six would start in Busan, go across North Korea and then into the Russian Far East and will, in its continuation, also lead to Europe. The current guidelines for the program includes a total of 55 different roads, together measuring nearly 140 000 km (ibid.).

Local production Korea's vehicle production, reached nearly 3.2 million units in 2003, of which 2.7 million passenger cars and over 400 000 commercial vehicles. This volume made Korea the world's sixth largest producer, while eleventh in domestic sales191. Production for 2004 is estimated at 3.3 million, based on strong export growth offsetting a dramatic decrease in domestic sales. Exports are expected to reach 2.1 million and domestic sales around 1.2 million. For the first half of 2004, exports increased by over 30% and domestic sales fell by over 25%, which in both cases were far above expectations, although this is expected to somewhat flatten in the last quarter of the year (Korea AMA, 2004-09-07). The strong export growth has compensated for the sharp fall in domestic sales during 2004, making manufacturers putting additional efforts into export (CI, 2004-08-01).

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- 309 - Hyundai - Kia, as Korea’s biggest producer, during 2004 overtook Peugeot- Citroen as the world's sixth biggest producer with its total of 3.4 million vehicles, 2.3 million and 1.1 million for each of the two. As a result of the positive development of exports sales from the motor industry vehicles and parts became the most important sector in the Korean export for H1 2004 with a share of 13% and over USD 31 bn (Korea AMA, 2005-07-10).

As a part of the government’s ambition to support high tech research and the car industry, the Ministry of Environment will fund research to develop new technologies to reduce emissions from cars by 2010. It will invest 65 bn in the development of “marketable and strategic technologies” in this field with the aim of approaching a level of low pollution or even near pollution-free cars. New techniques should reduce the pollution from diesel engines to a 30% level below that of “Euro 4”, that go into effect inside the EU from 2005. For gasoline motors the aim is to reduce carbon monoxide emissions 40% below the level of the ultra- low pollution cars used in California (ME, 2004-06-10). Research on the car industry is already ongoing, and Hyundai Motors, in October 2004, presented its hybrid car version of the Click model. Its fuel efficiency is 18 km/liter, 30% better than the standard version of the same car, with production of hybrid cars expected to reach 300 000/year by 2010 (KT, 2004-10-05). Also GM Daewoo has revealed its S3X model, hybrid car, fuelled by gas and electricity, and its fuel cell Hy-Wire. The S3X is said to be more fuel-efficient than regular gasoline-powered cars, but still with a too low top speed, with both models being scheduled for production by 2007 (gmdaewoo, 2004-10-28). If the global market for hybrid cars will grow as expected, from currently under 2% to 40% by 2020, the mass production stage, which will come in 2005 for the Click, is an important step forward for Korean carmakers.

In a time of already declining volumes of domestic sales, three of Japan’s car producers had by late 2004 established sales organizations in Korea. Toyota, Honda and Nissan, in that order, have from 2001 to 2004 established themselves in the Korean market. This has not happened earlier because Korea previously had a 20% import tax on new cars. In 1995 it was reduced to 8%, complemented by an import ban on Japanese-made cars that was finally lifted in 1999.

In the Korean automotive industry, it has only been Hyundai that has proved big enough to develop largely on its own. In late 2002, Daewoo Motor became GM Daewoo Auto & Technology Company after having faced financial difficulties, and having declined a takeover bid from Ford. It is now a part of the GM to 42%, with GM-controlled Suzuki holding another 15%. As a result of the negative publicity surrounding the bankruptcy of the brand name Daewoo in the European market, it will be abandoned and renamed Chevrolet (autointell,

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- 310 - 2004-10-07). However, the level of foreign ownership in the Korean motor industry was reduced in August 2004 when the former 10% partner of Hyundai Motors, Daimler Chrysler announced that it has sold on its stake, acquired in 2000 – 2001 (FA, 2004-08-17). The reason for the break-up of the partnership was said to be a disagreement between the two partners about expansion plans in the Chinese market. The third manufacturer in Korea, Ssangyong Motor, has also faced financial difficulties and during 2004, saw a 50% take-over from the Chinese car giant Shanghai Automotive (SAIC) in a USD 500 million deal (SAIC, 2004-11-25). SAIC's interest in Korea is not new, as it also took part in the 2002 restructuring of Daewoo, where it currently holds a 10% share, at the same time as SAIC is a partner of both GMs and Volkswagen in China.

Production abroad In contrast to Korea, China has increased production rapidly over the past couple of years. As a result, it moved up from fifth to fourth place in the world production in 2003, having increased production volumes by 37% during the year. The difference in volume between Chinese and Korean automotive production has increased from around 100 000 units in 2002, 1.3 million in 2003 and 1.8 million in 2004 (Korean AMA, 2004-05-02 & 2005-01-13). Behind the large increase is the Chinese jump in production and consumption, where a number of leading automakers, not least Korean, have established production units. Korean manufacturer KIA, a part of Hyundai Motors, is one such example producing 130 000 units in China, investing another USD 660 million to expand capacity to produce 430 000 cars by 2006 (KIA, 2004-08-10) 192. Hyundai is simultaneously expanding its capacity in China to reach a volume of 300 000 units by 2005 and 600 000 by 2008 (Hyundai, 2004-04-04). It is not only in the Chinese market where Korean manufacturers are expanding production capacity. On the Russian market, both KIA and Hyundai are set to invest into new production. KIA’s production is set to surpass 50 000 by 2006 and will include the launch of new models within its Russian JV, that is run together with Izh-Avto. Hyundai, on the other hand, has joined forces with Severstal-Avto, owner of UAZ plant in Ulyanovsk, where production will be centered (Interfax, 2004-09-22).

In Europe, KIA Motors is building a USD 800 million production plant near the northern Slovak city of Žilina that is expected to employ about 2 400 workers when reaching its estimated 200 000 cars per year volume by the end of 2006 (Slovak Spectator, 2004-03-28). The international expansion by Korean producers reached both Europe and the US in what is soon to become three decades ago. Korean products are becoming increasingly established in foreign markets, and Hyundai became the third Asian automaker, after Toyota and Nissan, to hold over 2% of the European market in March 2004 (Automotive News, 2004-04-

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- 311 - 23)193. Other foreign markets with Korean production or assembly are India, Turkey, Thailand plus a number of other countries with smaller operations.

5.4.3. Water transport

As a peninsular country with over 12 000-km coastline with few domestic raw materials and a strong export orientation, Korea has all the preconditions necessary to make the sea important for the national transport system.

Shipping The shipping sector in Korea has never really come to correspond to the importance of the country in the respect of foreign trade and shipping volumes. Since the beginning of the 1990’s to mid 2004, the number of registered ships in Korea has increased by near 50%, while their carrying capacity has increased, by only 15%. Mainly it is small ships that are increasing in numbers, while the capacity of cargo vessels has been falling by 10%. The only major increase in capacity over the past 15 years has been seen for tankers, +45%, to just above 1 million dwt (MOMAF, 2004-08-23). As is the case in both Russia and Japan, most, if not all, the larger Korean ships, owned by its shipping lines, are registered abroad.

There are currently three major shipping lines in Korea, with Hanjin as the largest one. Hanjin is the result of a merger between Hanjin Container Lines and the country’s first shipping company, Korea Shipping Corporation, established in 1950. Hanjin has diversified its business into both container and bulk vessels, but also land operations, including terminals and logistics services. At sea, it owns 20 container and 25 bulk ships, including large modern containerships, specialized gas tankers, and bulk carriers, that give it a fleet of 3.3 million dwt. At the same time, Hanjin is an active chartered and in all operates about 140 vessels (Hanjin, 2004-11-10). The second biggest shipping line is Hyundai Merchant Marine that owns about 50 ships, with the majority being containerships. In all its fleet comes to 2.4 million dwt (HMM, 2004-11-10). The third biggest shipping company is Korea Line. It has a somewhat different focus with its entire fleet of larger bulk carriers sailing on long charters for some of Korea’s biggest companies like POSCO, Kepco or Korgas. It also owns a smaller fleet of ships that sail on tramp contracts, which in all brings its owned fleet to 2.5 million dwt (Korea Line, 2004-11-10).

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- 312 - Ports In line with the President Roh's ambitions for the future of Korea, the Maritime Ministry is promoting the NEA hub idea: “Construction of hub-ports with a view of becoming the logistics centre of northeast Asia” (MOMAF, 2004-09-12).

The Korean port sector is highly dominated by the port in Busan. In the container sector it is even the fourth most important port in the world, only behind Hong Kong, Singapore and Shanghai (Busan, 2004-09-10). The port handles about 40% of the national seaborne trade and near 80% the national container volume. Busan is still the by far largest in total handling, despite the fact that Korea has 12 ports with a handling capacity over 10 mty each. On the container side, which is extremely important seen to the foreign trade structure of Korea, it is practically only three ports that are of any major significance. Busan is the biggest, with its near 80% of the total, followed by Gwangyang handling just under 10% and Incheon at about 6%. In all Korean ports handled 14.4 million TEUs in 2004 (13.2 in 2003), which was double the volume five years earlier, with the share handled by Busan remaining constant (MOMAF, 2005-01- 18).

Over the last two years the Korean port sector has seen the ports in Incheon and Busan reformed into being overseen by a port authority, independent from both central and local governments. Under this organization, the two will be able not only to develop more freely and to attract participation from users, but will also be forced to show performance under corporate accounting rules (MOMAF, 2004-08-10).

After recent problems with container congestion at the Busan port, the government is pressing ahead with the construction of the new Busan Port in a bid to decentralize container shipments. It is hoped that it will be possible to complete the project nearly two years ahead of schedule and to have some terminals in operation by late 2006.

Shipbuilding One of the export success industries in Korea is shipbuilding where the industry has developed from a purely minor domestic supplier to a world leader in 25 years. The first major Government initiative was taken in 1967, and already by 1979, Korea was the second most important producers in the world, with ULCC- size docks having come into use at Hyundai, Daewoo and the Samsung shipyards (ATIP, 2004-09-05). The Korean position as world-class shipbuilder over the last decades has been reinforced and today, the world’s three biggest shipyards are all to be found in Korea. The industry is said to include about 130 000 workers in shipbuilding and its supporting industries, with about half of the employees working at the yards (KOSIPA, 2004-07-09). The world leader

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- 313 - Hyundai delivering more than one ship per week, while Daewoo and Samsung deliver about 40 per year. In 2003, the export value of ships came to an all time high with 7 million compensated gross tons (CGT) delivered, up 4% on its previous highest in 2002, valued at USD 11 bn. A volume, and value, that made up nearly 1/3 of the world total and that placed Korea as the number one shipbuilding nation in 2003, after having lagged behind Japan for three years (MOCIE, 2004-01-24). Out of a total world ordering of 43 million CGT during 2003, Korean shipbuilders secured orders for a total record level of 470 vessels of 18.3 million CGT; or 43% of the total world volume (KOSIPA, 2004-05-05). Meanwhile, orders for 230 vessels totaling 7.6 million CGT was made during 2002, from a total of 22 million CGT, or 35% (Fearnleys, 2004-03-07). Korea continues to dominate among shipbuilding nations, compared to its closest competitors, Japan, that secured 29% of orders during 2003, Kina 13% and with the combined EU taking 7%. The trend has continued during 2004 with orders of about 18 million CGT, on a level way above Japan as second, at just under 9 million CGT (Kosipa, 2004-12-25).

The sharp rise in ordering and deliveries volumes in the world are much attributed not only to the replacement of old ships, especially new double-hulled tankers, but also to the persistent high chartering rates in world shipping. This has led to continued high ordering volumes during 2004, well surpassing previous expectations. Most important for Korea is that 90% of the orders for high value cargo ships (especially LNG carriers) were placed at Korean yards (KOSIPA, 2004-07-09)194. During 2004, Hyundai signed a groundbreaking order for the world's four first 10 000 TEU containerships from Chinese COSCO (HHI, 2005-01-21) 195. Development will not stop there as Samsung has started to market 12 000 TEU designs to shipping companies. As a result of the continued high ordering level, the production capacity for all yards has now been signed up in Korea, Japan and China. As a result it is currently practically impossible to book an order for a ship with a delivery date before mid-2008 (SeaNews, 2005- 01-13).

During 2004, shipbuilders not only in Asia, but also in other parts of the world, have had to face the effects of dramatically raising prices of steel and especially steel plates. Depending on ship design, steel normally makes up some 15 – 20% of the price for a vessel and with increases in the range of 50 - 70% in prices during the year. As an example, spot price for imported hot-rolled steel in China rose by 49%, to USD 450 per metric ton, over the last 12 months (Metal Bulletin, 2004-08-10). On the local Korean market there are only two possible suppliers of steel sheets; POSCO and Dongkuk Steel Mill Co, and both have raised prices by near 60% on average since the beginning of the year (Daewoo, 2004-08-28). Higher steel prices have eroded profits for shipbuilders. As a result, e.g., HHI,

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- 314 - despite its USD 8.5 bn of new orders and an 11% increase in turnover, posted a negative result for 2004 of USD 95 million (HHI, 2005-01-31). Consequently, the yards have also been forced to increase prices in the range of 10 - 15% for new orders. It is not only the steel prices that constitute a major problem for the profitability of the Korean yards, but also the increasing value of the domestic currency. However, it was positive for the Korean shipyards were given an interim clearance of having received Il legal subsidies, for which Korean yards had for years been accused by EU competitors (WTO, 2004-11-27).

Despite the gigantic number of orders for new ships in later years, that reached its highest level ever, the future of the Korean shipbuilding industry could be doubted. At 200 million dwt, the peak in delivery will be reached in 2008, when deliveries could come to exceed scrapping by 50 million dwt. The big question is if trade can continue to expand enough to absorb such an increase and to maintain a need for new orders (SSG, 2004-10-13). The peak of the Korean shipbuilding industry could be near for practically the same reasons as in car manufacturing. The future expansion of the yards could well be focused on increasing production capacity in foreign markets. The second biggest yard, Daewoo, has declared that its future includes the acquisition of yards in both Europe and joint ventures in other parts of the world, and possibly to build a facility in China. This expansion, including venturing into new fields, should be seen as a part of a strategy to raise sales manifold over the coming ten years (Daewoo, 2004-06-05). HHI, on the other hand, has agreed on the sale of technology and know-how to US shipyard for USD 27 million, a small and overprotected industry, for the design of ships (HHI, 2005-01-14). Additionally, Hyundai has already established production in Vietnam and is an important reason behind the very rapid expansion of shipbuilding in Vietnam in later years.

5.4.4. Aviation

The largest investment to date in the field of Korean aviation was the building of the new international airport at Incheon 40 km west of Seoul. Inaugurated in March 2001, it was built with two full-length runways and a capacity to handle 27 million passengers and 1.8 mt of cargo (Airports, 2004-08-23). After a slow start, it has reached a passenger volume around 19.5 million for 2002 and 2003, placing Incheon as the tenth busiest airport in the world (ICAO, 2004-05-10). At the same time, the domestic airport in Seoul, Gimpo, remains one of the world's bigger airports with 13 million passengers during 2003, but still a dramatic reduction from near 37 million passengers in 2000; the year before the opening of the nearby Incheon airport.

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- 315 - Outside of Incheon, there are other 8 international and 8 larger domestic airports in Korea. The popular domestic air travels have seen passenger numbers in the range of 50 million per year in later years on its 26 lines. Since the introduction of the KTX (the Korean Train Express) between Busan and Seoul in April 2004, domestic air travel has overall fallen by 11% and by 25% at airports along the line (KADA, 2004-10-17). Despite the fact that a slight fall in passenger numbers for the year has been expected at practically all airports, as a result of the contracting state of the economy.

In 2003, Korea was the 8th largest air transport market in the world. The cargo handling of the airline industry is expanding much as a result of the lucrative contracts from special air cargo exports of semiconductors, mobile phones, LCDs and PDPs. These are all product lines that require delicate handling and are more or less entirely shipped by air. After a troublesome time with a decrease in passengers due to public fear over SARS, terrorism and the Bird Flu, cargo handling generates an ever-larger share of air carriers turnover and has reached over 1/3 of the turnover for both of the two major Korean carriers (KAL-Cargo and Asiana-Cargo, 2004-05-20). In the case of Korean Air, the increase has been over 30% in one year with semiconductors, mobile phones, LCDs and PDPs making up almost 90% of the total air cargo exports. In the export boom that Korea has been experiencing in 2004, the conventional competition among the carriers has been set aside for competition among exporters for space onboard the aircrafts. An understandable development when the increase in Korean export of air-cargo products like semiconductors, mobile phones and LCD monitors has came to 40 - 100% during 2004 (MOCIE, 2004-12-22).

Korean Air Line, until 1969 was state-owned, and is the bigger of the two national flag carriers in Korea, carrying about 21 million passengers during 2003. The fleet of KAL includes 115 aircrafts connecting destinations in 29 countries. On the cargo side, KAL has expanded very rapidly and is currently the world's second carrier in volume, with 1.3 mt. The second largest carrier in the country is Asiana, founded as recently as in 1988 that carried a passenger volume of 600 000 in 2003 to 17 countries. Asiana is considerably bigger on the cargo side, with a volume of 500 000 tons, and holds over 60 aircrafts in its total fleet (Asiana, 2004-11-19).

When Korea established diplomatic ties with mainland China in November 1992, a number of the previous agreements with Taiwan, among them the Civil Air Traffic Pact, had to be abolished. As a result, all direct flights between the two had to be abolished. Beginning at the end of 2004 though, direct flights were resumed at an initial level of 18 times per week for passenger flights and twice per week for cargo, shared between Korean and Taiwanese airlines. Owing to

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- 316 - the special status of Taiwan, the new agreement is not a bilateral interstate agreement, which would be the conventional, but instead has the form of a civilian agreement signed by representatives from the two states (CI, 2004-09- 02). During these 12 years, charter flights, as well as indirect flights, have been operational between the two countries. The traffic volume that stood at 420 000 passengers in 1992 is expected to reach near 500 000 already during 2005 (MOCT, 2004-06-23).

5.5. Other

5.5.1. Iron and steel

Korean modern steel-making history does not really start until the beginning of the 1970s when crude steel production reached above the 1 mt mark. Since 1970, production volumes have seen continued increase, with a slight two-year slump in 1997 – 1998, approaching a production volume of about 48 mt for 2004. The production volume in Korea corresponds roughly to the domestic consumption volume with consumption having increased faster than production over the last five years. Average production costs for basic steel products in Korea are estimated to be in the lower range of the scale among larger producers in the world, some 25% above Russia but 10% below the costs in China (combined from IISI and WSD, various dates).

POSCO, the by far largest steelmaker in Korea and fifth in the world, produced about 29 mt during 2003 and 30 mt in 2004. As other companies in the steel sector, POSCO also has seen its sales and profits jump during 2004, by around 40% and 90%, respectively. In line with this international trend, it has been possible for POSCO to increase prices thee times during the year, due to an over 100% increase in coking coal and raw steel prices (DowJones, 2005-01-10). The most important factor behind the improved result is strong demand from China, with sales of 20 000 bn for the full year (POSCO, 2005-01-13). To secure what could be estimated to be a 30% share of its future needs of ore, POSCO during 2004 has signed an agreement with the world's largest miner, Brazilian Companhia Vale do Rio Doce (CVRD), for 103 mt of iron ore over 10 years (POSCO, 2004-11-15). At 2004 prices, the deal would probably be worth over USD 2 bn. In an innovative move, POSCO has embarked on the construction of a new production unit using the Finex Technology. When completed in late 2006, this will be the world's first full scale application of this “next-generation” process of steel making technology196. The advantages with the process are numerous, as it is hoped to cut production costs by 15 – 20%, plant construction costs by 8%, and perhaps most important of all, is expected to reduce pollution by up to 90%.

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- 317 - The new plant, being built at the company’s main production facility in the southeastern city of Pohang, will have a capacity of 1.5 mt of steels, at a cost of about 1 300 bn (POSCO, 2004-07-20).

Leading analysts already consider the company to be the most competitive among all of the world's major steel producers, topping World Steel Dynamics ranking of steel producers for 2003 (WSD and KT, 2004-06-21). The company plans to increase the share of its production of products with a higher value to maintain and strengthen its position, as these also give a higher margin. This should help secure its long-term profit, and try to strengthen its position in East Asia and China. Of the 2 trillion that POSCO intends to invest during 2004, up 35% from 2003, investments will be concentrated to its facilities in China and India, rather than in Korea (POSCO, 2004-07-20). However, the steel industry as a whole intends to increase investments by 88% over 2003, to 3 500 bn. Of this, about 50% will go into maintenance and 10% into R&D. (KOSA, 2004-04-05).

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- 318 -

6. Democratic People’s Republic of Korea - DPRK

6.1. Introduction to North Korea197

Finding a wide range of sources for a deeper analysis is almost impossible concerning North Korea because it is one of the most secluded countries in the world. Its secrecy persists in practically all sectors of North Korean society, especially on its economic situation. The difficulty to access domestic statistics effectively voids attempts to analyze the development, thus making the sources used being practically all foreign. Studies and statistics on North Korea often originate from the South Korean Ministry of Unification in Seoul, complemented by some other foreign sources. Although figures used here can be questioned in their details, the indications given of trends and the magnitude of changes can probably be seen as: “as good as possible”.

6.1.1. The Kim Jong Il years

DPRK is being ruled under a philosophy that has been called “Juche”, first introduced in the mid-1950s. Domestically it is the former leader, Kim Il Sung, who is personally given the credit for the intellectual development of the Juche philosophy. It could possibly be labeled as something that finds its theoretical base relatively near Soviet style Marxism – Leninism, “developed” by a leader first educated and later serving in the Russian army. However, over the years, it has been adapted along with the shifts in the fortunes of North Korea. Juche was initially a collective movement, but under the guidance of the North Korean Workers Party (NKWP) and its leader Kim Il Sung. It was, e.g., used in the late 1950s and early 1960s to avoid the problem of choosing side in the emerging conflict between the two main supporters: Russia and China. In the succeeding years, Juche was also used to justify the need of national self-subsistence and independence. This led to a forced industrialization, labeled as another Juche offspring, but in the conventional socialist way it was focused on heavy industry. This has resulted to a very high level of industrialization and has further led to a situation that became a burden, with reduced foreign support from the late 1960s onwards. After the death of Kim Il Sung on July 8 1994, Kim Jong Il unofficially took over as leader of North Korea. Although the country passed through a three-year mourning period after the death of what was named as its “eternal leader”, Kim Jong Il could celebrate ten years as a leader in the summer of 2004. Kim Jong Il has never been officially declared as the country’s leader, despite being commander of the armed forces. When he took over as leader, he had a reputation of being a somewhat unbalanced young man,

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- 319 - which led many in the late 1990s to predict that North Korea would eventually collapse in a not too distant future. For quite some time after the shift of power, the West doubted his political leadership. At the time the country was in the middle of ten consecutive years of negative GDP development of Kim Jong Il’s rise to power. This crisis had already started in 1989 and had largely been overcome by 1998, with 1991 and 1996 as the most difficult years. These were the years when the economy contracted by 6% during each of these years. Kim Jong Il regime got off to a very tough start due to severe floodings, famine and energy shortages. Kim Jong Il has brought few major changes ten years after the takeover of power from the country’s founder. Celebrating his 63rd birthday in 2005, he could still have some 20 years left as leader. If compared to his father that died from a heart attack at the age of 82. With three sons in the house the possibility of that there is an intention on his part to build a “family dynasty” could never be ruled out.

Despite having been founded on September 9, 1948, North Korea has only been in the headlines a few times since the end of the Korean War in July of 1953, as it completely cut-off all contacts with the west. There is still no peace agreement between the two Koreas and the mutual border along the 38th parallel remains heavily guarded. The initial economic system introduced in North Korea, under the NKWP, was originally formed on the basis of a Soviet style system, and included an early agrarian reform with the nationalization of companies, banks and infrastructure. Reforms were soon extended to collectivization of farming and later also made to include service and commerce. The North Korean economy was growing during the following years, although with a strong focus towards heavy industry and armament. The basic idea during much of its history has been system competition between the paths chosen in the north compared to the system of the south. The outcome of an assessment of achievements much depends on ones ideological point of departure and is therefore left open here. From an economic point of view, it was in late 1980s that the nation started to face problems, which were further aggravated by system change in the socialist block in Europe and the later break up of Soviet Union. The rigid system that had been created in North Korea, similar to other centrally planned economies, had great difficulty in reacting on changes in the surrounding environment. The acute crisis in the 1990s was triggered by floodings and droughts, and worsened by reduced energy deliveries from its two allies. These external factors were inflicted upon a Juche-economy that had already been degenerating for quite some years. In the same way as other centrally planned economies, North Korea also had come to promote quantitative ahead of qualitative, production goals. Production was never really aimed to meet demand, but to fulfill plans at a minimum quality, and with a price structure that had little relation to actual production and factor costs.

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- 320 - During the crises of the1990s, the central planning system faced increasing difficulties in steering the economy, as the crisis did not generate any surpluses for the system to distribute.

6.1.2. Neighbor relations - with a background of a nuclear crises

The first non-aggression pact on the Korean peninsula was signed in 1991 between Seoul and Pyongyang and a summit was held in 2000, but the current state of war between the two neighbours cannot be ended without involving Washington. From a more forgiving attitude to the conflict of the Clinton administration, the approach hardened when the Bush administration took office. For a long time a two-country Korea has served the interest of cold war enemies while the current status can hardly serve any neighbours and political system. In the long term, the other parties that must be involved, like China and Russia, and are not likely to approve to a long term solution that will include US troops to be stationed in a united Korea.

Over the years, it is China that has remained the unrivalled partner for North Korea and there has been a clear trend in later years of the promotion of contacts in a range of economic sectors (Unification, 2004-10-16). The only known upset in the relation between the two over the last year has been the problems in writing history. As mentioned above, the interpretation of the writing of history related to the kingdoms of Koguryo and Balhae has been allowed to surface and has been the cause of some tension (see also Korea; 5.2.2). North Korea has refrained from the strong diplomatic criticism of the Chinese actions of its southern neighbor. A seemingly moderate form of criticism has been voiced in the state controlled media (CI, 2004-08-08). The relation to Japan has for long been strained by the abduction of Japanese citizens to North Korea, to serve as teachers of language and customs for under cover agents to be sent to Japan. A number have been allowed to return, after visits by Premier Koizumi, but the full list, as seen from the Japanese side, has not been settled. The whole issue has become even more confused when remains of what was declared as Japanese abductees that was sent back and, by way of DNA testing, proved not to belong to the correct family. Additionally, there have been a number of incidents in Beijing wherein North Korean refugees in Beijing have succeeded, but on some occasions failed, to escape over the high fences of Japanese and South Korean institutions. These have also put strain on relations.

The first nuclear crises, in relation to North Korea, arose in 1994 but never took the proportions of the most recent one. The latest crisis started in October 2002, after a visit to PRNC by the US Secretary of State James Baker. Baker made

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- 321 - public that the US had secured information that PRNC secretly had started a build-up of its nuclear reactor at its located in Yongbyon, about 100 km north of the capital. If North Korea had built small-scale production facility for plutonium at Yongbyon this would be a clear violation of the previous agreement from 1994.

Initially, it appeared that the DPRK was willing to cooperate and accept inspections from IAEA of the critical sites, in exchange for oil and supplies for two low-scale nuclear reactors. Relations with Japan also improved by allowing some of the abductees to visit Japan. Relations with the US changed for the worse when President Bush, the same year, labeled DPRK as part of the “axes of evil”. Foreign nuclear inspectors were suddenly not welcome, and at the same time, a ship bound for Yemen was found to carry Scud missiles from DPRK. Simultaneously, surveillance from American satellites registered activities around the Yongbyon reactor that was said to confirm previous statements. Meanwhile South Korean attempts to mediate in the crises proved in vain. The escalation of the conflict then continued with an official DPKR confirmation that the reactor had been reactivated and with missile testing in the Sea of Japan. At the time of the fall of Baghdad in 2003, it was surprisingly suggested from Pyongyang that three party talks with DPRK, the US, and China should be launched. Progress in the talks proves to be minimal and the only real progress is to extend the group to six countries that met for the first time on August 27 – 29 2003. Negotiations have emerged from a standoff between the clash of identities between the “greedy American warmongers” and the ”dangerous North Korea”, giving an ocean to bridge for negotiators. It also involves the principal dilemma of, seen from any of the extremes, rewarding the wrongdoer despite “wrong” behavior. The current “balance of terror” along the mutual border between the two Koreas, the world’s most heavily guarded has been constantly upheld by both sides. The political costs involved have become increasingly difficult to bear and the situation is considerably worse here, and resembles what reined in regions of the world during the cold war. However, also now there were few results and no new date was agreed at the meeting as the list of demands from PRNC, including the exclusion of Japan from the talks, was seen as unacceptable from the US side. Since, the north has refused the offer to close the nuclear reactor because the demands for energy deliveries and the security guarantees that the North wants to see in return are deemed as unacceptable. In preparation for the next meeting, US experts – who were given permission to visit Yongbyon – have reported to the US Congress that they had seen traces of plutonium handling. Despite this, the second round of the six-party-talks started on February 25 2004. Again, little progress is made at the meeting and by April, the US has gotten what it sees as confirmation of the development of nuclear weapons in PDRK. The head of the Pakistan nuclear program, Abdul Qadeer

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- 322 - Kahn, confirms that he has been shown nuclear devices when visiting a secret underground plant (New York Times, 2004-04-13). To make matters worse IAEA, in early September 2004, published a report revealing that South Korea had enriched uranium and made plutonium separation experiments. This complicated matters dramatically, and made the North announce that the US used “double standards here, like with Israel”, and that under such circumstances the North Korean nuclear program could not be abolished (KCNA, 2004-09-08). Still, North Korea is said to be interested in continuing the six party talks that China wants to hasten, but the US election was said to have encouraged the North to adopt a wait-and-see attitude (Guardian, 2004-09-14). Even if the rhetoric's could be exceedingly strong in the Korean language, the Foreign Ministers made a very strong statement and said that North Korea can turn Japan into a “nuclear sea of fire”. He also stated that North Korea had turned 8 000 fuel rods into nuclear weapons (KEIA, 2004-10-10). However, it is difficult to assess if such statements are intended to raise the stakes in the negotiations just to maximize its revenue from an agreement. On the other hand, there is also a risk that the stakes have gotten so high that the retreat, and/or loss of face, could become too big for North Korea to back off after having openly declared itself as a nuclear state for ten years. Rumors in the West, during the latter part of 2004, have suggested indications that a regime change could be under way. The North has denied this, stating: “The system in the DPRK is politically stable and is as firm as a rock” (JT, 2004-12-18). Commentators in the west have suggested that the denials have been too strong, indicating that something is probably wrong.

Pyongyang has been demanding massive energy aid and other economic benefits from the US during the six-party talks, but the multilateral meetings have ended without an agreement so far due to Washington’s attempts to convince North Korea to dismantle its nuclear weapons first. Although the US unwillingly came to initiate negotiations with NK, it gave the impression of rewarding the threat by paying attention to it from the highest level. It is now necessary to find ways to lead North Korea away from the nuclear track and pursue other options than building its future on threat. Negotiations are also important for the US as a way to secure support from the outside world. If no solutions can be found by way of negotiations, then the ability of the US to secure such support for future actions will depend on how serious the approach to find a settlement at the negotiation table has been.

6.2. Economic development

The 1990s were largely economically backward for North Korea; however, the situation has stabilized, but not really improved very much. Since some limited

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- 323 - economic reforms have been introduced in July 2002, to counteract the continued deterioration this was practically the first step away from the central planning that has steered the country since it was formed in 1948. The economic activity per sector spread evenly as of 2002, with 32% generated from the service sector, 30% from mining and industry, 8% from construction and 30% from farming (Unification, 2004-10-16).

The 2002 reform included an overhaul of prices, wages and the system of central planning. A reform that included the reduction of state subsidies was also new, that workers were paid according to production, prices could be set freely at farmers markets at the same time as the free sale of production surpluses from industry would be allowed. In this new situation, when earnings should become better related to production, all kinds of workers who cannot influence or increase their productivity have come out as losers. These are, e.g., workers in outdated industries and employees in local and government administrations. At the same time, the economic reform has given a limited autonomy for entrepreneurs that did not exist before, although run under the state nominally. Many of the new entrepreneurs are ethnic Koreans but have found South Korean, Chinese or Japanese as sleeping foreign partners. North Korea has also established its first joint venture with South Korea in assembling cars. With the improved possibility to make profit at the market, farmers are among the winners in the economic reform program, with only 18% of the land being suitable for farming activities, as they can sell surpluses in city markets. The collectivization of farming, as opposed to a family ownership of land, can be expected to reduce both productivity and competition. However, farming remains highly inefficient with much manual labor still being used on the limited agricultural land. Structural problems in farming have – for three years in a row – resulted in far below average harvests, which have completely drained reserves. North Korea is estimated to have a yearly grain demand of about 6 mt, while domestic farming has produced about 4 mt in recent years (Unification, 2004-10-16). However, the 2004-05 new-year message from Kim Jong Il called for increased agri-production during the coming year, by the slogan “rice is our gun”, in the year of the 60th celebration of the party (KCNA, 2004-01-02)

Most North Koreans before reforms earned in the range of North Korean Won (NKW) 150 – 200 a month. Additionally, citizens used to have not only apartment, utilities, education and health care practically for free, but also basic food as distributed through the national rationing system; here called by the not so negatively sounding name of the “Public Distribution System” (PDS). Prices have gone up after the introduction of reforms, but so has wages. Non-qualified work now pays about 2 000, while a better placed civil servant can earn about 2

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- 324 - 700. At the same time, the price for a normal apartment, including utilities, has reached 150. Prices on the free market for products under rationing are also many times higher than the official price. Some visible signs of change have occurred in the three years that passed since North Korea initiated its market reforms in July 2002. Parts of the local population are also starting to understand the basics of mercantilism, and much so through the open agricultural markets that have been created. Street stalls with, e.g., beer and steamed potatoes can be seen in the streets, with products not only being sold in the local currency, but also in US dollars and South Korean won. Demand is also sharply rising at restaurants in Pyongyang, with prices for a better meal having reached the range of a normal monthly salary. There are more cars now, compared in the past when cars were scarce. A TV set sells for around 75 000 and demand is rising sharply. Per capita income in North Korea has been on a roller-coaster ride in the last decade, and after having peaked at USD 1 140 in 1990, it practically halved to USD 578 by 1998 and then has risen to approximately USD 820 for 2003 (Unification, 2004-06-05). Other negative sides of a market system also has started to emerge with increased economic inequality, at the same time as certain residential areas, with low-income housing, are rapidly degenerating. The official trading currency for foreign trade, since December 2002, is the Euro, with the official value set at 171 in April 2004. The level in the unofficial / black market is many times higher and one Euro can here buy over 1 500.

A considerable share of consumer goods are still distributed through the PDS despite the abovementioned changes at the same time the crises has made 15 – 30% of the population dependent on foreign assistance (Unification, 2004-10-16). The UN sponsored World Food Program (WFP) in 2004 distributed food for some 6 – 7 million North Korean’s who could hardly survive on the PDS ration of 250 - 350 gram rice per day and person. A food intake that covers only half of the minimum daily energy requirements (WFP, 2004-06-20). Still, some 70% of the 23 million inhabitants are by WFP estimated to be at least partly dependent on the food supplies that are distributed through the PDS. However, aid through the WFP has declined as donor countries are becoming increasingly reluctant in giving further support to the PDRN.

The economic development for the economy of North Korean has, despite problems in other fields, been relatively positive and has grown for five consecutive years. Its national GNI grew by 1.8% during 2003, up from 1.2% the year before, to a total of NKW 22 trillion (USD18 billion) (BOK, 2004-06-07). Statistics are based on estimations, as practically no official economic data are being released, and place the economic size of the country at about 3% of that of its southern neighbor (USD 600 bn) and on par with countries like Zimbabwe and Cameroon. The difference between the two Koreas can be summarized by

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- 325 - difference in the national GNI, which was 10 times higher in the south in 1990, 30 times in 2000 and 33 times by 2003 (Unification, 2004-10-10). The difference between the two neighbours is extremely striking in the field of foreign trade and has continued to widen. From 126 times larger in 1990 to 156 times larger in 2003, with the North Korean foreign trade volume corresponding to about 0.6% of that of the south (ibid.).

Today, however, China is not only the most important trade partner for North Korea but also its largest investor. Cooperation with South Korea is also expanding with the 650-hectare (16 000 acres) special industrial zone in Kaesong as a good sign. In Kaesong 15 South Korean companies have established manufacturing units, located eight kilometers across the mutual border and only 40 km away from Seoul. The wage level of workers in the zone has been set at USD 57/ month, or some 5% of the Korean level, will serve as an extremely good incentive. In line with the acceptance of the new industries, also the first Korean bank, and the country' third in size, Woori Bank, have been given permission to open an office in Kaesong (KEIA, 2004-10-10 & CI, 2004-09-09). In the near future, growth in the national economy of the North and its manufacturing sector has to overcome restrictions of outdated equipment and shortages of raw materials and energy. The chronic shortage of the same set of factors also poses a threat to possible foreign investments, which could assist in restructuring domestic production. It is only to lament that this happens at a time when relatively investor friendly policies, aimed at stimulating the economic development, have been introduced. As a result of the new approach handful of foreign ventures have appeared in Pyongyang during 2004. A London law firm became the first company from the west to open up a regular business, with an Irish company having been taken on as technical consultants in developing the local mineral and oil industry (KEIA, 2004-10-10).

The prerequisites for continued success of a reform of the kind introduced in 2002 were far from ideal as it was introduced in a situation when the economic system was under extreme stress. Also when similar reforms were introduced in other socialist countries in transition, the chances for a positive outcome without a continuation of reforms, proved minimal. In practically all cases, major liberal reforms have led to the fall of the governments that introduced the reforms. So far, little political reform has been seen and North Korea remains a one party state, with the Workers’ Party as the only party represented in the 687 members Supreme People’s Assembly. If a change of regime will be the near future outcome of the reform agenda also in North Korea remains to be seen.

However, the security dilemma remains the most important problem, where steps must be taken to break the vicious circle. One of the main interests of the

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- 326 - Pyongyang government – and the most difficult issue for the international community to overcome – is probably to save as much North Korean uniqueness as possible. The indicated cooperation in the fields of transport and energy could come to serve as an important tool to increase security and create confidence. Hopefully, this could instead be turned into a virtuous circle that could include the building of railways, roads, gas- and oil-pipelines as ways of attracting FDIs. Hopefully, this process could lead to increased prosperity for the whole North East Asian region.

The new and probably only realistic long-term, challenge is how to program a balanced opening of the country. A similar conversion of the system as China has done could be a possible way out, i.e. officially sticking strictly to the socialist/Juche label, while basically converting to capitalism. The difficulties during the six party negotiations in Beijing over the nuclear program will first have to find a way out of the current deadlock before an opening can be expected. However, it will also be necessary to keep North Korean political hardliners and the army happy with the outcome of the crisis. A possible access to nuclear arms will probably need a massive compensation offers to make a majority of influential North Koreans changes their opinion.

6.3. Trade, energy and transport

North Korea partly opened up to the west already in the 1970, when limited foreign trade was initiated. The first of several special economic zone, as defined by North Korea was opened in the Rajin-Sunbong area near the Russian border, already in the late 1980s. Factories in these zones appear to be in operation still today, but bear no resemblance to similar zones in other Asian countries.

As the domestic economy contracted, foreign trade also saw the same collapse in the later part of the 1990s. Foreign trade stood at over USD 2 bn in 1995 and then fell to below 1.5 bn in 1998 and recovered to above USD 2 bn in 2001. Trade, over the last ten years, has not been balanced as all years during the period have seen imports that are 2 – 3 times larger than exports. It has also been highly volatile with increases of as much as 45%, and declines of 25%, from one year to the next during the period.

Foreign trade during the recovery period – reaching USD 2.4 bn in 2003 – has seen China come out as the outstanding partner. Bilateral trade volume between China and DPRK during 2003 surpassed USD 1 bn, up by near 40% over 2002, from imports of USD 628 million and exports of 395 million (Unification 2004-10- 16 & CBW 2004-08-29).

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- 327 - The other big partner in foreign trade is its neighbor, Korea. Total inter-Korean trade, according to the Ministry of Unification, fell by nearly 4% during 2004, to just under USD 700 million. This was the result of an 11% fall in exports to USD 258 million while imports were up by 1% to USD 439 million. North Korean exports in later years have been concentrated to textiles and agro-fisheries while import products have been elaborated goods like steel and chemical products. The fall in exports during 2004 is not only attributed to the bankruptcy of some major textile manufacturers in the south but also the general fall in consumption in the south.

China and North Korea has been trading uninterruptedly since 1948, but trade has increased sharply during the 21st century and reached a volume of USD 1 bn for 2003. North Korea was initially under a trade embargo from Japan, which was lifted in 1962 when small-scale trade was initiated. Japanese trade has seen a reverse pattern compared to total trade, with exports to Japan being about twice the size of imports. With its peak volume in 1977, trade has since remained small, with a total value of USD 260 million in 2004, which was slightly lower compared to 2003. North Korean exports have been concentrated to animal products, textiles and minerals, while imports have first of all been transport equipment and textile products (Japan Customs, 2004-11-15 & MOF, 2005-01-31). A considerable problem for North Korea is that the foreign trade with its largest partner is of considerable importance to the stability of its national economy. This is while North Korean trade represents well under 1% of trade to its main partners and is completely neglectable to their economies.

Today, however, China is not only the most important trade partner for North Korea. It is also its largest investor. The number of delegations and ministerial meeting by delegations has increased dramatically in the last few years. As a result, DPRK has seen a number of investments from China in various fields. The most high profile, and the single largest foreign investment is the USD 6 million takeover of the management of “Department Store No. 1” in Pyongyang by Chinese investors (CD, 2004-08-28).

The North Korean energy base is strongly dependent on its domestic coal resources. Yearly mining is in the range of 20 mt, compared to the import of 500 000 tons of oil in 2002; or about 1/90 of the per capita import of South Korea in the same year. Nearly 4 mt of domestic iron ore were mined in 2002, resulting in 1 million ton of steel being produced by the domestic industry; or about 1/45 of the volume in South Korea.

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- 328 - As for transport network, there are about 5 200 km of railroad in North Korea, with over 80% electrified. The road network is 96 000 km, with only 12% of this being paved. There are very few cars, trucks and busses in DPRK with domestic production never having reached above 10 000 during the last ten years.

The theoretical capacity of the available ports is given as 36 mt, which is probably a somewhat outdated figure (Unification, 2004-10-16). Nampo, the most important port that serves as a gateway to goods in the Pyongyang region, currently has just a single container berth completed in late 2003. Only small ships of 250 TEU, and equipped with self-loading equipment, can be accommodated (Fairplay, 2005-01-09). Domestic involvement in international shipping is a small thing, with aggregated vessel volume being only 810 000 dwt in 2002.

Tourism in general, and especially from China, has been promoted as a way to earn foreign currency. A new regular air route between Shenyang and Pyongyang, the fourth by the state carrier Air Korea, was opened during 2004 to facilitate access. It still remains possible for outsiders to visit DPRK, but it remains both difficult and expensive to obtain a visa, with citizens from a number of countries not being allowed in. Very few inhabitants speak any other language than Korean and all visitors, coming in groups as well as individually, from the few selected countries are always “assisted” by several especially assigned personal guides. This system has made it practically impossible for visiting foreigners to establish any form of contact with the local population.

6.4. The information problem

Not only does the DPRK remain what still today is the most sealed and secret country in the world, but also information is being both distorted and withheld. Foreign information agencies have not really been able to secure much reliable information about sensitive issues, despite considerable efforts.

An example of the information problem was the official North Korean handling of the explosion that occurred in Ryongchon, in the North Phyongan Province, on April 22, 2004. Two trains in a shunting station exploded and killed at least 160 and injured another 1 300. The domestic media did not even confirm that anything had happened at all until April 24. Also then the news-line was very brief, without mentioning the damages, indicating no more than that an accident was “under investigation”. The next mentioning appeared on April 26 when the condolences that have arrived from abroad were commented. A statement appeared for the first time on April 27 that included the number of dead and

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- 329 - injured, along with the size of the crater (KCNA, 2004-04-22 - - 27). In a similar incident, on September 9, 2004, a huge explosion was said to have taken place in a practically uninhabited part of northwestern PDRK near the border with China. This incident, which originated from South Korean media, was given wide coverage in other western media. The explosion was first mentioned by the North Korean state news agency two days later in the form of a denouncement stating that the news about the explosion had been planted as a distraction of attention from the news of South Korean nuclear experiments – that appeared the day before (KCNA, 2004-09-09 - - 14). The explosion that took place on the same day as the 56th jubilee of the establishment of the state, was officially declared to have been aimed at “demolishing a mountain” as a part of a hydropower construction project. A few weeks later, it was stated by South Korean defense sources that there had perhaps not been any explosion of the size first announced. North Korea also allowed a delegation of diplomats to visit the proposed site of the explosion to prove its point in this matter (KT, 2004-09- 19).

However, the explosion in Ryongchon seems to be similar with the Soviet Union way of handling negative news, e.g., the catastrophic accident at the nuclear station in Chernobyl in late 1986. Initially, nothing unusual was said to have happened at Chernobyl and later, as the full scale of the accident emerged, secrecy became practically impossible. This accident was probably the single most important event in creating media openness, and “glasnost”, in the former Soviet Union. As a result, the next major Soviet disaster, the earthquake in the then Union Republic of Armenia in 1988, was given a more or less fully open media coverage. The scale of the Ryongchon explosion did not reach anything near the dimension of Chernobyl, but nevertheless well demonstrated the increased difficulty for the government in concealing the truth. The state media of DPRK has been devoted to spread the message of positive domestic achievements, at the same time as the negative news have been reserved for stories about the enemies abroad throughout the years of the PDRK. Logically, the DPRK has even been given the highly un-attractive award as the country in the world with the lowest degree of press freedom (RSF, 2004-05-10). All news media are under strong state control, and all radios and TVs sold are pre-set to domestic channels only and cannot access the Internet and foreign news, making these practically inaccessible from North Korea. At the same time, the cracks in the information monopoly are clearly appearing as, e.g. smuggled mobile telephones, which can be used in border areas, and the ongoing micronisation of electronic equipment, increases the difficulty of upholding an information monopoly.

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- 330 - At the time of the first nuclear crises in 1994, and the domestic natural catastrophes that surrounded it, North Korea seemed to be on the edge of economic collapse. However, the collapse never came about, then, but it is not difficult to make very negative predictions for the future, also ten years after the worst crises. If a system change is to take place then the process has better to be a gradual and controlled one, than the more catastrophic scenarios that could follow from an outright collapse. The road to a future unification, if it will happen, could be a bumpy one and will need huge support from the outside world to lift a country that, from a western economic point of view, is both underdeveloped and genuinely poor.

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- 331 -

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7. Discussion and Conclusions

The spirit in this book has generally been very positive, much as a result of the economic development that is taking place in the NEA countries during the last few years. This development was made possible by the relative stability in the world economy, which can partly be ascribed to the phenomenal economic growth that is taking place in China.

Globalization was set out as a theme already on the first pages and a most important issue, where the NEA countries are very active participants. The process is not really possible to pin down in a simple definition as initially discussed as it appears with so many different faces and leads to different results, depending on the setting. Increasing long distance international trade followed by energy and raw material dependence are just examples of this. The flow of manufacturing employment away from developed countries in the direction of low labor cost locations is an indirect result of the same process. The rapidly increasing flows of capital in-between countries is another aspect, although not being physical, of the ever-tighter international net that is being woven. A similar process that is both reducing and changing employment in developed countries is the moving out of service functions to far away locations. This bears a resemblance with capital flows as something less visible than the movement of production and workplaces inside the manufacturing sector.

This global change also makes the process of making value creation from any kind of the above-mentioned undertakings less connected to the geographical location of consumption. A trend that also increases the anonymity of the players involved as initiators, sellers, middlemen, owners, and buyers. This aspect makes pure rent-seeking behavior less visible and as a result more attractive. With the creation of a more open and interactive world society, the search for expected quick returns has become increasingly commonplace, partly replacing the more conventional form of entrepreneurship in business.

Contradictory in the process is that e.g. investment- or pension-funds in the developed world where employees save for the future has also turned into a highly competitive business. Savings in these funds must show high returns to retain old and attract new customers, which is achieved by way of putting pressure on the companies they invest in. If the expected returns for the fund are not achieved, the capital will be reinvested in other companies, as investors are free to move around capital to the company or country where the best payback is expected.

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- 333 - On the other side, in this process are these business leaders in the companies appointed to make companies remain profitable and to, preferably, increase shareholder value on top of that. Under these circumstances any manufacturing operation, especially so if labor- intensive, will find it hard to be highly attractive to by opening up shop in countries that offer wages of about USD 100 / month. The result is a process that sometimes practically forces companies to move out to locations where they expect to find the highest returns to remain attractive. As a result of recent years advances in technology, transport, as well as ICT, the prerequisites now exist to make it possible to both control and operate separate undertakings that are being performed in units separated by many 1 000’s of kilometers.

In the example mentioned here and in the introduction, using e.g. the capital from a pension fund for an investment, the contradiction become very obvious indeed. That is when the persons making their monthly installments to the fund who have an interest in receiving an as high payback as possible and the conduct of the fund, or indirectly the company receiving the investments, contributes to unemployment by moving production facilities abroad from the very region/country where the original pension installments were made. Creating macroeconomic problems in the nation of origin that can many times over outweigh the advantages gained by the individual from his investment. Such conflicts of interest arise based on a previous stable system that is being overtaken by a new development. In the case of the pension fund, used as an example here, it was originally seen as a solution to the future pension payment crises problem that faces the aging populations in the developed world. Instead it has now increasingly come to contribute to the creation of new structural problems for tomorrow. If the same process is looked upon from the point of view of conventional trade theory, as described by Adam Smith and David Ricardo, then it is perfectly logical that lower prices will enable increased consumption for all. However, it most often remains difficult to quantify the advantages, and even more so to explain these positive effects to the workers in the developed world who were made redundant in the process. As these changes are ongoing, more research is needed to better understand the processes involved and explain how these processes are interrelated. Workers in the developed world will not need science and theory to understand that they have been made redundant by development, but science will be need to explain how it actually came about.

The access to more information on changes have always happened, albeit in other shapes and of which we have not been fully aware, have perhaps lead us to become increasingly worried about developments and accidents where mankind previously never found reason to worry. Natural disasters are

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- 334 - examples of areas where information currently spreads rapidly around the world, and have had reason to do so especially during 2004. A year with a record number of typhoons hitting China, Taiwan and Japan (26), record- breaking summer temperatures, a record strong storm hitting the Philippines, several earthquakes in the area and with the disastrous tsunami devastating other parts of Asia on December 25. The more interconnected the business society and countries become, the more widespread will the effects of disturbances to the everyday pattern from natural disasters and other accidents be. Such interconnection has increased both the importance and the price of rapid information concerning all kinds of sudden changes.

Economy A positive economic performance can be seen in the four NEA countries during 2003 and 2004, albeit for different reasons. First of all, the economic position of the four coming into 2003, as well as their approach to handle their situation, was fundamentally different. Two, China and Russia, had come little over a decade into a transition period from central planning towards a more market- oriented economic system. These are two countries with two different approaches to this process. Both have been successful reformers in some sectors, while they have failed in others. Japan, as the strongest economy, had in 2003 just began to see signs of what was hoped to become a more long-term and sustainable growth period. Korea was at the time approaching a new period of what looked like a continued rapid economic growth, but instead has proved a somewhat unpredictable development.

Major economic crises often emanate out of debt problems or foreign exchange problems, but this seems not to be at risk here. Instead, there are relatively healthy state finances at hand, supported by highly successful large companies that are leading the way in generating considerable foreign incomes. What has instead become a problem in the two developed economies is the relatively low level of domestic consumption and stable, or even rising, unemployment. A problem that is most often ascribed a cure in the form of reforms to the labor market encouraging free employment while emphasizing the importance of promoting both domestic and foreign investments. Other initiatives that are often quoted as necessary to revive a market are reducing barriers by opening- up for increased domestic and international competition. However, this also often requires other bold and painful reforms. Processes that are not seldom being initiated or speeded-up in relation to e.g. negotiations for membership in the WTO; like in the case of China. This is also bound to happen in the near future also for Russia.

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- 335 - Companies are often well suited to find the road to prosperity on their own when entering established markets. On the other hand, this is less likely when entering markets in the NEA group of countries, and especially so in Russia or China. Domestic firms in these countries have an unparalleled advantage in their understanding of the local market and from the fact that they already know the language, local customs, have ready networks and a commitment to the market. That is often the explanation to that so relatively few outsiders have been successful in these markets without working through a JV. However, the low wage levels for average workers in e.g. China, in the range of USD 100 – 150, could also be seen as a reflection of low productivity. It is undoubtedly so that productivity is lower, but probably not 1/10 – 1/20 of what is the case in developed countries. If an investor with labor-intensive production can organize and establish his production and new logistics needs well enough inside a not too long time, then considerable profits could be harvested.

However, there is still an ever-present information problem when it comes to emerging markets on company as well as on the macroeconomic level that could lead to anything from individual misjudgments to misleading national initiatives. An example of the severity of the problem came into focus in an UNCTAD report, released in late 2004, on the Russian economy and its FDIs. The report stated the Russian FDI volume for 2003 as USD 1 bn. This figure was based on the information posted on the CBR homepage in the beginning of June 2004. Later an updated figure, promoted by the state, had been posted in July, but now setting the figure to near USD 7 bn. It is noteworthy that a preliminary figure can be revised by some 700%, and to make use of a figure that is given six months into the year cannot be considered all to wrong. This example deals with what is both a high profile and important figure being stated by the national bank. It then turns out to be completely wrong. If misjudgments of this dimension can still happen, then there are few figures that can be trusted, making both international decision-making, as well as book writing, even more difficult. The CBR figure above relates to problems in collecting information about the past, but it is even more difficult to predict the future. The official estimations for the Current Account and export values of Korea during 2004 demonstrated this. The predicted full year value was, in the case of the Current Account, reached by the end of Q1 and the export value was reached in the first six months. It is apparently becoming increasingly evident, with both Japan and Korea as examples, that what used to be the governments conventional set of adjustments to keep the economy on track, e.g., easing monetary policies and keeping the interest rates low, works less efficiently than before. As a result not only predictions becomes increasingly insecure, as high liquidity and low interest rates does not necessarily lead to increased investments and consumption, as was hoped in Japan and Korea.

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- 336 - Russia for its part has seen major currency crises over the past ten years but has been able to ride this out by making use of a considerable international economic support. It has now reached considerable economic stability while profiting from a much higher price level for its energy and raw material export. China, so far, has not been anywhere near currency instability, but it probably needs to accept more flexibility in currency operations as its involvement in the world economy increases. China has been accused, sometimes unfairly, to strongly influence unemployment figures in faraway countries. However, there can hardly be any long-term sustainability in a trade system being built on a long-term huge deficit in the largest of the import market of products from China, Korea and Japan, the US. Somehow there will have to be an adjustment in currency values, i.e. a depreciation of the US dollar, which will result in a fall in US imports. Both governments and companies in highly export dependent countries in both South and North East Asia will have to prepare for this situation. Albeit being a change that could indicate difficult prospects for the same group of countries.

The economic stability of all the NEA countries currently relies strongly, and from what it appears increasingly, on the success of its multinationals. Many of these multinational corporations have created a system of both dependence and reliance in-between the major countries of the world where many economies will struggle as soon as their neighbours will face a crisis. These multinationals may well become the glue between the nations of the world that could see-to that potential conflicts will be kept at bay. At the very least, the multinationals could serve as mediators and lobbyists for dialogue as the international-political- economy continues to change in a dramatic and often unexpected fashion. In a global capitalistic world, as it is shaped in the beginning of the 21st century, there are no major opposing economic blocks as during cold war years. Instead, global competition has partly come to replace, or supplement, geopolitics in its search for the best partner or location for different functions of the biggest of the global corporations.

The functions of the state cannot be summarized into just something of a supplier of favorable conditions to its economic actors while enforcing law and order. It also has a duty towards its citizens to organize services and education allowing citizens and economic actors to take a longer-term perspective on their actions. Under more liberal conditions, enterprising could come to take over the responsibility for some national needs that would require less central control. However, this seems not to be the direction in which Russia under Putin and China under socialism are moving. Both have seen widespread economic freedom but have practically made no advances in the political field. In Korea under Roh, the picture is mixed, while Japan under Koizumi is slowly moving towards increased liberalism with a decreased role for the state.

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- 337 - Trade Trade is increasingly important to most countries, but possibly even more so for those in the NEA group. Here foreign trade moved into the centre of attention to overcome the burdens from the Asian crises in 1997. Trade dependence, when measured by the relation between the GDP and the foreign trade value, is constantly increasing as trade figures have been going up by double digits for some countries, while GDP growth has remained much lower. Increased trade dependence makes countries increasingly dependent on both the global and regional development while reducing the domestic window of opportunity for governments. As a result, the importance of trade rules and their use is increasingly coming under scrutiny. A rapid increase in the interest of concluding FTAs has been seen to secure future access to important markets. With the current eagerness to negotiate FTAs with neighbor nations inside the group, it will probably not take long until the forming of something like an extended ASEAN is being formed. These steps in the NEA region are currently being taken within the rules of the WTO and could lead to, if the momentum can be kept, the emergence of larger trade areas that is much more rapidly developing than what has been seen elsewhere. Both the Southeast and Northeast Asian region must continue to improve their internal relations to make such a scenario possible the internal relations between neighbours. However, there are a number of bilateral issues to be solved that could stall the process at any time, like several of the different contested islands. There are also other internal conflicts among the NEA group, e.g., opposing views on historic conflicts that could spill over into trade conflicts, if not carefully contained by the involved governments. If something like a dark scenario was to develop, the economic and trade related effects on a lot of countries, not only in NEA, will be both widespread and immediate. In the case of Russia, again something of and exception, more than 2/3 of its recent years growth originates from increased prices in the fuel / energy complex and other raw material sectors such as wood, ferrous metals and mining. All being products that are not based on any unique know-how or manufacturing skill, which is the case for the export of the other three in the group. The Russian situation is unique because it is dependent on a string of basic products in high demand and has so far seen little when it comes to diversification into other sectors. Russia has yet to raise its general competitiveness in most other fields. The same kind of dependence, but on a small number of products, can also be seen in Korea, but its products are basically high-tech in nature. Consequently both Russia and Korea are exporters vulnerable to changes in demand for a small number of products in overseas markets. In this respect both Japan and China find themselves in a better position, with a considerably wider export base.

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- 338 - There are also concerns in the international arena that emerges from increasing trade imbalances between the world’s big powers. The ever-increasing trade deficit of the US in relation to China, Korea and Japan looks unhealthy and is more or less bound to generate upcoming trade disputes. So far, much of the US deficit has been financed by the central banks in these same countries that save much of their ever increasing foreign assets in US state bonds, making the NEA group ever more dependent to the development in the US.

Energy Energy remains a major problem area for the NEA group of countries. On the other hand it is a positive problem for Russia that is more about maximizing profits with no supply problems to be expected as long as the country can be held together. The main worry in the remaining countries is to secure a future supply of energy in the form of oil, LNG, coal and increasingly important, nuclear material. Energy has already been the cause of many conflicts around the world and remains one of the reasons behind the infected discussions about islands in this region. With the seabed's surrounding these islands not having been properly surveyed, no country wants to let go of potential offshore resources. However, it is difficult to move beyond the everyday issues with the lack of a regional forum for discussions at the top level in the region. In this respect, it is probably Japan that holds the key to any future success. The high profile, and by neighbor countries detested, shrine visits by Prime Minister Koizumi makes him Il l-suited to take the lead in bridging these disagreements. At the same time, he holds a relatively strong domestic position and will probably have to be the accepted by the neighbours, as the only available alternative for a dialogue.

In the absence of large-scale renewable energy resources, a future dark scenario could always be predicted where the tension mounts among major powers of the world while attempting to secure enough energy for themselves. Cooperation among the world's most important countries would therefore be the best solution for everyone, but will and can these countries cooperate? Again, a strong reason for countries to cooperate is continuously being generated by the sometimes much criticized globalization process and the increasing interdependence.

During 2003 and 2004, prices in the international energy market have surged, much due to increased Chinese demand for practically all kinds of energy, as well as other raw materials. Inevitably, the continued problems surrounding the Persian Gulf, the worlds main source and reserve of world oil resources, has aggravated the energy situation further. As a result, a new and higher price levels for energy seem to have been established, with crude oil being the

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- 339 - commodity that has come to represent the turnaround. The volatility of energy and raw material prices has added an extra dimension of insecurity for all countries and even threatens to lead to a possible rebirth of inflation in some cases. For the countries that are relatively energy inefficient in relation to their GDP, energy costs have increased its share in their currency spending and have had a clear knock-on effect on all sectors of their economies through higher costs for electricity, heating and transport.

For Japan and Korea, the consumption of hydrocarbons in later years have fallen in volume, but both, since the 1970s, have had the necessary infrastructure to handle large import volumes. Since the first oil crises, the mix in the energy imports has changed with a considerable increase in coal imports and with LNG and nuclear material having been added to the mix. These changes have widened the energy sourcing alternatives during years when total consumption has been rising. Changes in China have been dramatic and in later years when the combination of a stagnation in domestic production volumes has coincided with a dramatic surge in demand. Simultaneously, bottlenecks in transport capacity have become a major problem related to the handling of all kinds of energy, from the transmission capacity in the high-voltage electricity grid to the distribution of the imported coal from the ports. The transport problems that occurred in Russia were practically the opposite, as at the time of the falling apart of the Soviet Union production fell dramatically, but so did consumption, and therefore both the energy sector and the transport system were faced with overcapacity. Instead Russia has been in the fortunate position during the last few years to be able to harvest considerable profits from both high energy and raw material prices, while it has continued to be less successful in many other sectors.

Energy, and especially oil, remains a strategic heavyweight among products in what will continue to be a geopolitical game for energy security. This will leave Russia in a relatively unique position for a long time where it can make use of cooperative partner nations and companies to its own good. Russia and its Far East region, wants to profit economically from the Chinese growth, at the same time as Moscow has no intention what so ever of giving away control over this largely uninhabited area. China is building much of its expanding economy on a growing manufacturing sector and low wages, a trend that has proved strong enough to absorb also the uninterrupted surge in prices for the extra energy and raw materials that must be imported. Japan, with the most advanced industry in the group, has also had to pay more for its imports, but with energy and raw material representing a relatively small share of product prices, these costs have proved easier to absorb. Korea, for its part, is much less energy efficient and more raw material dependent, which has made the upward global price trend considerably more difficult to handle.

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- 340 - Transport in all the countries in the NEA group could be said to be key in the energy sector as they all source most of their consumption from far away suppliers. Also inside Russia, findings supplying oil and gas are increasingly found 1 000 kilometers away from most domestic consumers. Energy of different kinds weighs in heavily in the trade balances for all the countries in the group and it is an additional problem that it is being sourced from faraway locations. The combination of high-energy costs and insecurities has resulted in considerable efforts to develop nuclear power in all of the NEA countries, despite the increased risk and long-term problems involved.

Transport Trucking dominates the domestic cargo transport market in the NEA countries in the two more developed and smaller, countries Japan and Korea, while rail transport dominates in Russia and China. It is a similar situation in passenger transport, where private cars are performing much of the transport work in Japan and Korea and where the market is mature when it comes to car ownership. In China and Russia, the share held by cars in the transport sector is relatively small, but booming car sales in both markets have made these two the currently most interesting in the world for producers. However, sales of cars and trucks have, by far, outgrown the infrastructure development for years, resulting in considerable congestion problems on a deteriorating road system.

Changes in Russia and China have been fundamental over this period, as both energy consumption and transport needs have multiplied. Initially, and during socialistic years, domestic energy sources were favored and self-sufficiency was an integrated part of the official policy. As prices picked up in 1999 it took time for the energy sector and for the Russian state to fully understand that exports would become as profitable to start making transport investments. At a time when new energy fields reached production, new transport infrastructure in the form of rail tracks and pipelines were also needed. Additionally, new ports were also needed to export the increasing volumes and to profit from the higher prices. In China, the problem soon became the opposite, to increase the import capacity. At the same time findings in both Russia and China were located even further away than the previous ones and domestic transport distances have increased as a result. This is despite the fact that the big consumer countries can be found relatively near large Russian findings, but where no cross border pipeline has been laid so far. A possible connection from somewhere in Siberia towards China or Japan has been much debated and despite the fact that a decision appears to have been made, a completion of such a connection is several years distant. Meanwhile, other long distance connections have been laid, with a gas pipelines across China as one example and, e.g., the ongoing work to connect oil fields in Kazakhstan with western China.

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- 341 - Another aspect of the increasing dependence on long distance transport and increased global goods interdependence is the booming shipping sector. Shipping over long distances is in itself no new phenomenon, but the continued accelerated increase in ship size in the container sector is. The ship size has rapidly doubled to carry increasing volumes of manufactured goods and the first 10 000 TEU ship have already been ordered, with yet bigger to come around the corner. Although there is an increased demand, prices for long distance shipping have doubled in approximately one year, it still remains a very small portion of average product prices. Although increasing transport costs are negative for exporters it is positive for the shipping companies. This it has led to a boom in shipbuilding that has booked up all available capacity until 2008 in the three biggest shipbuilding nations of the world: Korea, Japan and China.

Security concerns in the shipping sector are constantly being kept on the agenda and during a voyage to/from Europe and the Middle East, ships pass the other major security worry; the narrow and pirate-rich Singapore Strait. No other waters in the world see some 50 000 ships pass loaded with something like one- third of world trade. There could also be a similar security burden to be carried by a pipeline, regardless of the connected regions. Not only does some of these long distance lines originate in less democratic countries, like Kazakhstan, but are also being laid in sparsely populated areas. As a result, they could become ideal terrorist targets in obstructing the functioning of a state. However, no matter how rapid the increase in shipments from Siberia, Central Asia and from booming production around Sakhalin will be, the main transport origin for energy for the three big consumers in the NEA group will continue to be hydrocarbons shipped from the unstable Middle East.

The road to future prosperity To achieve a state of future prosperity in an ever more interconnected and globalised world stability is a major concern. With the exception of Russia, the NEA nations are all considerable raw material importers, manufacturers as well as traders, which further enhances the need for peace and stability. Geopolitically, the peace agreement signed between Russia and China during 2004 was a huge step forward, which included a common stance on a number of issues, e.g. over Taiwan, and they are also planning their first common military exercise. However, the NEA region still includes a number of current hot and potential problem spots, where some have over the years turned into something like a part of every day life. The most obvious is the nuclear problems related to North Korea, with the slowly improving relation, that has also seen setbacks, Russia and Japan, still 60 years after WWII have not moved much closer to a peace agreement. Also the infected wound caused by Japan's war crimes, and forgiving descriptions of this in school books, have lead both China and Korea to

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- 342 - show continued anger as old wounds have been slow to heal. Attention on islands are also seen, e.g., the Diouys that remains disputed between Japan and China while there has been continued friction over the Dokdo islets that are currently under South Korea and not Japan; not to mention the island of Taiwan. The future existence of Taiwan as a separate country continues to be based on fundamentally opposing opinions on the mainland and a large part of the Taiwanese population. A relation that has seen considerable improvements in later years, but also several setbacks, continues to be based on fundamentally opposing opinions as to the future existence of Taiwan as a separate country.

As long as mainland China continues its rapid economic and military expansion, it will inevitably and increasingly often come across situations where its interest in energy or in geopolitics will oppose interests among its neighbours, or the US. Despite a firm official stance on the Taiwan question over the years, actions, or the lack of Chinese actions, speak louder than words. This should perhaps be interpreted as a sign of a benign giant panda instead of a frightening dragon. On the other hand also China must be ready to accept responsibilities and to actively participate in the running of the world as a consequence of its increasing economic power. At the same time, others must also overcome the fear of letting China shoulder such a position.

Additionally, there are a number of internal problems in the NEA countries that are slowly getting increasingly difficult to handle, although they have hardly been mentioned here. Demography is just one aspect with long-term effects on the macro economic situation in each of the countries. In Japan, the age group over 65 is now over 20% of the population, while in Russia, the mortality has reduced male life expectancy to below 60 and the population as a whole is falling by about 500 000 per year. Korea displays a pattern similar to Japan, which is also happening in China, but with a worryingly large surplus of boys among the newly born.

If the increasing average age will affect all inhabitants of the mentioned countries more or less equal, then that is not the case with increasing income inequalities. As private car ownership in China and Russia is increasing rapidly, the lower income strata of the population are increasingly unlikely to ever earn enough to pay the price of a medium size car - in a lifetime. This development is exceptionally contradictory if the constitution, like in China, clearly banns “…the exploitation of man by man”. Also in Korea and Japan, the well offs are connected to higher positions and active in prosperous sectors that are increasing their wealth, while workers in the less-favored sectors and locations are constantly losing out. Although the numbers are smaller than in Russia and in China, both countries see a growing group of younger people that never enters the labor

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- 343 - market and that are often unlikely to ever earn any official income. All NEA countries have developed from a history where life-long employment was the rule, guaranteed either by the employer or the state ideology. This has changed completely as 30% of workers in the Japanese labor market get along on short- term contracts, are employed by temporary staff agencies or have a part-time job. If strong economic growth with low employment generation is a phenomenon for the future that is to stay it will certainly be something that will limit the window of opportunity for governments. As policy measures to steer away from threats of increasing unemployment, increasingly liberal arguments could be used, and are already in line with the freeing the market forces. Some are based on real tendencies and hard facts, while other remains open to change. If this is the best way forward is probably impossible to tell, as it much remains partly guesses to predict the future. It serves here to remind the reader that concerns are already being voiced in China that the shifting focus towards more capital-intensive industry sectors will lead to an industrial development that cannot generate enough work opportunities already in the near future.

Income inequality is often a politically sensitive subject, but is still to be seen as a standard issue compared to democracy. All societies, being transition economies or not, face the problem of finding a path to initiate their necessary changes and make use of available opportunities where advantages are more or less fairly balanced by the drawbacks. The necessary decisions, by politicians who have been elected democratically, on which path to follow as a nation, should be taken at the political level. However, the world has so far not seen a clear-cut definition of democracy that has been accepted by a majority of its countries.

In the NEA group Japan is leading the way in applying a western style democracy, with Korea having seen an impressive democratization in approximately 20 years’ time. The two transition economies are considerably more open today than ten years ago, but few, with a western definition, would call Russia fully democratic and certainly not so with China. Increased democracy is probably needed in all countries that would like to see stability and long-term economic growth. Such countries must be willing to make the necessary investments in education and health care, and not only focus on economic growth. These two directions of development are not always fully compatible, as attempts to promote diversification of the economy is often doomed without having reached a stage of good democratic governance. While many countries, e.g. the “Asian Tigers”, have seen their strongest economic growth during stages when they are less democratic, the Russian transition appears to be different. In the Soviet Union, the collapse of the government, at the time of the break-up, was followed by continued weak governance. As a result, no central governing “strong hand” steered the development and set out

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- 344 - the direction for the manufacturing and service industries to follow. Instead, the focus was set on the attempts to introduce democracy before a sound economic development had taken root to carry the economic burden of such a development. In 2004, the president gave his verbal support to a continuation of this dual development: “Our goals are absolutely clear: high living standards… … a mature democracy and a developed civic society” (State of the Nation Speech; Kremlin, 2004-05-26). China, as the other transition economy, although from a socialist point of view, has largely followed the same track as the “Tiger Economies” did some 20 years earlier; a strong state controlling the economic development. However, it maintained the socialistic ideology behind its emerging market economy. Of the two approaches to economic change, the few examples used here indicate that strong central governance has initially been better suited to carry through the large-scale reforms needed. Gradually, Singapore, Taiwan and Korea have, since their years of rapid economic development, converted themselves into full-fledged democratic societies. This can, sooner or later, be expected to happen also in Russia and in China, and, in a long-term perspective, also in North Korea.

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1 South Korea will from here on be referred to as only Korea in contrast to North Korea. 2 Outsourcing is the process of letting other companies take care or functions inside a company that traditionally has been done by own employees, e.g., transport services <= >the opposite is to do something “in-house”. 3 Countries, which offer secrecy to owners of bank accounts and very low company taxes, but sometimes attracts deposits from not always legal business. Examples could be countries like Lichtenstein, Switzerland, Cayman Island and Guernsey. 4 The GDP figure is based on UN estimations for 2003; Population figures are UN medium development estimation for 2005, based on 2002 population figures. 5 The “current-account balance” measures the total flow of goods, services, investment and other financial transfers in and out of a country. 6 ASEAN includes Brunei Darussalam, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. ASEAN + 3 -> is normally being referred to as the ASEAN group + China, Japan and Korea. 7 Clusters -> geographic concentrations of related and supportive business in one line of business. 8 The “Asian Tigers” are normally referred to include Hong Kong, Singapore, South Korea and Taiwan. 9 The natural advantage comes from the fact that one country is richly deposited with something the other has nothing or very little of. The comparative advantage derive from the fact that both will still profit from the fact that despite only a seemingly minor advantage for one of the countries, in one of two possible products, both will still profit from specialisation. 10 The expression “inside companies” here relates to when products are exported to other units of the company abroad, or another company inside the same group of companies. 11 What is currently the EU was initiated as an initiative to establish common control over coal and steel production, to make future wars impossible. ASEAN –Association of Southeast Asian Nations; APEC – Asia Pacific Economic Coorporation. 12 GATT was one of the organisations that were outlined as a result of the 1944 Bretton Woods conference, between the powers that were winning WWII, together with the World Bank and the International Monetary Fund, and came into being in 1949. In late 2004, WTO had 147 countries as members. 13 “Non-tariff” refers to regulations that makes trade/imports more difficult without being in the form of a money tariff that should be paid; it could instead be difficult permissions or specifications needed. 14 The regulated quota system under the MFA terminated by the end of 2004. Trade in textiles is also being discussed in greater detail in the chapter about China, under the headline “Textiles and its trade”. 15 Agreed on July 30, 2004, as a negotiation step in the framework of the Doha round (WTO, 2004-08-01). 16 For non-WTO members, it is often difficult to settle such difficulties if they become subject to anti-dumping on over-sea markets. A membership does not make a country immune to complaints, but the way these are launched has to be standardised and will

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- 347 - be decided by a third party; the WTO. The name originates from the capital of Qatar, Doha, where the negotiation round was initiated. 17 Most countries have a “Foreign Trade Legislation”, setting the limits of how foreign trade can be conducted, it still must be reformed and brought in line with the framework of the WTO. 18 “Structural unemployment”is the result of that a whole line of industry has lost it competitiveness and is unlikely to generate any future employment; e.g., coalmining, textile industry and older steelworks. 19 GATS – General Agreement for Trade in Services; concluded in 1995 before the inauguration of WTO. 20 The number of FTA’s in the world that currently exist can not be set very exactly as it continues to increase, and as there is no standard definition what is needed to be considered an FTA. With the US, about 50 countries have signed different kinds of arrangements related to trade. For an update see: http://www.fas.usda.gov/itp/Policy/trade_news.htm 21 This will be further exemplified within the China chapter dumping case against TV manufacturers. 22 It was not until then that WTO’s predecessors, the GATT, stared to take notice of such actions. What happened before was seen as bilateral issues that were not given any wider attention. 23 “Provocation” representing the Chinese point of view while the Koizumi view would be one of personal freedom of religion. 24 In contrast to the latest visit to the shrine the German Chancellor, Gerhard Schroeder, as have his predecessors, repeatedly acknowledged the Germany guild in WW II and at the nearly the same date participated in the commemoration of the Warsaw up-rising that claimed some 100 000 victims. 25 The latest on the sidelines of the APEC meeting in Santiago in November 2004. The Yasukuni issue was as the main subject brought up from the Chinese side, with gas explorations as the main Japanese issue. 26 “Oil-equivalent” is a measure used to compare or sum-up different sources. The energy content, e.g. in coal, is recalculated to the corresponding volume of oil that would supply the same amount of energy. 27 1 million bbl/day equals approximately 141 000 tons (one barrel is equal to 159 litres); setting world consumption at about 11.5 mt/day, or at 4.2 bn tons per year. 28 There are eleven OPEC (Organisation of Petroleum Exporting Countries) members: Algeria, Indonesia, Iran, Iraq, Kuwait, Libya, Nigeria, Qatar, Saudi Arabia, the United Arab Emirates and Venezuela.

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Chapter 2 29 At the end of 2004, Russia had a population of 143 million on a surface of 17 000 000 km2.

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30 “The Duma” is the lower house in the Russian Parliament; “The Federation Council” being the upper. 31 The following values refer to each country’s domestic currency, if nothing else is being stated. The GDP for 2004 was first given as 6.9%, but within weeks adjusted to 7.1%. 32 The latest available statistics related to most factors of the economy can be found at the information page of the Ministry of Finance (Minfin, 2005-01-25). 33 “Federal State Statistic Service” is the renamed former statistics unit called “Goskomstat” 34 In a 2004 survey 60% of business leaders set “Bueroucrats and state regulations” as the main hindrance to the development of small and medium sized companies (Expert, 2004-06-06).

36 In September 2004 the average per capita subsistence minimum in Russia was 2 400 (USD 85) 37 "They are inviting Russia into the club as an important partner in the energy dialogue, that is, as an aide on raw-materials questions." Sergei Rogov – Director, Institute of the U.S.A. and Canada (Vedomosti 2004-06-08). 38 The use of Yukos-kind of tax breaks has continued during 2004 when steel and metal companies have been said to have used companies in Chukotka to save billions (Bloomberg, 2004-09-21). 39 Benefits that could include; free health care, free public transport, subsidised vacations and housing. 40 The first figure includes also e.g. bank loans, while the second is only long term “real” investments. 41 In the worst years of capital flight in the mid 1990’s the level was estimated to have reached USD 80 bn. 42 Among the “unknown” on this listing, with assets valued at USD 350 millions, mostly in real estate in and around Moscow, are Yelena Batuirna – the wife of Moscow’s Mayor, Yury Luzhkov. 43 It must be remembered though that the background data used are far from perfect as much of the ownership is, on purpose, very difficult to trace through complicated company cross ownership structures and offshore trusts, often placed in distant tax- heavens. Leaving little chance of scrutiny. 44 A situation that is often said to resemble the curbing of US “robber barons” in the late 19th century. 45 During the crises, the CBR, e.g., reduced the reserve requirements by 50% for the sector to free capital. 46 Sberbank alone holds 60% of all private deposits. Vneshtorgbank later acquired a struggling Gota Bank. 47 The WB definition is: “an income just adequate to cover essentials” – it topped at 42% in 1998. 48 The ten new members included in 2004 were; Cyprus, Malta, Slovakia, Czech Republic, Slovakia, Hungary, Poland, Lithuania, Latvia, and Estonia. 49 The Russian export tariff has been in operation since 1999, but with world steel supply having outstripped demand up until mid-2003, the tariff have had little effect prior to that.

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50 Nikolaev, 30 in 2004, spent 3 ½ year in prison for beating a Krai legislator and threatening to kill another. 51 In the year since September 2003 there has also been a fall in value of the US Dollar of about 10%. 52 If the huge shuttle trade in the years around 1998 had been included, it would probably have meant that the import figure should have been 20 –25% larger. 53 It can be expected that the values exported are considerably higher than what is stated, as exporters have a tendency to underestimate, which is supported by import values from Russia in Asian countries. 54 Trade-related conflicts that include Russian products currently counts in the hundreds, e.g., just anti dumping actions against Russian products are by mid-2004 well over 100 (MOEDT, 2004-06-15). 55 China also demanded this, for one week, and then the demand was withdrawn again (MT, 2004-07-25). 56 As for agriculture, Russia, is currently relatively free from agriculture subsides, and wants to count the level from 1989 as its base for the negotiations on the reduction of subsidies. WTO regulations allows some limited restrictions for agricultural products in the form of subsidies and import quotas. 57 A pirate CD with any major artists has so far sold for around USD 2, just off the high streets, in Russia. 58 Asian Pacific Economic Cooperation, set up in November 1989, includes Russia among its 21 members. 59 The zone where the conflict was staged can be found where the two rivers Amur and Ussuri meet. 60 E.g. Gazprom, Transneft, United Electric System, Rosneft (merging with Gazprom), Irkutskenergo 61 The shares in Gazprom rose by about 15% in only the day of announcement (Kommersant, 2004-09-14) 62 When using international accounting standards, the oil companies do this in their annual reports. 63 On June 1 2004, a day when oil prices jumped USD 4 after militants had killed 22 people in an attack in Saudi Arabia, Texas oil in New York sold for USD 42.5, and Ural Brent at USD 36.8 (MT, 2004-06-02). 64 Worldscale is a % of a nominal, yearly recalculated, rate on set routes for a fixed ship size. Shipping prices are then negotiated as a percentage of the base rate for the leg: e.g. Persian Gulf -> Singapore. 65 80 mt x 20 years x 7.1 (bbl/ton) -> total transported volume will reach 11.2 bn bbl -> USD 1.6/bbl 66 The latest strong earthquake, measuring 6 on the Richter scale, hit Sakhalin on June 1, 2004. 67 BP bought a 50% stake in the then third largest Russian oil company, TNK, for USD 7 bn in 2003. 68 With the former CEO of Rosneft as a large shareholder in many of the subsidiaries of the company, the merger is said to have run into difficulties over compensation claims (Kommersant, 2004-10-05)

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69 Transit fees for oil and gas in the Ukraine fund 15% of the state budget. At the end of H1 2004 Belarus, Moldova, and the Ukraine owed Gazprom over USD 3 bn in unpaid gas bills (Bofit, 2004-34). 70 Mosenergo, which is about to be restructured, has seen considerable speculation during the fall of 2004, with Gazprom having become a 25% owner, at the same time owning 10% in the UES (MT, 2004-11-05) 71 Although it is technically possible to also produce heat, all plants produce only electricity 72 In April 2004 the previous ministry, Minatom, was stripped of its status as ministry. Instead it became the Federal Atomic Agency under the Ministry of Industry and Energy, but this will not change the status of the former ministry’s international agreements. 73 What probably is the most misplaced Soviet reactor can be found in Jerevan, Armenia, site to the large 1989 earthquake, but put back into use in 1995 and still supplying 40% of national electricity. 74 Seversk and Zheleznogorsk could be better known under their under-cover names when they were secret Soviet cities: Tomsk-7 and Krasnoyarsk-26. 75 Not a unique situation as e.g. the four reactors in Murmansk Oblast, at the Kola Nuclear Power Plant, two are of Chernobyl type, with the plant producing 60-70% of the electric energy in the region. 76 The Soviet-designed reactors built in DDR have all been closed. 77 The description “Chernobyl type” has been given to the RBMK reactor after the fatal accident that occurred in April 1986. This kind of reactor has no safety containment and use fire dangerous graphite. 78 EPR – European Pressurised Reactor designed by German-French Siemens-Areva in the 1980’s. 79 During later years any visitor travelling on local Russian bus has been able to see for himself that at least 50% of passengers present different kinds of permissions to the conductor and do not pay any fee. 80 Any visitor in Russia cannot have avoided noticing the high willingness among Russian drivers to take unnecessary risks, which adds considerably to the raising fatality statistics. 81 To be compared to the ownership in the US is at around 700 per 1 000 inhabitants. 82 The following 4 – 7 on the list of foreign producers are all from NEA: Daewoo 35 000 (+90%), Mitsubishi 30 000 (+70%), Nissan 28 000 (+210%), Kia Motors 19 000 (+40%). 83 Only during the first six months of 2004, Sovcomflot alone took delivery of three new ships, and has placed orders for seven new ships by October 2004. The company already has an average age of its near 4 million dwt fleet of a near world record low, for that large a fleet, of 8.2 years, with 9 new ships on order. 84 The port in Vostochny changed hand for UAD 150 million as late as in January 2005 from its former steel based, Severstaltrans, owners to its new coal based owners. 85 “flat-” products here are sheets; “long-” products refers to wire in different forms. 86 The approximate raw material consumption for one ton of steel is in the range of 1,5 – 2 ton of ore, 1,5 tons of coal, six tons of water and additional minerals/additives depending on the quality produced.

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Capter 3 87 In 2003 Japan had a population of 128 million on a surface of 378 000 km2. 88 The Japanese accounting (fiscal) year starts on April 1 – in contrast to the normal fiscal year 1/1 – 31/12 and often leads to confusion as published statistics often do not refer to calendar years. 89 CA - gives not only the import and export values of goods and services, but also the capital account of the balance of payment, which includs data about short and long-term capital flows (Over time it should largely balance – problems related to deficits are much more frequent than the NEA surplus problems). 90 The Governor of Bank of Japan, Toshihiko Fukui, has endorsed such actions as consistent with the central bank's efforts to drag the Japanese economy out of deflation, including the issue of a record level of short-term debt financing bills to pay for the market operations (JT, 2004-03-11). 91 From mid October to the end of November the Yen appreciated by over 7% against the US dollar. 92 Government bonds make up nearly 90%, with per capita dept. corresponds to about USD 50 000. 93 The standard analogy handsets of the 1980’s and digital handsets of the 1990’s are labelled first and second generation respectively; the third generation could also handle Web-pages in the phone. Currently 3G phones used in the three nations use different transmission standards. 94 “New Deal” was originally the Roosevelt economic policy adopted in 1932 to curb the US depression. 95 Authors extrapolation based on METI trade figures for 2003 and H1 2004. 96 Also known as “voluntary restraint agreement” – VRAs 97 Cases against Japan at the WTO have been opened at a rate of about two cases per year. Most have been settled bilaterally, while of the outcome of two rulings have been against Japan. 98 The shrine can be virtually visited, anonymously, by anyone at www.yasukuni.or.jp/english/ 99 The Japanese Constitution Article 20 reads: “Freedom of religion is guaranteed to all. No religious organization shall receive any privileges from the State, nor exercise any political authority" 20:3 reads: "The State and its organs shall refrain from religious education or any other religious activity" 100 The Korean comfort woman, also called “sex slaves” were women that had to serve the Japanese army during WWII, while the Nanjing Massacre, refers to alleged mass killings and rape in Nanjing Dec. 1937 to Jan. 1938 after Japanese forces captured the city. 101 Lee, 81, was President for 12 years and born under the Japanese rule of Taiwan. When asked about the mainland’s opposition to his visit he stated: “Taiwan is not part of Chinese territory” (Kyodo, 2004-12-28) 102 The record summer of 2004 gave the Tokyo area 68 days with above 30 degrees and 89 in Osaka.

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103 A derailment, but with no passengers hurt, by a Shinkansen train did happened at the Nigata earthquake in October 2004 when the train happened to be at the 6.8 epicentre on the Richter scale. 104 “creative bookkeeping” – to make adjustments to in the accounting to improve results – not always have to be illegal, more often in the dubious sector of accounting principles. 105 Figure includes only cars with engines > 660 cc. 106 The given information must be seen as indicative as the different companies use different basis to include or exclude subsidiaries when it comes to plants and employees. Some are also big producers of other products like trucks, buses, motorcycles, outboard motors and equipment. 107 The 54 km Seikan Tunnel; 24 km is under water, with its lowest point at 240 meter under the sea level. Needed 16 years for completion, until 1988; is one of the worlds major engineering achievements. 108 Several of the larger companies have joined forces in alliances like this one, comparable to those among air carriers. Here it is NYK together with Hapag-Lloyd of Germany; Malaysia International Shipping; OOCL of Hong Kong and P& O Nedlloyd of the United Kingdom/Netherlands; the MOL group includes APL of the United States and Hyundai Merchant Marine (HMM). Grand Alliance has the largest capacity of the two at 3.5 million TEU in the beginning of 2004 and TNWA 2.8 million TEU. 109 Among subsidiaries of the main companies there are a large number of co-operation agreements and cross ownership, e.g. for development projects and non-core activities.

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Chapter 4 110 In early 2005, China had a population of 1 300 million on a surface of 9 600 000 km2. 111 Most often known as Yuan, the Chinese currency has Renminbi as its unit of measurement – a pair that resembles that of the UK pair of Pound and Sterling. 112 Contractual value of FDIs in 2004 reached USD 153 bn, up 33%, from a total of over 43 000 approved projects, but investments of USD 61 bn were realised. 113 “non-performing” here refers to loans where no interest is being paid and where it is unlikely that the lender will be able to fulfil his commitment or even parts of it. 114 The Yuan is officially not a convertible currency, but still in circulation in neighbouring economies. 115 “float” indicates that the value of the currency is set by the market without state influence. 116 “pegged” value is practically the opposite to a float – a fixed value in relation to another currency. 117 With more than half of the zones having been set up informally, competing with the official ones. 118 In the late 1960’s the average stood at above five children per woman to have fallen to 1.5 in 2003. 119 “In China, shortages of water are an unavoidable issue challenging national security” (Wang Shechung, Minister of Water Resources, quoted in CD, 2004-04-12).

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120 Originating in its inner northern parts, China has seen an increasing number of sand storms in later years, with the storm in March 2004 covered 2 million km2 (approx. 5 times Japan) CD-2004-03-30) 121 Already in 1952 Mao Zedong is said to have suggested “the north should borrow some water from the south”. In 1992 President Jang Zemin gave priority to the project as a part of the national development strategy. The only comparable projects in the world could be the Russian projects, from the late 1970s, to divert a part of the flow in the river Ob south, towards Central Asia and the Aral Sea; abandoned in 1986. 122 The Harbin division of Bank of China saw its manager disappear in January 2005, but not alone, as also customers’ deposits to a value of USD 115 million had vanished (CD, 2005-01-24). 123 March-June 2003 some 5 000 on the Chinese mainland were infected, of which 350 died. 124 During much of H1 HK was hit by SARS resulted in low productivity during the period. 125 Relations are improving in many fields and in late 2004, the first cruise ship ever sailed from the mainland with tourists to Taiwan (CD, 2004-12-10). For the Lunar New Year, during the first days of February 2005, special negotiations made it possible to run charter flight across the strait – first since 1949. 126 The “One-China” policy is based on the outcome of negotiations between the mainland and Taiwan in Hong Kong in 1992, when the parties agreed on this principle; but with different interpretations. 127 An increase by USD 10/ bbl in oil prices represents an increase in imports by app. USD 8 bn. 128 A volume that corresponds to about 30% of that of Japan or 70% of that of Africa (WTO, 2004-08-28) 129 It includes calculations of GDP, currency exchange rate, the trade method and the trade competence of the nation that could be done by slightly different methods in different countries. 130 EU 25 is the largest export destination, US largest single nation. Japan is the largest source for imports. Largest countries in order of importance for total trade in 2003 were: US, Japan, Hong Kong, Korea, Taiwan, Germany, Malaysia, Singapore and Russia; with Japan overtaking the US during 2004. 131 Not true for textiles though, where the EU promised increased mushroom(!) quotas to compensate for problems during the transition time until the end of the multi-fibre agreement in the beginning of 2005. 132 ASEM was formed in 1996, with the aim of promoting co-operation between the regions. ASEM 36 includes EU 25, the EU Commission, China, Japan, Korea and seven ASEAN countries. 133 In the case of Chinese exports, the first anti-dumping cases appeared in 1979 when the EU launched an investigation into the export pricing of Chinese saccharin. 134 The high profile German Maglev technique used for the Shanghai airport railway is said to have been subject to infringement as well as GM, with a full car model, are just two examples (CW, 2004-12-12).

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135 By September 2004, the ten APEC countries, New Zealand, Kyrgyzstan and South Africa have granted market economy status to China (CW, 2004-09-08). 136 The production volume of China's textile industry continues on its growth trend and was up by 15% during H1 2004, despite state measures to curb the growth in industry. 137 The US president, in early November 2004, rejected a request from a group of congressmen to bring up a case at the WTO concerning the Chinese currency policy (Whitehouse, 2004-11-14) 138 Filed in April of 2004, it gives the US government 45 days to accept the petition, then 60 days to hold hearings on the matter followed by a year to decide what actions to be taken. None of this happened. 139 Some odd examples of the miscalculations are given: as e.g. the use of airfreight to ports for the products, when the actual distance from the factory to the port was just over 2 kilometres. 140 It could be discussed if Taiwan should be counted as a country – if not so, then three sea borders. 141 The latest meetings between a Chinese President and Koizumi have been at the sidelines of the G 8 meetings in May and October 2003, the APEC meeting in November 2004 and the International Socialist Union meeting in Djakarta in March 2005. 142 A ruling in favour of the plaintiff was given by a Fukuoka court on 2004-03-26, while a court in Sapporo had rejected a similar claim on 2004-03-23. 143 The islands were seized by Japan in 1895, when Japan defeated the Qing Dynasty forces. Then put under US control after World War II, until returned to Japan in 1972. 144 Additional discussions on relations to other neighbouring countries can be found in the chapters on Russia, Japan, Korea and North Korea. 145 This was a continuation of previous programs: "Interim Provisions Concerning Certain Questions on the Multipurpose Utilization of Resources" in 1985, and the "Opinions on Making Further Multipurpose Utilization of Resources" and "Catalogue of Resources for Multipurpose Utilization" in 1996. 146 This could include, e.g., to make use of and not just burn off gas findings at oil wells. 147 The US reserve normally corresponds to 50 – 70 days consumption while the Japanese reseve has at times seen its volume correspond to near 150 days of consumption. 148 The two companies are both ranked among the 20 largest in the world in their line of business. 149 Other oil fields are located in Shengli, in Central China and Jilin, Dagang. New fields and fields under development are all in Jianghan, Xinjiang, Tarim, Tulufan, Hami, Changqing and Qinghai. 150 Until late 2003 oil companies on the local market oil had to pay a 17% VAT on oil and oil products, but received a 13% reduction if the oil was exported. Since late 2003 this rebate has been largely abolished, but remains at 11% for gasoline. 151 “Resource” - is the total existing content of e.g. iron in an iron ore finding. “Reserve”- is the quantity that is worth to mine at the current price and with existing mining techniques and equipment. 152 After Japan concluded its largest foreign oil deal ever in Iran in early 2004, despite of US protests, the position of Iran has, perhaps, been somewhat improved.

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153 Yukos at the time paid USD160 in transport tariffs and export duties per ton of the 650 000 tons exported to China; 400 000 to CNPC and 250 000 to Sinopec (Yukos spokesman Puchkov quoted by V.). 154 The most important regions of current gas production are in Sichuan, Shaanxi, Gansu and Ningxia and the basins of Tarim and Jungar. The main fields of oilproduction in the future will probably be located in the outskirts, in the northwest, the northeast or offshore to the east. 155 A figure that includes pipeline related costs only. If total costs for construction, exploration at the gas fields, excavation at the fields, distribution networks were included in the 10th 5-year plan 2001–05. 156 Best: Haikou (HP), Zhuhai and Zhanjinag (GP), Guiling and Beihai (GZAR). 157 China Hua-nong, China Da-tang, China Hua-dian, China National Power, and China Power Investment; two grid companies State Grid Corporation of China, China Southern Power Grid Co. Ltd. 158 In tear of roads from one truck is approximately set to correspond to over 5 000 cars, and with overload, resulting in increased axis pressure, the tear on the road is considerably higher. 159 The new line from Sichuan to Lhasa is under construction and will pass at over 5 000 above sea level (highest in the world for a railway). It is due to open in late 2006. 160 In 2000, the German government abandoned a plan to build the first long distance magnetic suspension “show-case” train link on the 292 km separating Hamburg and Berlin. 161 In 2001, China had 460 towns and 70 000 villages practically inaccessible by road. 162 In 2003 VW sold near 700 000 cars in China, first of all Santana and Jetta models, a rise of 36%, but still saw its market share shrink to 31% from having held a 54% share as recently as in 2000. 163 A general rule is to start the prospecting for new handling capacity after 70% has been reached. 164 Baosteel - the largest steel producer; Sinopec – the largest oil refiner; Haier – largest household manufacturer/exporter; Huaneng – the nations largest energy producer. 165 To compensate for copper shortages, China spent more than USD 3 bn on imports in 2003, which was before prices shot-up. 166 The metal content of ores and different grades of refinement and storage levels often makes it confusing to compare statistics in the mining / metal sectors in-between years, consumer, countries and producers.

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Chapter 5 167 Korea in 2003 had a population of 48.3 million, on a surface of 99 000 km2. 168 As this kind of statistics is based on current value of the USD, currency fluctuations in between years can often become the most significant change, ahead of what is a “real” GDP increase. 169 Bank of Korea has, in 2003, in accordance with UN recommendations, changed the base year for GDP and GDI calculations from 1995 to 2000, and the calculations from the

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UN agreement SNA 68 to SNA 93. The latter changed results in more economic activities that are included, e.g., activities like broker-age services by financial institutions, previously left aside. This partly explains why the Korean per capita GDI grew as much as 10% for the year, to USD 12 650, despite negative tendencies in the economy. 170 Initiated by Prof. Man-woo at the Korea University – partially in line with these demands the president has both set-up and led debates and panels, and has initiated discussions with labour unions. 171 For both indexes a figure under hundred indicates that more respondents are negative than positive. 172 A “non-convergence trap”- can affect a developing country that remains highly dependent on imported technologies from other advanced economies and that as a result of this, at least in theory, will experience a gradual slowdown in its economic growth. 173 The Hanjin Group Chairman, Cho Yang-ho owned the largest stake at 2.92% 174 Samsung Group is Korea's largest conglomerate and the world's largest producer of memory chips for computers and the world's number three producer of mobile phones (Samsung, 2004-07-07) 175 Among the top 10, the percentage of foreign holding is very unequal, with the retail Doosan Group, appearing to be the least popular as foreign owners holds a merger 1.6% of the shares. As a result of foreign ownership outbound payments for royalties and patent rights have soured in recent years, reaching about USD 4 – 5 bn/year – three times of the similar incomes (BOK, 2004-05-02). 176 Transfer pricing refers to the setting of (unfairly high / low) product prices in between subsidiaries of multinational companies to, e.g., lessen the tax burden in one or the other of their countries of operation 177 The index measures the “degree of economic freedom” in a country by assessing the size of government, legal structure and property rights, access to sound money, freedom of exchange with foreigners as well as regulations related to credit, labour and business. 178 A trade conflict with Japan has surfaced as Matsushita has accused LG of patent infringements and has, through a court case, been able to stop all import of LDC screens from Korea (JT, 2004-11-13). Two weeks later the same ban on imports and sales of Matsushita (Panasonic) LDC’s was introduced in Korea. 179 Again, this shows the difficulty of making predictions about the development, although the scale of the error here could be seen as near unprecedented. 180 The share over plus 65 standing at 8.7% at the end of 2003, which is a relatively low, but it is increasing more rapidly than for comparable countries. At the same time, the average birth rate by Korean women is among the lowest in the world at 1.2 children. 181 Refers to when a persons disposable income, after tax, is being lower than minimum living costs 182 When the value is under 100, it indicates that the export products are losing in value relative to the imports of the country. 183 The Korean price index for the 30 most important imported raw materials, The Koima Index, reached its highest level ever in March 2004 of 137, up by over 30 index points in 12 months (Koima 2004-05-02).

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184 At the end of 2004, Samsung was the world's third largest manufacturer with LG at number four. 185 Requested building permits are often used as a good indicator of near future economic expectations, and permits were given for 6.7 million m2, a drop of over 40 % compared Q1 2003 (Federation of Korean Industries 2004-04-15). 186 For H1 2004 the Korean share had increased to 3.1% with the other shares unchanged. 187 Samsung Electronics alone, the largest producer, generated over 10% of Korea's exports in 2003. 188 In the aftermath of the panic from the earthquake, it was rumoured that Koreans in the area were looting and committing arson, which led to that 100s, or perhaps 1 000s, of Koreans were killed in riots. 189 Condensed version of the original text. 190 The spelling Pusan is perhaps the most frequent in English, but in “Korean-English” it is only Busan. 191 The five Korean vehicle producers are (approximate production in million units, 2003): Hyundai (1.8), KIA (0.7), Daewoo (0.3), Ssayong (0.2) and Renault Samsung (0.1). 192 KIA Motors, previously a independent manufacturer, was acquired by Hyundai Motors in 1998 193 The first Korean cars reached the European market in 1977 (Hyundai, 2004-07-15). 194 A VLCC has a early 2005 order value of USD 70 million and a large LNG carries USD 200 millions. 195 Although these ships are in the 120 000 dwt range and 350 meters long, the worlds largest remains the Norwegian tanker Jahre Viking at 565 000 dwt and 485 meters (loading 650 000 m³ or 4.1 million barrels). 196 Finex technology enables a production of molten iron directly from using iron ore fines and non-coking coal rather than processing through sintering and coke-making.

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Chapter 6 197 In 2003 North Korea had a population of 22.8 million on a surface of 122 000 km2. DPRK is organised into two major cities, Pyongyang and Nasun, and nine provinces, with Korean as the only language in this ethnically homogeneous and largely atheist country.

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Aeroflot – Aeroflot Russian Airlines (Russia’s largest air carrier) www.aeroflot.ru/eng/company.asp (Moscow) Aflcio - American Federation of Labor - Congress of Industrial Organizations www.aflcio.org (Washington D.C.) Airbus – Airbus Industries (world’s second largest airplane manufacturer) www.airbus.com (Toulouse, France) Airports – Airports Council International (international airport organization) www.airports.org/ (Geneva, Switzerland) ANRE - Agency for Natural Resources and Energy www.enecho.meti.go.jp/english/ (Japanese Ministry; Tokyo) Antonov – Antonov ASTC (leading FSU, now Ukraine, producer of aircrafts) www.antonov.com/ (Kiev, Ukraine) APEC – Asian Pacific Economic Cooperation (adm. office located in Singapore) www.apec.org (Singapore) APN-BBC - Asian Pacific News (news line of British Broadcasting Corporation - BBC) news.bbc.co.uk (London) ASEAN – Association of South East Asian Nations (area of ten Asian nations) www.aseansec.org/home.htm (administrative office located in Jakarta) ADB - Asian Development Bank (regional member countries investment bank) www.adb.org/ (administrative office located in Manila) Asian Migrants (labor rights support organization) www.asian-migrants.org/ (Hong Kong) Asiana – passenger / cargo (Korea’s second air carrier) flyasiana.com/english/index.htm or cargo side: (Seoul) www.asianacargo.com/English/index.jsp Atip - Asian Technology Information Program (non-profit org. for Asia – West) www.atip.org (Tokyo) ATMI – American Textile Manufacturers Institute (US producers organization) www.atmi.org/ (Washington, D.C.) Aton - Aton Capital (major investment advisor/researcher business newsline) *research.aton.ru/ (party subscription site) (Moscow) Automotive News – (One of the world’s leading car industry weeklies) www.autonews.com (Lancashire, UK) autointell - Automotive Intelligence News (web based auto-industry news source) www.autointell-news.com (no base given)

1 Links below refers to the English language site, if there is one and if the information has been found on the English pages. If not, then to the original language page. When linking up to pages it is mostly possible to only write the address given until the first slash “/”, which will be enough to connect. Then go on via the icon indicating English (sometimes not very logically placed though, but mostly in the upper right of the pages).

- 3 60 - AvtoVAZ – OAO Avtovaz (leading Russian automaker) www.vaz.ru/english.html (a very poor English version) (Togliatti) , www.vaz.ru (Russian version is much better) Bakerinstitute – Rice University (James A. Baker III Institute for Energy Policy) www.bakerinstitute.org (Houston) Baltic Exchange – (global market place for shipbrokers, owners and charterers) www.balticexchange.com (London) Base21 - Building A Solidarity Electronically 21 (- century) www.base21.org/base21hot/migrant.html (Seoul) Bellona – (environmental NGO) www.bellona.no/en/index.html (Oslo, Norway) Berlitz – Berlitz International Inc. (worlds leading foreign language school) www.berlitz.co.jp/?ISO=en (Princeton) Bloomberg – Global (financial analysis and communication company) www.bloomberg.ru/ (New York/Moscow) Baosteel – (Shanghai Baosteel Group; the largest steel manufacturer in China) baosteel.com/english_n/indexe_n.html (Shanghai) Bofit – Bank of Finland’s Institute for Economies in Transition (weekly newsletter) www.bof.fi/bofit/ (Helsinki, Finland) Bofit –CR – Bank of Finland’s Institute for Economies in Transition (China review) www.bof.fi/bofit/ (Helsinki, Finland) Bofit DP – Bank of Finland’s Institute for Economies in Transition (discussion paper) www.bof.fi/bofit/ (Helsinki, Finland) BOK - Bank of Korea (national bank - with statistics service function) www.bok.or.kr/index.jsp (Seoul) BOJ - Bank of Japan (national bank) www.boj.or.jp/en/ (Tokyo) BP - (formerly named British Petroleum; one of the leading oil companies) www.bp.com/home.do (London) Brunswick UBS (private investment advisors) www.bubsw.com (Moscow) Busan – Port of Busan (Korea’s largest port, worlds no. six container port) www.portbusan.or.kr/english/ (Busan) Business Week Magazine (located in Washington) www.businessweek.com/magazine/toc/04_20/B3883magazine.htm CAAM - China Association of Automobile Manufacturers (producer association) www.auto-ccpit.org/english/index.htm (Beijing) CAEA - China Atomic Energy Authority (domestic state atomic energy authority) www.caea.gov.cn/ecaea/index.asp (Beijing) CANSI – China Association of Shipbuilding Industry (producer association) www.cansi.org.cn:8080/cansi/en/all.htm (Beijing) CAS - Chinese Academy of Science english.cas.ac.cn/Eng2003/page/home.asp (Beijing) CATIC – China National Aero-technology Import and Exp. Corp. (aviation holding) web.catic.com.cn/Eindex.asp (Beijing) Cato - Cato Institute (libertarian research NGO) www.cato.org (Washington, D.C.)

- 3 61 - CBR – Central Bank of Russia (national bank) www.cbr.ru/eng/main.asp (Moscow) CBRC - China Banking Regulatory Commission www.cbrc.gov.cn/english/index.htm (Beijing) CBW – China Business Weekly (Business weekly from the China Daily publishing) www.chinadaily.com.cn/english/ (Beijing) CBPP - Center of Budget and Policy Priority (NGO with focus on the US budget) www.cbpp.org (Washington D.C.) CEC-CEDA - China Enterprise Confederation / China Enterprise Directors Association www.cec-ceda.org.cn/english_version/ (Beijing) CEFIR – Centre for Economic and Financial Research (foreign supported think-tank) www.cefir.org/papers.html (Moscow) CCC - China Chamber of Commerce for Import and Export of Textiles www.ccct.org.cn/ (Beijing) China Avia. – China Civil Aviation Administration (national civil aviation authority) www.caac.gov.cn/ (Beijing) CD – China Daily (English language daily newspaper) www.chinadaily.com.cn/english/home/index.html (Beijing) China Economic Net (news agency with, mostly for southern China and economic news) *en.ce.cn/main/index.shtml (Guangzhou) China Radio International – (state radio broadcasting in 24 languages) en.chinabroadcast.cn/ (Beijing) China Southern – China Southern Airways (Chinas largest air carrier) www.cs-air.com/en/ (Guangzhu) China Youth – China Youth Daily (official party youth organization daily) www.chinayouthdaily.com/ (Beijing) China.org – Official state information page for China www.china.org.cn (Beijing) Chinaesteel - China Iron & Steel Association (member organization for 119 producers) www.chinaesteel.com/mmi_en/ (Beijing) Chubu - Chubu Electric Power Ltd., Co. (major Japanese energy company) ww.chuden.co.jp/english/ (Nagoya) CI - Chosun Ilbo – (English version of a large Korean daily newspaper) english.chosun.com/business/ (Seoul) Citigroup – (major US banking group) www.citigroup.com/citigroup/homepage (New York) CNNIC – China Internet Network Information Community www.cnnic.net.cn/en/index/ (Beijing) Clarksons – Clarkson's (shipping research provider) www.clarksons.co.uk/index.html (London) CNFTI – China National Textile Industry Council (producer organization) www.cnfti.org.cn/ecnfti.htm (Beijing) CNOOC - China National Offshore Oil Corp. www.cnooc.com.cn/english/default.asp (Beijing) Coalinfo – China Coal Information Network (domestic industry information agency) ns.coalinfo.net.cn/eng.htm (Beijing)

- 3 62 - Coaltrans – Coaltrans International (leading business magazine for coal) www.coaltransinternational.com/ (UK., Leatherhead) COI - China Oceanic Information Network (state institute) www.coi.gov.cn (Beijing) Commondream – (progressive NGO, for a brighter future vision for America) www.commondreams.org/headlines04/0810-02.htm (Portland) Cordis – Community Research & Development Information System (EU’s system) www.cordis.lu/fp6-euratom/library.htm (Brussels) COSCO – China Ocean Shipping Company www.cosco.com.cn/en/index.jsp (Beijing) Cotton – National Cotton Council of America (producer and user member org.) www.cotton.org/ (Memphis) Council of Economic Advisors (government advisory organization) www.whitehouse.gov/cea/ (Washington, D.C.) CRI - China Radio International-English (official newsline) www.crienglish.com/news/ (Beijing) CSCL - China Shipping Container Lines (major state shipping line) www.cscl.com.cn/ (Shanghai) CSD - China Statistical Data (sub-page on the National Official page “China.org"), www.china.org.cn/e-company/index.htm (Beijing) CSI - Council of Service Industries (US network for the promotion of service ind.) www.uscsi.org/ (Washington) CSIC - China Shipbuilding Industrial Corporation (leading Chinese shipbuilder) www.csic.com.cn/Csic/en/eindex.asp (Beijing) CSSC - China State Shipbuilding Company (China's second largest shipbuilder) www.cssc.net.cn/enlish/index.php (Beijing) Customs-Ru – Russian Federal Customs Bureau (state customs office) www.customs.ru (Moscow) CV – China View (daily newspaper based on Xinhuanet) www.chinaview.cn/ (Beijing) Daewoo – Daewoo Shipbuilding & Marine Engineering Co., Ltd (Korean shipbuilder) www.dsme.co.kr/ (Busan) DG-Tren – EU Directorate-General for Energy and Transport (EU ministry) europa.eu.int/comm/dgs/energy_transport/index_en.html (Brussels) Daihatsu – Daihatsu (one of the smaller Japanese car producers) www.daihatsu.com/ (Tokyo) Dow Jones – Dow Jones & Company (business and financial news) www.dowjones.com/ (New York) DRC – Development Research Centre (- under the Chinese State Council) www.drc.gov.cn/e/index.htm/ (Beijing) Duma – Russian Parliament (information page of the national Duma) www.duma.gov.ru/ (Moscow) East Line – East Line Airlines (Russia’s number two freight airline) www.eastline-airlines.ru/en/about/ (Moscow) EBRD - European Bank for Reconstruction and Dev. (bank for EE and FSU countries) www.ebrd.org alternatively; www.ebrd.ru (London)

- 3 63 - EBSCO – EBSCO Publishing (Leading full text journal and database publisher) www.epnet.com/ (partly free and partly pay-site) (Ipswich, MA, USA) ECCJ - Energy Conservation Center of Japan (NGO promoting energy saving) www.eccj.or.jp/index_e.html (Tokyo) ECMT – European Conference of Ministers of Transport (intergovernm. European org.) www1.oecd.org/cem/ (Brussels) ECRIN – Institute of Economic Research, FE Branch of the Russian Acad. of Science www.ecrin.ru/ (Khabarovsk, Russia) EIA – Energy Information Agency (US government agency) www.eia.doe.gov/ (Washington, D.C.) EIU - The Economist Intelligent Unit (partly free and partly pay-site) www.eiu.com (London) Ekspert – (Russian weekly business magazine) www.expert.ru/ (St. Petersburg) Elections – 2004 Legislative Council Election (official homepage of the HK election) www.elections.gov.hk/elections/legco2004/ (Hong Kong) ESA-UN – Economic and Social Affairs of the United Nation *esa.un.org (New York) European Union - (25 member European countries organization) *europa.eu.int/ (Brussels) Euromoney - (monthly investors magazine) www.euromoney.com (London) EU-Ru – Delegation of the European Commission in Russia www.eur.ru/en/index.htm (Moscow) AsiaEuro – Asia Europe Meeting (EU organization for relations towards Asia) www.eu.int/comm/external_relations/asem/intro/index.htm (Brussels) Eurostat – Statistical Office of the European Union *europa.eu.int/comm/index_en.htm (choose “statistics” – direct link very complicated) (Brussels) EvrazHolding – (Russia’s largest iron and steel producer) www.evraznet.ru/ (Moscow) FA - Frankfurter Allgemeine (one of the leading German daily newspapers, www.faz.net/s/homepage.html (Frankfurt) Fearnleys – (leading shipping magazine, statistics and consultant company) www.fearnleys.com/fearnleys/fearnley_consultants.htm (Oslo, Norway) FEBRAS – Far Eastern Branch of the Russian Academy of Science www.febras.ru/index_.html (Russian version better) (Novosibirsk) FKI - Federation of Korean Industries (member organization of industry) www.fki.or.kr/en/ (Seoul) FMPRC – Foreign Ministry of the People’s Republic of China (national ministry) www.fmprc.gov.cn (Beijing) Forbes - Forbes Magazine (international business leader’s weekly magazine) www.forbes.com (New York/Moscow) Fortum – Fortum (Nordic energy [gas, oil and electricity] supplier) www.fortum.com (Espoo, Finland) Fortune - (weekly US business magazine) www.fortune.com/fortune (New York)

- 3 64 - Fraser Institute; Freetheworld (liberal research institute in economics) www.freetheworld.com/2003/EFW2003Dataset.xls(Vancouver BC, Canada) FSA - Financial Service Agency (Japanese state watch-dog in the financial sector) www.fsa.go.jp/ (Tokyo) FSC - Korea Financial Supervisory Committee (national financial regulator) www.fsc.go.kr/eng/about/index.asp (Seoul) FSSS - Federal Service of State Statistics (national statistic’s authority) www.gks.ru/eng/ (Moscow) FTA - Korea Fair Trade Commission (responsible for enforcing competition) www.ftc.go.kr/eng/index.html (Seoul) Gazeta – Gazeta.RU (Russian newslist with an English section) www.gazeta.ru/english/ (Russian version is best) (Moscow) Gazprom – OAO Gazprom (worlds leading gas company) www.gazprom.com/ (Moscow) www.gazprom.ru (Russian version more updated) Globalwoman – (World network for women in business and public administration) www.globewomen.com (New York) GNPJVC - Guangdong Nuclear Power Joint Venture Co. Ltd. (nuclear power operator) www.gnpjvc.com/ (in Chinese only) (Guangzhou) Groppelong – Groppe, Long and Littell (Oil and gas analyst and forecasters) www.groppelong.com (Huston) Guardian – The Guardian (major English daily) www.guardian.co.uk (London) Gunagzhou – Guangzhou New Baiyun Airport (airport in the Guangdong Province) www.newsgd.com/specials/airportguide/ (Guangzhou) Guangdong – Guangdong Travel Agency (south China travel news) newsgd.com/travel/travelagency/ (Guangzhou) Hakuhodo Inc. (Japanese advertising agency) www.hakuhodo.co.jp/english/ (Tokyo) Hanjin – Hanjin Shipping Co., Ltd. (Korea’s largest shipping company) www.hanjin.com/home/main.jsp (Seoul) HK, Chamber of Commerce (local business chamber) www.chamber.org.hk/business_world_h.asp (Hong Kong) HK, Census and Statistics Department (statistic’s department of the government) www.info.gov.hk/censtatd/eng/hkstat (Hong Kong) HK-esd – (Gov, & Department and Related Organisation’s Services - with good links) www.esd.gov.hk/gov_dept_index/eng/default.asp (Hong Kong) HK, Gov - Government Electronic Service Delivery (service page of administration) www.esd.gov.hk/home/eng/default.asp (Hong Kong) HK, Port – Hong Kong Port Development Agency (state port organisation) www.pdc.gov.hk/eng (Hong Kong) HK, Public Administrative Association (central org. for public administration services) www.hkpaa.org.hk/index.shtml (Hong Kong) HK, Special Administrative Region (central administration of the region) www.info.gov.hk/eindex.htm (Hong Kong) KNNIC – Hong Kong Nuclear Investment Co. Ltd. (owner of nuclear power in China) www.hknuclear.com/nflash/eng/html/shome.htm (Hong Kong)

- 3 65 - HLWM – Ministry of Health, Labor and Welfare (Japanese ministry) www.mhlw.go.jp/english/ (Tokyo) Honda - Honda Motor Co., Ltd. (one of the larger automotive manufacturers in Japan) *world.honda.com/automobile/ (Tokyo) Hyundai – Hyundai Motors International (leading car and commercial vehicle producer) *worldwide.hyundai-motor.com/intro/index.html (Seoul) Hyundai HI – Hyundai Heavy Industries (Korea and world’s largest shipbuilder) english.hhi.co.kr/ (Ulsan) HMM – Hyundai Merchant Marine (One of Korea’s largest shipping companies) http://eng.hmm21.com/hmm/jsp/eng/index.jsp (Seoul) IEA – International Energy Agency (member org. for energy consumers) www.iea.org/ (Paris) IEA 2003 - International Energy Agency; Information Center (Paris) *library.iea.org/dbtw-wpd/Textbase/nppdf/free/2003/key2003.pdf IAEA – International Atomic Energy Agency (member organization) www.iaea.org/ (Vienna, Austria) ic-Newcastle – (information and job page for Newcastle upon Trent, UK) *icnewcastle.icnetwork.co.uk/ (Newcastle, UK) ICAO - International Civil Aviation Organization (world organization of civil airports) www.icao.org (Montreal) IHI - IHI Marine United (major shipbuilding group in Japan) www.ihi.co.jp/ship-e/index.htm (Tokyo) IIE - Institute for International Economics' (independent research institute) www.iie.com/ Washington, D.C.) ILO – International Labor Organization (UN worker’s organization) www.ilo.org/ (New York) IISI - International Iron & Steel Institute (non-profit research member organization) www.worldsteel.org/ix.php (Brussels) Imabari – Imabari Shipbuilding Group (major Japanese shipbuilder) www.imazo.co.jp/English (Imabari, on Shikoku) IMD - International Institute for Management Development www01.imd.ch/wcy/ (Geneva/Lausanne) IMF – International Monetary Fund (members organization) www.imf.org/ (Washington, D.C.) Institutional Investor (monthly investor’s magazine) www.institutionalinvestor.com/ (New York) Investhk – Invest in Hong Kong Agency (state trade and investment promotion agency) www.investhk.gov.hk/ (Hong Kong) ITU - International Telecommunication Union (members organization) www.itu.int/home/index.html (Geneva) Izvestiya – Izvestiya (one of the leading Russian newspapers) www.izvestiya.ru/ (Moscow) JADA – Japan Automobile Dealers Association (retailer member organization) www.jada.or.jp (Tokyo) JAERI - Japan Atomic Energy Research Institute (semi-state / industry institute) www.jaeri.go.jp/english/index.cgi (Tokyo)

- 3 66 - Japan Automobile - Japan Automobile Manufacturers Ass. (producer member ass.) www.japanauto.com/ (Tokyo) Japan Customs – (state customs authority) www.customs.go.jp/index_e.htm (Tokyo) Japanrail – Japan Railways Group (Holding company for the six major operators) www.japanrail.com/ (Tokyo) Japex - Japan Petroleum Exploration Co., Ltd. (international and offshore explorer) www.japex.co.jp/en/ (Tokyo) JAT - Japan Airport Terminal Co., (Japanese airport terminal operator) www.tokyo-airport-bldg.co.jp/index.html (Tokyo) JCCI - Japan Chamber of Commerce and Industry (member organization) www.jcci.or.jp/home-e.html (Tokyo) JDA - Japan Defense Agency and Self Defense Forces (Japanese army) www.jda.go.jp/e/index_.htm (Tokyo) JETRO - Japan External Trade Organization (state agency) www.jetro.go.jp/ (Tokyo) JFE - JFE Steel Corporation (Japan’s second largest steel producer) www.jfe-steel.co.jp/en/ (Tokyo) JHPC - Japan Highway Public Corporation (state administrator of highways) www.jhnet.go.jp/english (Tokyo) JISF - Japan Iron and Steel Federation (member org. for iron & steel industry) www.jisf.or.jp/sij/ (Tokyo) JNF - Japan Nuclear Fuel Ltd. (the Japanese nuclear operators common fuel comp.) www.jnfl.co.jp/english/ (Aomori, Japan) Joblink- Joblink (Korean internet employment agency) www.joblink.co.kr (Seoul) jrfreight – Japan Railway Freight Company (freight handling on Japan’s railway) www.jrfreight.co.jp/english/index.html (Tokyo) JRTR - Japan Railway Transport Review (tech. English railway journal issued by JR) www.jrtr.com (Tokyo) JT - Japan Times (Japan’s leading English daily newspaper) www.japantimes.co.jp/ (Tokyo) IWPR – Institute of War and Peace Reporting (mailing list covering Central Asia) www.iwpr.org (London) K-Line - Kawasaki Kisen Kaisha, Ltd. (Japan’s third largest shipping company) www.kline.com/ (Koby/Tokyo) Karelia – Local Government of the Republic of Karelia (Russian Federation subjects, www.gov.karelia.ru/index_e.html (Petrozavodsk, Russia) KADA – Korea Civil Aviation Development Association (Aviation industry promotion) www.airtransport.or.kr/english/index.html (Seoul) KCIC – Korean Chamber of Industry and Commerce *hp.korcham.net/eng/index.asp?cciid=B001 (Seoul) KCNA – Korean Central News Agency of PDRK (Democratic Peoples Repub. of Korea) www.kcna.co.jp/index-e.htm (Pyongyang) KDB - Korea Development Bank (Korea's representative bank) www.kdb.co.kr (Seoul)

- 3 67 - KDI - Korea Development Institute (research institute connected to the BOK) www.kdi.re.kr/kdi_eng/main.jsp (Seoul) KEF - Korea Employers Federation (members organization) www.eng.kef.or.kr/ (Seoul) KEIA - Korea Economic Institute (Government org. promoting contacts with the US) www.keia.com (Washington D. C.) KEMCO – Korean Energy Management Corporation (state agency for energy efficiency) www.kemco.or.kr/english/ (Seoul) KEPCO – Korean Electric Power Corporation (state controlled electric holding company) www.kepco.co.kr/kepco_plaza/en/index.html (Seoul) KH - Korea Herald (leading English daily) www.koreaherald.co.kr/ (Seoul) KHNP – Korea Hydro & Nuclear Power Company (Korea’s largest electric producer) www.khnp.co.kr/eng/khnp_eng.html (Seoul) KIA - KIA Motors (Korean car producer, since 1998 a subsidiary of Hyundai) www.kiamotors.com/ (Seoul) KIEP - Korean Institute for International Economic Policy (government funded inst.) www.kiep.go.kr/main.nsf/emain.htm (Seoul) KIET - Korean Institute for International Economy and Trade www.kiet.re.kr/e_main.html (Seoul) Kingdee - Kingdee International Software Group (software and event organizer, *global.kingdee.com/en/index.htm (Hong Kong) KIS-Moody’s – Korea Investors Service (Korean arm of Moody’s; partly password) www.kisrating.com/english/english_index.asp (Seoul) KNSO - Korea National Statistical Office (state agency) www.nso.go.kr/eng/ (Seoul) KNOC - Korea National Oil Company (state oil company) www.knoc.co.kr/eng/index.htm (Seoul) KNTO – Korea National Tourist Organization (state tourist organization) www.knto.or.kr/eng/english0.jsp (Seoul) KOGAS – Korean Gas Corporation (national gas company) www.kogas.or.kr/ENG/ (Seoul) KOIMA – Korea Importers Association (member organization for importers) www.koima.or.kr (Seoul) Kommersant – (Leading Russian daily with an English internet version) www.kommersant.com/ (Moscow) Korea International Trade Organization (state agency) www.kita.org/ (Seoul) Korea Importers Association (members importers organization) www.aftak.or.kr/ (Seoul) Korea Recruit – Korean employment agency www.recruit.co.kr (Seoul) Korea Line – Korea Line (Korea Line Corp., Korea’s third largest shipping line) www.korealines.co.kr/index.html (Seoul) Korea.net – (Korea.net is the official state information page of Korea) www.korea.net/news/issues/goguryeo.asp. (Seoul)

- 3 68 - Korean Air – Cargo (Korea’s air carrier) *cargo.koreanair.com/ (Seoul) Korean AMA – Korean Automobile Manufacturers Association (membership org.) www.kama.or.kr/eng/K_eng_main.jsp (Seoul) Korean FSS – Financial Supervisory Service (state watch-dog for the financial sector) *english.fss.or.kr/en/laws/com/lawcomm_l.jsp (Seoul) Korean MOL – Korean Ministry of Labor (ministry) www.molab.go.kr:8787/English/link/link_dlo.html (Seoul) Korean Railway - (state railway operator) www.korail.go.kr/ROOT/main-top.top?lang=eng (Seoul) KSE - Korean Stock Exchange (nations share trade exchange) www.kse.or.kr/webeng/ (Seoul) KOSA - Korea Iron and Steel Association (members organization) www.kosa.or.kr/new/eng/guide/guide_01.html/ (Seoul) KOSHIPA – KOrea SHIPbuilders Association (association for the nine major shipyards) www.koshipa.or.kr/index.jsp (Seoul) KOTRA - Korea Trade - Investment Promotion Agency (non-profit government agency) www.kotra.or.kr/eng/ (Seoul) Kremlin – Official Web Site of the Russian President www.kremlin.ru/eng/articles/archive.shtml (Moscow) KS - Kobe Steel Group (Japan’s number four steel producer) www.kobelco.co.jp/index_e_wi.htm (Kobe/Tokyo) KSE - Korean Stock Exchange (Korean stock market for shares, Seoul) www.kse.or.kr/webeng/ (Seoul) KT - Korean Times (English version of one of the leading Korean dailies) *times.hankooki.com/ (Seoul) Kyodo – Kyodo News (Japans biggest news agency) *home.kyodo.co.jp/ (Tokyo) LBL - Lawrence Berkeley National Laboratory (independent laboratory) www.lbl.gov/ (Berkeley, US) Lenovo – Lenovo Group (largest lap-top manufacturer in China) www.lenovogrp.com/ (Beijing) LG - ERI – LG Economic Research Institute (company financed research institute) www.english.lgeri.co.kr/ (Seoul) LG - Philips LCD (one of the largest private companies in Korea) www.lgphilips-lcd.com/en/index.html (Seoul) Lloyds – Lloyds Register of Shipping Group (shipping consultants) www.lr.org/code/home.htm (London) Lloyds List – Lloyds List (Words oldest shipping daily) www.lloydslist.com (London) LUKoil – OAO LUKoil (Russia’s biggest oil company) www.lukoil.com (Moscow) Maritimeindustries - Society of Maritime Industries (membership org. of suppliers) www.maritimeindustries.org (London) ME - Korean Ministry of Environment Republic of Korea (Korean ministry) *eng.me.go.kr/user/index.html (Seoul)

- 3 69 - MES - Mitsui Engineering & Shipbuilding Co. Ltd. (major Japanese shipbuilder, www.mes.co.jp/english/index.html (Tokyo) Metal Bulletin (one of the world’s leading metal trade magazines) www.metalbulletin.com (pay-site; with a free-trail offer) (London) METI - Ministry of Economy, Trade and Industry (Japanese ministry) www.meti.go.jp/english/ (Tokyo) MEXT- Ministry of Education, Culture, Sports, Science and Tech. (Japanese ministry) www.mext.go.jp/english/ (Tokyo) MHI - Mitsubishi Heavy Industries (major Japanese shipbuilder) www.mhi.co.jp/ship/english/ (Yokohama/Tokyo) MHLW - Ministry of Health Labour and Welfare (Japanese ministry) www.mhlw.go.jp/english/ (Tokyo) Minatom – Ministry of Atomic Energy (Currently under The Min. of Trade and Energy) www.minatom.ru/ (alternatively via: www.economy.gov.ru) (Moscow) Minfin – Ministry of Finance (Russian ministry) www.minfin.ru/sdds/nsdp.htm (Moscow) Ministerio de Economia y Energia (Ministry of Economy and Energy of Chile) www.economia.cl/ (Santiago, Chile) Ministry of Information Industry (Chinese ministry) www.mii.gov.cn/mii/index.html/ (Beijing) Mintrans – Ministry of Transport of the Russian Federation www.mintrans.ru (Moscow) Mitsubishi – Mitsubishi Motors (leading Japanese car producer) www.mitsubishi-motors.com/ (Tokyo) Mitsui - Mitsui & Co., Ltd. (one of the major Japanese trading houses) www.mitsui.co.jp/tkabz/english/ (Tokyo) MMK - Magnitogorsk Iron & Steel Works (Russia’s largest steel producer) www.mmk.ru/eng/index.wbp (Magnitogorsk, Russia) MOCIE - Korean Ministry of Commerce, Industry and Energy www.mocie.go.kr/english/home/default.asp/ (Seoul) MOE - Korean Ministry of Education and Human Resource Development (ministry) www.moe.go.kr/en/intro/research.html (Seoul) MOEDT- Ministry of Economy, Development and Trade (Russian Ministry) www.economy.gov.ru/ (Moscow) MOEA – Ministry of Economic Affairs Republic of China (Taiwanese ministry) www.moea.gov.tw/ (Taipei) MOF - Ministry of Finance Japan (Japanese ministry) www.mof.go.jp/english/ (Tokyo) MOFA – Ministry of Foreign Affairs of the People’s Republic of China (ministry) www.fmprc.gov.cn/eng/ (a home page in six languages) (Beijing) MOFCOM – Ministry of Commerce of the People’s Republic of China (ministry) english.mofcom.gov.cn/ (Beijing) MOFE - Korean Ministry of Finance and Economy (ministry) *english.mofe.go.kr/main.php (Seoul) MOCT – Korean Ministry of Construction & Transportation (ministry) www.moct.go.kr/english/ (Seoul)

- 3 70 - MOIAC – Ministry of Internal Affairs and Communication (Japanese ministry) www.soumu.go.jp/english/ (Tokyo) MOL - Mitsui O.S.K. Line (Japan’s largest shipping company) www.mol.com (Tokyo) MOMAF – Ministry of Maritime Affairs & Fisheries (Korean ministry, Seoul) www.momaf.go.kr/eng/ (Seoul) Morgan Stanley – (investment bank and economic advisor) www.morganstanley.com/ search word: China (Hong Kong) MOST - Ministry of Science & Technology (Korean ministry) www.most.go.kr/most/english/index.jsp (Seoul) MOST-CH - Ministry of Science & Technology (Chinese ministry) www.most.gov.cn/English/ (Beijing) MPS - Ministry of Public Security (Chinese ministry for, e.g., police and fire-fighters www.mps.gov.cn/ (in Chinese only) (Beijing) MT – Moscow Times (Russia’s leading English language daily, Moscow) www.moscowtimes.ru (Moscow) Muzi News – (magazine and newsline, with large achieve) *dailynews.muzi.com/cc/english (Hong Kong) Narita Airport – Narita International Airport Corp. (operating company of the airport, www.narita-airport.or.jp/naa_e/ (Narita, Japan) NBS - National Bureau of Statistics of China (state statistics service) www.stats.gov.cn/english/ (Beijing) NDRC - National Development and Reform Commission (state agency) www.chinacp.com/eng/cporg/cporg_ndrc.html/ (Beijing) NEDO - New Industrial and Technology Development Organisation (semi-state org.) www.nedo.go.jp/english/index.html (Tokyo) NERI - National Economic Research Institute (non-government institute, Beijing) *neri.homeway.com.cn/lbi-html/reform/jj_e.htm (Beijing) Nestro – Russian Foreign Economic Association Zarubezhneft (Moscow) www.nestro.ru/www/nestroweb.nsf/main_eng New York Times (archive access requires free registration - leading American daily) www.nytimes.com (New York) NIER - National Institute of Environmental Research (Korean state research inst.) www.nier.go.kr/nierdepart/e_nier/ (Seoul) Nihon Keizai – Leading Japanese daily issuing an English version) www.nni.nikkei.co.jp/ (Tokyo) Nikkei Net (nations stock exchange) www.nikkei.co.jp/ (Tokyo) Nippon Keidanren (Japan Business Federation- member’s organization) www.keidanren.or.jp/ (Tokyo) NIRA – National Institute for Research Achievements (state agency) www.nira.go.jp/index.html/ (Tokyo) Nissan – Nissan Motor Co., Ltd. (major Japanese producer of cars) www.nissan.co.jp/EN/ (Yokohama/Tokyo) NLMK – Novolipetsk Metalurgical Kombinat (Russia’s number four steel producer) www.nlmk.ru/eng/news/ (Novolipetsk, Russia)

- 3 71 - Norilsk – Norilsk Nickel (Russia’s / world’s leading nickel and rare mineral producer) www.nornik.ru/en/ (Norilsk/Moscow) Novoship – (Russia’s second biggest shipping company) www.novoship.ru/ (Novorossiyisk, Russia) NS - Nippon Steel Corporation (Japan’s biggest steelmake) www0.nsc.co.jp/shinnihon_english/index.html (Tokyo) NSO - Korea National Statistical Office (Korean state statistics service) www.nso.go.kr/eng/ (Seoul) NTS - Korean National Tax Service (state tax service) www.nts.go.kr/eng/default.html (Seoul) NYK - Nippon Yusen Kaisha Line (generally called NYK Line) www2.nykline.com/home/index.html (Tokyo) PBC - Peoples Bank of China (national bank) ww.pbc.gov.cn/english/ (Beijing) PetroChina – Petro China Company Limited (state owned oil company) www.petrochina.com.cn/english/ (Beijing) PetroleumNews – (leading oil and gas magazine) www.petroleumnews.com/ (pay-site with free trial period) (Haines, Alaska) PFC - PFC Energy (strategic advisors in global energy) www.pfcenergy.com/ (Washington, D.C.) Port of Qingdao (port operator in Qingdao, Shandong Province) www.qdport.com/ (Qingdao, China) PMOJ - Prime Minister of Japan and His Cabinet (the governments information page) www.kantei.go.jp/foreign/index-e.html (Tokyo) POSCO – (Korea’s largest steel maker, HQ and main production facility in Pohang) www.posco.co.kr/en/index.jsp (Pohang, Korea) Pravda – Pravda.ru (leading Russian daily with newsline) english.pravda.ru/ (Moscow) President – President of the Russian Federation (homepage of the Russian president) president.kremlin.ru/eng/ (Moscow) Prime-TASS (news agency with on-line business news from Russia) www.prime-tass.com/ (Moscow) publicdebt – US Bureau of Public Debt (department of the US Treasury) www.publicdebt.treas.gov/ (Washington D.C.) Pulkovo – Pulkovo Aviation Enterprise (third most important airline in Russia) *eng.pulkovo.ru/main/ (St. Petersburg) Raiffeisenbank – (Austrian investment banks Russian office) www.raiffeisen.ru/rBank/welcome (Moscow) RIA - RIA Novosti (state news information agency) *en.rian.ru/rian/index.cfm (Moscow) RIETI - Japan’s Research Institute of Economy, Trade and Industry (state institute, www.rieti.go.jp/en/index.html (Tokyo) RFE - Radio Free Europe/Radio Liberty (daily e-mail news update) search.rferl.org/ (Pragh, Czech Republic) RJ – Russian Journal (leading English daily Russian business journal) www.russiajournal.com/index.shtml (Moscow)

- 3 72 - Rotterdam – Port of Rotterdam (world’s largest port in cargo turnover) www.portofrotterdam.nl (Rotterdam) RRR - Russian Regional Report (Montly e-report, Swiss Federal Inst. of Technology) www.isn.ethz.ch/ (Zurich, Switzerland) RTRI - Railway Technical Research Institute (institute of the Japanese railways) www.rtri.or.jp/rtri/rtri_E.html (Tokyo) Federal Institute of Technology www.isn.ethz.ch/infoservice/secwatch/rrr/ (Zurich, Switzerland) RosBusinessConsulting – Russian Business Consulting (news-list with mainly eco. news) www.rbcnews.com/ (Moscow) Rosneft – (fully state-owned Russian oil company – but under merger with Gazprom) www.rosneft.ru/english/ (Moscow) RSF – Reporters Sans Fronti’eres - Reporters Without Borders (world network) www.rsf.org (London) Ru-Gov –Homepage of the Russian Government (information page) www.gov.ru (Moscow) RUSAL – Russian Aluminum (Russia’s largest aluminum producer) www.rusal.com (Moscow) Russian Railways – JSC Russian Railways (Russian state railway company) www.eng.rzd.ru/ (www.rzd.ru - version much better) (Moscow) SAC - Standardization Administration of China (state standardization committee) http://www.sac.gov.cn/english/home.asp (Beijing) SAFE - State Administration of Foreign Exchange (Chinese state control of exchange) www.safe.gov.cn (Beijing) SAIC - Shanghai Automotive Industry Corp. (China’s second largest car manufact.) www.saicgroup.com/saic01/fore/english/ (Shanghai) Samsung – Samsung Group (largest conglomerate) www.samsung.com (Seoul) Samsung ERI – Samsung Economic Research Institute (company research institute) www.koreaeconomy.org/ (Seoul) Sakhalin1 – (Homepage of the four member company Sakhalin-1 consortium) www.sakhalin1.com/en/index.htm (Yuzno-Sakhalinsk, Russia) Sakhalinenerg - (Production company on Sakhalin island Sakhalin-2 consortium) www.sakhalinenergy.com/ (Yuzno-Sakhalinsk, Russia) SB - Statistical Bureau – Ministry of Public Mgmt, Home Affairs, Posts and Tele www.stat.go.jp/english/index.htm (Tokyo) Science Magazine (published by the American Ass. for the Advancement of Science) www.sciencemag.org/content/ (Stanford, US) Secretaria de Economia (Secretaria de Economia de Mexico/ Department of Economy) www.economia.gob.mx/ (Mexico City) Seoul Times – (English language newspaper and bulletin) *theseoultimes.com/ (Seoul) SEPA – State Environmental Protection Agency (Chinese state environm. prot. agency) www.zhb.gov.cn/english/ (Beijing) SERC - State Electricity Regulatory Commission www.serc.gov.cn/ (Beijing)

- 3 73 - Severstal – Severstal Joint-Stock Company (Russia’s third largest steel producer) www.severstal.ru/english/default.htm (Cherepovets, Russia) SGCC - State Grid Corporation of China (the major electric grid company) www.sgcc.com.cn/english/default.htm (Beijing) Shenzen – Shenzhen Stock Exchange (second largest stock exchange in China) www.szse.cn/main/en/default.aspx (Shenzhen) Shenzhenair – Shenzhen Airlines (largely domestic Chinese airline) www3.shenzhenair.com/index2.sh (Shenzhen) Shipgaz – Scandinavian Shipping Gazette (paid e-mail service, partly for free) www.shipgaz.com/english/ (Goteborg, Sweden) Shiptimes – Shipping Times (shipping part of The Business Times) business-times.asia1.com.sg/shippingtimes (Singapore) Sibera - Siberia Airlines (Russia’s second biggest airline) *english.s7.ru/company/about.shtml (Novosibirsk) SIKA - Swedish Institute for transport and Communications Analysis www.sika-institute.se/english_fr.html (Stockholm, Sweden) Sinopec Corp. (state-owned oil company) www.english.sinopec.com/ (Beijing) SKB – Svensk Karnbranslesakerhet (Swedish National Board for Spent Nuclear Fuel) www.skb.se/english (Stockholm, Sweden) SMI - Sumitomo Metal Industries, Ltd. (Japan’s third largest steel producer) www.sumitomometals.co.jp/e/ (Osaka/Tokyo) Sovcomflot – (Russia’s biggest shipping company) www.sovcomflot.com (Moscow) Standard & Poor’s (one of the world’s leading credit rating institutes) www2.standardandpoors.com/ (Searchword: “Korea”) (New York) SSE - Shanghai Stock Exchange (non-profit stock exchange under state ownership, www.sse.com.cn/sseportal/en_us/ps/home.shtml (Shanghai) SUAL - Siberian Ural Aluminium (Russia’s second largest aluminium producer, www.sual.com/ (Moscow) SUEK - Siberian Coal & Energy Co., (top-three Russian coalmining holding company) www.suek.ru/section.phtml?id=7#switch_to_english (Novosibirsk) Suzuki – Suzuki Motor Ltd. (major Japanese car and motorcycle producer) www.globalsuzuki.com/index.html (Takatsuka/Tokyo) T&E - European Federation for Trp. and Environment (NGO for environmental trp.) www.t-e.nu/ (Brussels) TDC - Hong Kong Trade and Development Council (state trade promotion agency) www.tdctrade.com (Hong Kong) Technology Management and Economics – Chalmers University of Technology www.mot.chalmers.se (Goteborg, Sweden) The Slovak Spectator (leading daily Slovak newspaper) www.slovakspectator.sk/clanok-15479.html (Bratislava, Slovakia) Three Gorges – (world’s largest hydro-power project in the upper reaches of the Yangtze River, China) www.chinaview.cn/ (linked from “Major Projects”) Tianjin Port – Tianjin Port Company (the third largest port in China) www.ptacn.com/ (Chinese page much better) (Tianjin)

- 3 74 - TNK-BP – (former Tyumen Oil and British Petroleum JV) www.tnk-bp.com/ (Moscow) Tohoku – Tohoko Eectric Power Co., Inc (Japanese leading electricity producer) www.tohoku-epco.co.jp/index-e.htm (Sendai, Japan) Toyota – Toyota Motor Corporation (Japan’s leading automotive manufacturer, www.toyota.jp/en/index.html (Toyota/Tokyo) Transneft - Transneft Open Joint Stock Oil Transporting Company (pipeline operator) www.transneft.ru/Default.asp?LANG=EN (Moscow) Transparency – Transparency International (International NGO combating corruption) www.transparency.org (Berlin) TSE - Tokoyo Stock Exchage (stock corporation that provides the market place) www.tse.or.jp/english/ (Tokyo) Tupolev – PSC (Russia’s largest civil aircraft manufacturer) www.tupolev.ru/English/ (Moscow) TV-Tsentr – (Russian news agency/TV-channel) www.tvcenter.ru/ (Moscow) UES - United Energy System (Russia’s leading producer of electricity) www.rao-ees.ru/en/ (Moscow) UN-PP - (UN Population Prospect database) *esa.un.org/unpp/ (New York) UN-SNA - (Un agency for co-ordination of national accounting standards) www1.oecd.org/std/escap98/sna20.pdf/ (New York) UN-Stat - (United Nations Statistics Division) *unstats.un.org/unsd/default.htm (New York) UNCTAD – United Nations Council for Trade and Development www.unctad.org/ (page rich in free statistics) (Geneva) UNCTAD2 – United Nations Council for Trade and Development (Geneva) www.unctad.org/ (Commodity Price Bulletin Database) (Geneva) UNDP – United Nation’s Development Program *hdr.undp.org (New York) UNESCAP – UN Economic and Social Commission for Asia and the Pacific www.unescap.org/ (Bangkok) UNESCO – United Nations Edu., Scientific and Cultural Org. (World Heritage List) *whc.unesco.org/ (Paris) UNFCCC – United Nations Framework Convention of Climatic Change *unfccc.int/ (New York) Unification – Ministry of Unification (South Korean ministry) www.unikorea.go.kr (Seoul) Universal – Universal Shipbuilding Group (major shipbuilder in Japan) www.u-zosen.co.jp/html_e/index.html (Kawasaki/Tokyo) University of HK (university of Hong Kong) www.hku.hk/ppaweb/ (Hong Kong) UFJ Institute (research institute of private Japanese bank) www.ufji.co.jp/eng/ (Tokyo) US CB – US Census Bureau, Foreign Trade Statistics (national census bureau) www.census.gov/foreign-trade/www/ (Washington, D.C.)

- 3 75 - US CFR – Council of Foreign Relations (state advisory council) www.cfr.org/index.php (Washington, D.C.) US Dept. Agri., - United States Department of Agriculture (Sub. Dept. for trade policies) www.fas.usda.gov/trade.html (Washington, D.C.) US Dept. of Labour - United States Department of Labour (US ministry, www.usdl.gov?? (Washington, D.C.) USTR - Office of the United States Trade Representative (president’s advisers office) www.ustr.gov/ (Washington D.C.) Vedomosti – (leading Russian daily) www.vedomosti.ru/ (Moscow) Vladnews – Vladivostok Novosti (local Russian daily with English page) www.vladnews.ru/ (Vladivostok) Volga-Dnepr – Volga-Dnepr Group (world’s leading large-air-cargo company) www.vdg.com.ru/english/ (Ulyanovsk/Moscow) Water Diversion – (The world’s largest diversion project from Yangtze to the Yellow River, China) www.chinaview.cn/ (linked from “Major Projects”) WB - Ch – The World Bank’s China office www.worldbank.org.ru/ alternatively www.worldbank.org (Beijing) WB - Ru – The World Bank’s Russia office www.worldbank.org.ru/ alternatively www.worldbank.org (Moscow) Werner Int. – Werner International Ltd., (private legal advisors) www.wernerinfotex.com/ (New York) WebJapan – Gateway for Japanese Information (very good state official statistics page) *web-japan.org/ (Tokyo) WFP – World Food Program (UN agency) www.wfp.org/index.htm (Rome, Italy) whitehouse – The White House, President George W. Bush (presidential adm.) www.whitehouse.gov (Washington D.C.) WHO – UN World Health Organization (UN org. for world health) www.who.int (Geneva) Willkie Farr & Gallagher (private legal advisors) www.willkie.com/News (New York) World Economic Forum (independent organization: “committed to improving the status of the world") www.weforum.org (Geneva) WSD - World Steel Dynamics (leading analysts of the world steel market) www.worldsteeldynamics.com/index.html (New Jersey) VCIOM – All Russia Center for the Study of Public Opinion (also called VTsIOM) www.wciom.ru/?new_lang=2 (Russian page much better) (Moscow) WWF - World Wilde Life Foundation (international NGO for wildlife protection) www.wwf.ru/eng/ (Moscow) Xinhuanet (state agency, “New China News Agency”) news3.xinhuanet.com/English (Beijing) Yonhap – Yonhap News (Korean news agency) *english.yna.co.kr/ (Seoul) Zenginkyo – Japanese Banker’s Association (one of the Japanese bankers associations) www.zenginkyo.or.jp/en/ (Tokyo)

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