The China Alternative – North Korea

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The China Alternative is our series covering other manufacturing destinations in emerging Asia that may start to compete with China in terms of labor costs, infrastructure and operational capacity. In this issue we look at North Korea.

By Kaitlin Shung

Jun. 29 – North Korea, or “the Hermit Kingdom,” is more often in the media for its domestic and international political strife than for potential foreign investment opportunities. However, taboo aside, some investors may be surprised to learn about how viable an option North Korea really might be. Although it is unconventional, North Korea does have a number of benefits and opportunities for investors willing to undertake the risk.

Economy overview
The country is officially known as the Democratic People’s Republic of Korea (DPRK) and shares the Korean Peninsula with its neighbor to the south, the Republic of Korea (South Korea). To the northwest, the DPRK is bounded by northern China. From a geographic perspective, North Korea is located centrally in an economic hub of activity in emerging Asia. With an area of 120,538 square kilometers, the DPRK has a population of roughly 24.5 million. The state is highly militarized and power is centralized in the capital city of Pyongyang.

Historically, the leaders in Pyongyang focused on building an economy which was completely self-sufficient. Aside from this objective, the military-focused central government tended to prioritize political strategy over solid investment in economic factors of production and infrastructure. Natural disasters and famine in the 1990s sent the country’s economy into a tailspin. Since then, Pyongyang’s objectives seem to have shifted in the direction of market-led growth. The state’s objective in 2012, the 100th anniversary of the birth of the nation’s founding father Kim Il-sung, is to become a “strong and prosperous nation” focused in economic growth.

Economic information on North Korea is difficult to confirm and keep up to date. The CIA’s most recent estimate of GDP is US$28 billion, with real GDP growth of -0.9 percent. Figures on North Korea’s GDP may vary from source to source depending on whether or not the analyst considers trade between North Korea and South Korea to be inter- or intra-national trade. Figures show that the majority of the economy is focused in industry (46.9 percent), followed by services (32.1 percent) and agriculture (20.9 percent).

Exports totaled US$1.997 billion in 2009, primarily focused in minerals, metallurgical products, manufacturing, textiles, agricultural and fishery products. North Korea is a mineral rich nation and consequentially, minerals make up a notable portion of exports. Imports amounted to US$3.096 billion, composed largely of coking coal, machinery, equipment, textiles and grain.

It should be noted that these figures don’t account for black market trade or foreign aid. It has been estimated in the past that the sale of narcotics, missiles and counterfeit goods constitute a significant portion of unreported export income. Considering imports, the DPRK receives a substantial amount of tied and untied aid from numerous sources, including China. Examples of aid include food, fuel, machinery and weapons.

Foreign investment
Despite the mysterious and sometimes off-putting actions of the ruling party, North Korea is not a completely unviable investment opportunity and a number of firms have found success there. Take for example Egyptian conglomerate Orascom, which has a successful US$115 million joint venture stake in a North Korean cement company. Furthermore, the state is undoubtedly not opposed to foreign investment and has, in fact, taken steps since the 1990s to try and attract foreign direct investment. Since before 2000, the government has implemented a number of legal reforms intended to facilitate the entry of foreign firms. Some of these laws include a foreign investment law, a free economic and trade zone law, an equity joint venture law, and a foreign enterprises law.

Companies interested in doing business with North Korea need to work through the International Korean Business Center (IKBC), a government organization. For additional support, companies can look for consulting companies like Phoenix Commercial Ventures Ltd., which claims to be the only European company to maintain an office in Pyongyang. These kinds of organizations will seek out investment projects in the DPRK and identify both local and foreign partners for joint ventures.

The IKBC lists a number of advantages to investing in North Korea, some of which should be taken with a grain of salt while others certainly show potential. First, the DPRK touts its workforce as a strength, for whom free education, housing and health care are provided. Hypothetically, within this socialist framework, individuals don’t have incentives to seek higher salary positions and will thus work for lower wages for longer periods of time. For a company, this means lower employee turnover, less spent on training and overall, lower labor costs. Furthermore, North Korea has a relatively large and literate work force, with over 68 percent of the population between the ages of 15 and 64 and nearly 99 percent of the population able to read and write.

Next, the government also lists its taxes as the “lowest tax schemes in Asia.” Finally, for companies willing to dive into the local North Korean market, there’s an opportunity for a first-mover advantage in this relatively untapped and isolated market.

The IKBC also names a number of benefits associated with North Korea which are questionable, or likely out of date. First, they consider being able to deal directly with the government as a positive because it is a “very stable political system, without corruption.” The centralized nature of decision making in North Korea does not necessarily work in the favor of foreign companies, both in terms of efficiency and corruption. Next, North Korea’s “full diplomatic relations with most EU members and rest of countries” and “transparent legal work” are both questionable, especially given recent global tension over North Korea’s controversial nuclear program.

Foreign direct investment in North Korea typically takes one of three forms: South Korean investment, Chinese or Russian investment, and foreign private investment. Relations between South Korea and North Korea have taken a turn for the worse recently, but during the “sunshine policy” period of 2007, improved relations led to the development of special economic zones for South Korean firms in North Korea. In the past, South Korean investment was subsidized by the government and was more often a political and diplomatic initiative rather than a purely business one. One of the major perks for South Korean firms was the inexpensive and plentiful labor found in North Korea.

Investment from China, North Korea’s most important ally and one of its largest trading partners, and Russia tend to focus on large-scale industry development with a focus on exploiting mining resources and shipping.

The risks of investing in North Korea are varied and daunting, ranging from internal regulatory concerns to global geopolitical conflict. Internally, regulatory and legal risks are most prominent. From a regulatory perspective, the highly militarized government’s interests have historically focused on short-term political goals instead of economic ones. This divergence of interests means that the regulatory environment can be unpredictable and unstable. For example, a Thai telecom company found itself on the losing end of a sudden regulatory shift when the government banned cell phones in 2004 after it had already begun plans on a mobile-phone network in the DPRK.

Legally, the implementation of laws favorable to foreign investors is a positive step and it appears as if the country has implemented a process for dispute resolution as well as incentives for improved quality and efficiency. However, the enforcement of these laws is generally perceived as weak and so their true value has yet to be realized. Intellectual property protection issues are also a concern for firms which may not receive adequate protection in North Korea.

Inflation and currency issues in North Korea are an ongoing and notable concern. The won is currently trading at 900KPW: US$1, but the currency faced a serious setback with a failed attempt at reform in 2010. An attempt to revalue the currency through implementing a trade-in system for a new currency resulted in riots, the free fall of the won and escalating inflation. Aside from the negative effect on the internal economy, the failed currency reform is suggestive of a larger problem with the country’s leadership as a whole. The long-term consequences of the currency problem have yet to be seen, but The Wall Street Journal suggests that the social unrest may lead to a renewed military focus by the DPRK and a reduced openness to the West.

North Korea’s nuclear problem has put it in hot water on a global scale, most notably drawing sanctions and condemnations from the United States after failed Six Party Talks. Similarly, South Korea’s declaration that North Korea was its archenemy last year has led to strained relations between the two nations. The sinking of the South Korean naval ship the Cheonan last year and the North’s shelling of Yeonpyeong Island are indicators of escalating violence. It’s not entirely clear if the conflict will be resolved or if war is inevitable on the Korean Peninsula.

Future outlook
Moving forward, one of the biggest factors in how viable North Korea will be as an investment destination is whether or not it will ever completely open up and/or re-unify with South Korea. Since the ascension of Kim Jong-il, economists were saying it was only a matter of time before the nation’s economy crumbled and the two Koreas unified. Nearly two decades later, this small country (and its leadership) has managed to survive and gauge out a place for itself on the international stage. The reunification of the Koreas, and the opening of North Korea, would open the floodgates for new investment opportunities, and companies already with a stake there would stand to benefit immensely.

In the mean time, there’s considerable risk in investing in North Korea from both internal and external sources. Internally, the sometimes sporadic and misled actions of the highly militarized government have led to a degree of uncertainty for investors. A number of external issues have been touched on but it is also important to consider how an association within North Korea can affect a foreign company. The DPRK’s association with human rights and freedom of speech abuses can certainly hurt companies seen to work with the government. Noko Jeans, a company which manufactures jeans out of North Korea, struggled to find foreign outlets willing to carry their goods because of their concern with public backlash. Keeping this in mind, a thoughtful analysis of North Korea will need to carefully weigh the potential against the admittedly daunting risks.

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