Kang: North Korean Trade Potential

Kang: North Korean Trade Potential

David C. Kang, an expert on Asian business, examines what economic development in North Korea could potentially mean for the region.

December 13, 2007 1:46 pm (EST)

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

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On December 11, North and South Korea opened limited cross-border freight rail, connecting the countries for the first time in over fifty years. South Korea will use the service to send materials to the Kaesong Industrial Region, a North Korean special economic zone where several South Korean companies are already active. More generally, the two Koreas have pushed for deepening their trade relations, particularly following a historic inter-Korean summit in October 2007. David C. Kang, a professor of government at Dartmouth College and an adjunct professor at Tuck Business School, discusses the potential for North Korean trade. He says South Korea’s immediate interests lie mainly with improving ties and fostering growth and seeds of economic change in North Korea. But longer term, he says the North offers real economic potential, particularly as a long sought-after rail byway connecting Japan, South Korea, China, Russia, and Europe.

For the first time in over fifty years, cargo train service recently opened between North and South Korea. Right now it’s fairly limited, basically one train a day carrying goods to and from a specific industrial complex in North Korea. Is this mostly symbolic, or do you think it has much economic significance?

It doesn’t have huge economic significance in the overall GDP [gross domestic product] of North Korea. But it does have major economic significance in the fact that what North Korea had to do in order to let a train go through was an awful lot of adjustment. Legally, militarily, and in terms of how they’re going to set up a regularized system of exchange for getting people back and forth across the border. So that, actually, is fairly significant. It’s not like they just opened the door, in comes the train, and out it goes. They had to do a lot of institutional restructuring.

Do you mean in terms of customs, or what?

Customs and border control is one. But in terms of linking up the railroad, all the ministries had to prepare. So ramping up from one train to X number of trains is much easier. The old KEDO [Korean Energy Development Organization] had this problem as well. In the 1994 nuclear agreement, when they wanted to come in and have Americans and South Koreans working in North Korea to build this light-water reactor, they didn’t just say, “Okay, here you go.” They had to set up protocols for everything. Post offices, phone calls, where they were going to stay—all this kind of stuff. This is the same thing for a cargo-type exchange. It’s not going to mean North Korea’s economy is going to grow at 10 percent. But it is pretty significant in terms of how much they had to adjust.

Do you suspect it will lead to substantially more cargo traffic in the near future?

I’d put the question a different way. The trains aren’t the beginning. They are a middle step in which North-South trade, over the last decade, has grown really rapidly— from $200 million in 1998, to now exceeding $1.7 billion in 2007. The trains are one aspect of trade that’s still at a very low level, but that’s increasing quite rapidly, along with the increases at Kaesong [North Korea’s largest special economic zone]. I was in Kaesong in July and they had fourteen thousand workers. Now they have twenty-one thousand workers. So in the context of that, the trains are just one very visible symbol of changes that are already beginning to take place.

Could you elaborate a bit on these changes? Obviously, one of the goals coming out of the recent North Korea-South Korea summit has been to better integrate North Korea economically, and particularly with South Korea. What all is entailed in that?

The stuff they’re talking about right now is obviously increasing the amount of interaction through North and South, through the Kaesong Industrial Zone. They’re going to open up plans for South Korean tourists to go to Pyongyang, and Mount Baekdu, up in the North. Along with larger discussions, or more long-term discussions, about increasing the size of the industrial zone from Kaesong—extending it westward, trying to work out the northern limit line so they can both fish in the water [in the Ocer Sea, a lucrative fishing area where North and South Korea have a disputed border]. So there’s a whole bunch of different proposals that are in play to increase the economic interactions between North and South Korea.

How much of a difference is this making in terms of North Korea’s economy?

People were skeptical, ten years ago, when North Korea began to claim that it was going to undergo economic reforms. They said, “They have no intention of changing, and what they’re going to do is try to keep this as closed off from the North Korean citizens as possible.” They’re still doing that—these economic zones are fairly closed off from the North Korean population. But a lot of these exchanges are beginning to incorporate more and more North Koreans into the experience. For instance, these twenty-one thousand workers at Kaesong who are North Koreans, eventually are going to go home and tell their families and friends what they experienced. At this point what we’re seeing is very initial steps on the part of North Korea as they try to open up reform and yet maintain control. At the same time, they are being forced into a number of institutional changes and mind-set changes that are the first step forward in this process.

Now in terms of specific businesses, specific sectors, where do you see North Korea having the best growth potential. I guess this sounds a bit absurd, but are there specific sectors where we might say they are particularly well positioned?

[Laughs] How about least poorly positioned? Most of the companies that have gone in—the South Korean companies that have gone in—are assembly and light manufactures, such as or textiles and light consumer goods. This is the sort of obvious point of departure. It’s not hugely capital intensive in terms of building factories, and can take advantage of North Korean cheap labor and South Korean technological advantages. And that’s where a lot of the companies that are in Kaesong right now are going. Longer term, South Korean companies are looking at building larger factories in North Korea where you actually produce things. There are a lot of potential mineral resources in North Korea, which would require a whole infrastructure of legal reforms to happen before anyone would take care of them. But at this point the safest bets are the ones that are on the order of assembly and light manufactures in the North and then exporting them out.

Other than Kaesong, what else is there in terms of special economic zones?

Right now there are a number of them. There’s Kaesong. There’s the Geumgangsan project, which is basically a tourist special economic zone. That’s on the east coast. They used to make them get on a boat, and I think now they’re going to allow overland travel over the Geumgan Mountains from South Korea. Then they have the Rajin-Sonbong project, up north, which was the first special economic zone. And then they have one in Sinuiju, which is right across from Dandong on the Chinese border, which they announced six or seven years ago, but that fell apart and they haven’t really started it back up yet. Though I’ll note it fell apart on the Chinese side. The guy who was going to run it was Chinese and he got arrested by the Chinese government for corruption.

What’s at stake here, economically, for South Korea? Are they basically just hoping political good will come from this, or is there any chance this will substantially help the South in terms of economic growth?

There are two things going on. In the short term, South Korea’s total trade is some $250 billion. So a billion worth of trade with North Korea is nothing. In the short term, it’s clearly considered a political tool for increasing good relations with North Korea and hopefully fostering some change up there. Even the direct aid, which is fairly small—a couple hundred million dollars—is tiny compared to the costs South Korea would pay if there was war or collapse. So I don’t think there’s a whole lot of concern about wasting that money.

Long term, the complementarity between the sides is fairly large. If there’s unification, or even better relations, and South Korean companies can use cheap North Korean labor, instead of having to send those factories to China or Vietnam—not only do they speak Korean, they’re culturally similar, and the labor would be cheaper. So in the longer term there’s a feeling that this might actually be a plus for the South Korean economy. But nobody’s thinking about that in the near future.

I had also seen—at least just mentioned in the news stories surrounding the cross-border rail traffic—that some people are thinking South Korea could get rail going up through North Korea, and that that could get help their exports to China and Russia, and even out to Europe. Would that be very far off?

It would be very far off. But actually, a lot of people are very excited about that. In the long term, the previous Japanese prime minister had mentioned it. The Russians would all be in favor of it. It’s a natural place for the Russian, Chinese, and Japanese economies. They intersect on the Korean peninsula. So if you could reconnect the railroads, from Japan, through Pusan [South Korea], up through North Korea, then out to China and Russia, you would be linking up all these economies in a much more efficient way than they are now. So everybody wants that. But obviously there’s the political problem. And even on the infrastructure side, the North Korean rail system is so old and so decrepit, that basically it would have to be rebuilt from zero. But the potential upsides are massive, in the long run.

Last, let me just ask about China. How involved are they here?

China has been essentially as deeply involved in economic engagement with North Korea as has South Korea—and by some measures, actually more so. Whereas South Koreans just do this assembling, some Chinese companies are moving in and building full factories in the North. There’s a lot of interest in Chinese-North Korean economic relations on both sides.

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