North Korea and Economic Integration in East Asia 9780367179762, 9780429058790

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North Korea and Economic Integration in East Asia

Throughout North Korea’s history, it has regarded external relations with suspicion and as a potential threat to its regime. With North Korea working towards denuclearization, there is now hope for an economic opening. This book examines the external economic strategies that North Korea may consider for its reforms and development, which are related to the East Asian economic integration process. This book emphasizes that considering theoretical factors as well as conditions of the North Korean economy, economic opening and integration should have high priority, anteceding or at least being parallel to economic reforms and transformation. Also, among various alternative strategies for achieving the goal of economic reforms and development based on economic opening, the utilization of East Asian regional economic integration framework would be the best option for North Korea, because this framework can provide an opportunity for North Korea to overcome structural problems in its external economic relations and to circumvent political conflicts, thus leading to a smoother rapprochement towards economic opening. This book is timely as it shows how a new economic development strategy on the Korean Peninsula may be accomplished. Yeongseop Rhee is Professor at Graduate School of International Studies, Seoul National University, South Korea. He was formerly Research Fellow at Korea Development Institute and non-resident Fellow at Brookings Institution. He is also co-author of Asian Monetary Integration: Coping with a New Monetary Order after the Global Crisis (2012) and Overcoming Financial Crises: The Korean Experience (2013). Patrick Messerlin is Professor Emeritus of Economics, Sciences Po Paris, and Chairman of European Centre for International Political Economy, Belgium. He is co-author of Potential Benefits of an Australian-EU Free Trade Agreement: Key Issues and Options (2018) and Trade for Development (2014) and author of Measuring the Costs of Protection in Europe: European Commercial Policy in the 2000s (2001).

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North Korea and Economic Integration in East Asia

Yeongseop Rhee and Patrick Messerlin

First published 2020 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN and by Routledge 52 Vanderbilt Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2020 Yeongseop Rhee and Patrick Messerlin The right of Yeongseop Rhee and Patrick Messerlin to be identified as authors of this work has been asserted by them in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging-in-Publication Data Names: Yi, Yæong-sæop, 1960– author. | Messerlin, Patrick A., author. Title: North Korea and economic integration in East Asia / by Yeongseop Rhee and Patrick Messerlin. Description: Milton Park, Abingdon, Oxon ; New York, NY : Routledge, 2019. | Series: Routledge studies in the modern world economy | Includes bibliographical references and index. Identifiers: LCCN 2019009217 | ISBN 9780367179762 (hardback) | ISBN 9780429058790 (ebook) Subjects: LCSH: Korea (North)—Foreign economic relations. | Korea (North)—Economic conditions—21st century. | Korea (North)—Foreign relations—2011– | Korea (North)— Commerce. | East Asia—Economic integration. Classification: LCC HC470.2 .Y56 2019 | DDC 337.519305—dc23 LC record available at https://lccn.loc.gov/2019009217 ISBN: 978-0-367-17976-2 (hbk) ISBN: 978-0-429-05879-0 (ebk) Typeset in Galliard by Apex CoVantage, LLC

Contents

List of figures List of tables Preface

vi vii viii

1

Introduction

1

2

Theory of economic integration and transformation

8

3

North Korea’s motives and strategies for external economic relations

22

4

North Korea’s external economic relations

34

5

Progress of regional integration in East Asia

50

6

North Korean trade policy: Constraints and options

70

7

Regional financial cooperation and North Korean development

102

Conclusion

123

Bibliography Index

127 137

8

Figures

3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 4.8 4.9 5.1 5.2 5.3 6.1 6.2 7.1

South Koreans’ perception of North Korea North Korea’s strategy for international transactions Trends in North Korea’s foreign trade North Korea’s trade deficit North Korea’s trading partners North Korea’s exports, by destination North Korea’s imports, by source countries Distribution of North Korea’s export products, 2016 Distribution of North Korea’s import products, 2016 Foreign investment in North Korea SEZs and economic development zones in North Korea CMI currency swap arrangement Chronology of Asia’s financial integration initiative Multi-layered structure of East Asian regional integration initiatives History of the uniform tariff in Chile, 1979:1–2011:4 (trimester basis) Chile’s exports of goods and services, 1974–2012 (2005 constant US dollars) Investment and savings rates in East Asia

24 30 35 36 37 38 39 39 40 41 43 52 57 64 85 86 116

Tables

2.1

Economic disparities between the EU and CEE counties, 1998 2.2 Transformation vs. integration for CEE countries 2.3 Discussions on the German monetary union 2.4 Early vs. late currency union 4.1 North Korea’s foreign trade: Share of South Korea, China, and Japan 4.2 Foreign investment in North Korea, by country 4.3 Three phases of the KIC plan 4.4 Production of KIC companies, by sector 5.1 CMIM contribution and borrowing amount 5.2 Sequences for monetary and financial integration using the ACU 6.1 Product composition of North Korean trade, 2016 6.2 Milestones in Vietnam–US trade relations, 1989–2007 6.3 A brief presentation of countries of interest for North Korea 6.4 Tariff structures of South Korea and the EU 6.A1 Key components of trade policy reforms: the Baltics and Georgia 6.A2 GDP per capital of the Central European member states, 1995–2013 7.1 Annual growth rate of per-capita income 7.2 Comparison of SEZs 7.3 World Bank Group 7.4 Estimation of infrastructure demand in Northeast Asia 7.5 Pros and cons of three financing options 7.6 Comparison of strategies for development financing in Northeast Asia

10 11 13 16 37 42 45 46 54 58 72 80 84 95 98 99 105 108 110 115 118 120

Preface

What is the most imperative to save the North Korean people from poverty and adversity? The answer is clear to me: Economic development. Then what is the most needed to develop the North Korean economy? The answer is also clear to me: Economic opening. Simply speaking, there is no other way than economic opening for North Korea to overcome its current difficulties and advance to a modernized economy and better life for its people. This is widely recognized and shared among not only pundits but also the general public. Of course, the nuclear issue is so important that even a minor change in this situation can easily bury all other issues related to the Korean Peninsula. This may make any discussion on economic reforms and opening of North Korea meaningless. Nonetheless, North Korea seems to be ambivalent about external economic relations, sending signals that it is willing to economically engage with the international community, while simultaneously emphasizing that it will stick to its stance of self-reliance. To make North Korea have a more positive attitude and more incentives toward opening, trust-building among all the parties involved in the Korean Peninsula and among North Koreans themselves on their future is essential. One way to contribute to this trust-building is that we keep discussion on specific policies to develop North Korea and do not sever but instead maintain the economic linkage between North Korea and the world. This book focuses on specific external economic policies, i.e. trade and foreign investment policies of North Korea, and examines how these policies can be designed for economic reforms and development of the North Korean economy. The book emphasizes three things among others. First, the discussion must focus on concrete proposals for specific economic policies. The more we discuss specific and concrete issues, the more North Koreans will be informed about the options and opportunities which can be available in the future and the more they should realize that economic reforms and opening do not necessarily lead to economic collapse but instead to a manageable shift to a more prosperous economy – as in the case of the Central and Eastern European countries. Second, among various alternatives to economic opening, participation in regional economic integration in East Asia is probably the best option for North Korea. East Asia can provide a large market for North

Preface

ix

Korea’s exports; in addition, it can be a major source of funding for North Korean infrastructure development. Also, participation in regional economic integration can reduce the political interference, and will lead to a smoother movement towards economic reforms and opening of North Korea to the international community. North Korea’s participation can create more opportunities for the country to make contact with South Korea and other neighboring countries, and these meetings will be made more for concrete issues, and become less political and less confrontational, but more practical business. Third, discussions of concrete proposals should deal not only with issues related to the opening of the economy but also with other policies key for economic success, including exchange rate policy, macroeconomic policies, labor market policies, structural policies, and social policies. These policies are also needed to promote economic reforms of North Korea and to sustain its economic development. In preparing this book, I have had much support and assistance from many institutions and persons. This research was supported by the Research Grants for Asian Studies of the Seoul National University Asia Center (SNUAC), and I thank the Center for its financial support. I am also very grateful to the Cengage for granting permission to reprint the previously published materials. When I was preparing the draft of Chapter 6, I found an article written by Professor Patrick Messerlin of the Sciences Po Paris, France. Since he explained the trade policy of North Korea much better than what I had in mind, I asked him to coauthor this book. His work is included in Chapter 6, and he helped to write the introduction. I am grateful to him for his acceptance of the co-authorship. Professor Hong-Tack Chun of the KDI School of Public Policy and Management worked together with me to write many papers and books on the issues covered in the book, and I wish to thank him for providing me with intellectual advice and comments. Also special thanks go to my mentor Professor Barry Eichengreen of the University of California, Berkeley, who always shows me what a good teacher and scholar is. Last, but not least, my deep gratitude goes to my family for providing continuous and warm relief. Yeongseop Rhee

1

Introduction

1. Background and purpose1 There is no doubt that denuclearization is the top priority for the area within the range of North Korea’s missiles (which includes not only South Korea but also all of China and a part of the US) as well as for the entire world if North Korea is smuggling nuclear material to other chaotic countries. The problem is that this issue is so important that it tends to “freeze” all the parties involved in the Korean Peninsula (a classical situation in the face of nuclear threats). Nobody is ready to move because the costs and risks generated by a violent collapse of the current North Korean regime are felt to be too high. As stated by Kim Jong Nam in his interview (the uncle of the current North Korean Leader used to live in Macau and was assassinated in 2017): I personally believe that economic reforms and openness are the best ways to make life better for the North Korean people. However, taking North Korea’s unique position into account, there is a fear that economic reforms and openness will lead to the collapse of the present system.2 This prevailing view of “make no move now” relies on arguments that can be briefly summarized in terms of the main four actors in North Korea. •

•

Members of the top nomenklatura are not ready to move because they fear that they will lose their current wealth and possibly their lives in a transition process that they perceive will be very fast at best, violent at worst, and in any case incontrollable. Members of the lower ranks of the nomenklatura share the same view – though with (possibly large) variations, depending on the extent to which these officials are truly protected from food crises, on how much money they earn by oiling the system via corruption, and also on how much they care about the rest of the population among whom they live (some officials have loosely enforced some of the policies dictated by the top nomenklatura in order to protect North Koreans from the worst effects of these policies).

2

Introduction

•

North Koreans running officially blessed private businesses focus all their energy on consolidating what they have already achieved at such great pain, and may be afraid of expanding their businesses in a more market-oriented environment. The rest of the North Korean population is probably mostly consumed by the struggle to survive. The consequences that the brutal reversals of North Korean economic policies during the last two decades have had for their welfare may even have made them more nostalgic of the Kim Il-sung era (the only memory they have of a period of stable economic conditions) than of an unchartered market economy.

•

To make things even more difficult, fear of a market-based future is, almost certainly, deeply entrenched in these four layers of the North Korean population. Of course, this fear has been fueled by intense propaganda for three generations now. But, more importantly, it has been magnified by North Korean policies that have associated (black) market-based successes with punishment: The 2009 currency change was a spoliation of all the savings made in the previous currency unit by North Koreans (except those of the top nomenklatura made in foreign currencies). It was magnified by devastating hyper-inflation that has hurt every North Korean – and sheds a light on the profound lack of economic understanding in the top nomenklatura.3 Last but not least, black markets that are not protected by the rule of the law are better than empty shelves, but they have surely created countless frustrations among North Korean consumers. These four ideas make a lot of sense. Indeed, they describe a population and its ruling group exhausted by 70 years of an increasingly inefficient economic regime and by one of the strictest single-party arrangements. That said, they do not eliminate the reverse arguments that should often cross the minds of North Koreans and would induce them to move forward. These ideas can be briefly summarized as follows. •

Members of the top nomenklatura can witness the reality that their peers in other communist countries have survived the transition process—indeed, they have done well. Those who have lost the power they used to have are now very wealthy by North Korean standards and even often by the standards of their own countries under communist rule. Since the fall of the Berlin Wall, no one has lost his/her life in this process (with exception of Nicolae and Elena Ceauşescu), in sharp contrast with the many violent deaths under communist regimes. The danger involved in belonging to the top nomenklatura is often under-rated in democracies while it is certainly very present in the minds of top North Koreans: Life at the top of despotic regimes is full of fear, as amply documented by history from Han Wu-di to Stalin. Market-based and democratic countries are the only ones where being at the top does not involve the risk of being violently overthrown.

Introduction 3 •

•

•

Lower-ranking members of the nomenklatura should consider the experiences of their peers in other former communist countries, with some of them even running their own countries (Vladimir Putin being the best example). Very few members of the lower ranks of the nomenklatura have paid a price for having been part of the communist system: The hunt for former East German Stasi or Romanian political prisons staff or the members of the Polish Communist Party has not gone very far. The managers of officially blessed private businesses have not had the same role in other communist countries as in North Korea: According to some estimates, roughly half of North Korean food and basic consumer goods is produced and/or delivered by these managers.4 Despite the absence of evidence on the fate of these managers after the fall of communist regimes in other countries, it seems reasonable to assume that they have faced the usual fate of every business: The clever ones have adjusted to the changes and survived or prospered, while others have simply gone out of business. The rest of the North Korean population have some hint – when they can get some news about the rest of the world – that they have little to lose because there are very few countries in the world as poor as North Korea.

Most North Koreans who have time to think about their future (and some access to information about the rest of the world) should be torn between these two sets of arguments. The number of these people may not be large, but it is probably large enough to trigger reforms and to support them if launched. What could be done to make the balance of arguments shift from those favorable for the status quo to those favorable for change? A good start seems to debate concrete proposals – the key word being “concrete” – about every economic policy to be implemented for economic reforms and development: What should and can be done, how fast, how wide, etc. The main goal of these debates would be to provide enough information and options to North Koreans for them to realize that the transition is not necessarily a fall into a chaotic and hellish world, but a reasoned and manageable shift to a more prosperous one via economic policy. Even crude, concrete proposals have some merit for conveying ideas about the future, while improving North Korean knowledge of economic issues. By contrast, keeping the debate on the economic future of the Korean Peninsula to broad generalities cannot be conducive to the much needed trust among North Koreans because it leaves too much room open to interpretation, fueling countless suspicions and leaving intact the existing fears. In short, the primary role of these debates on concrete proposals is to build trust among all the parties of the Korean drama, including building trust among the North Koreans themselves regarding their own ability to move on to a path to transition. Regarding reforms and economic development of North Korea, various proposals are floating around. Despite the wide range of proposals, it is clear that they agree on one thing: Implementing economic reforms and

4

Introduction

modernization based on economic opening is the only option to prevent a further deterioration of the North Korean economy and a destabilization of its regime. North Korea should adopt economic opening and expansion of its external economic relations as a part of a grand development strategy, not just as an instrument to collect hard currency, so that economic opening can provide meaningful impetus to economic development. Participation in East Asian regional economic integration is probably the best option among alternative approaches to economic opening of North Korea. In particular, utilization of a regional economic cooperation framework in East Asia will make it possible to overcome the structural problems in North Korea’s external economic relations and to encourage and sustain its development projects. East Asia can provide a large market for North Korea’s exports. The East Asian market is larger than and growing faster than other regional markets, and North Korea shares a border with the largest countries in the region, including South Korea, China, and Japan. Once North Korea is open for participation in regional economic integration, it can easily expand its trade with neighboring countries. The expansion of external economic relations through regional economic integration is not confined to trade, but also extended to foreign investment. In the world financial market, East Asia as a region is a net creditor; a huge amount of capital is readily available for investment in the region. In particular, large capital holders in the region are actively seeking new investment opportunities, because investments in their domestic markets are somewhat saturated and it is not easy to expect high returns. If big potential risks resulting from the internal problems of North Korea and external problems such as international sanctions are reduced, North Korea can attract huge foreign investment from neighboring countries. Also, participation in regional economic integration can lessen the political constraint, and will lead to a smoother movement towards economic reforms and opening of North Korea to the international community. If North Korea becomes a party to regional economic arrangements, it can have more contact with neighboring countries. As discussing economic policies becomes more and more routine, ideological confrontation would be reduced. Thus such a movement towards economic reforms through regional cooperation would be politically desirable. This book intends to contribute to the debates on concrete proposals for trade policy and foreign investment policy, focusing on North Korea’s external economic relations (of course, there should be similar debates on other economic policies). It will specifically discuss how North Korea can utilize the East Asian regional economic integration framework to formulate trade and foreign investment policies so that North Korea has incentives to be more open and to make use of the regional economic integration processes for its economic reforms and development. Under the present circumstances, the most likely place to start such debates is South Korea. But, that is not specific to the Korean Peninsula. Most of the debates on what could and should be done in Central Europe in the early 1990s

Introduction 5 started in Bonn (German reunification), Brussels (accession of Central European countries), and London (covering the former Soviet Union with the European Bank for Reconstruction and Development) before spreading to the Central European countries involved. Indeed, rather than the initial location for these debates, what counts is their capacity to percolate into North Korea. This capacity is a function of the abundance and quality of the options discussed, and their ability to attract the attention of the North Korean actors (including all four social strata), and reduce the imbalance of information between the two Korean economies. The fact that such debates should start in Seoul has a useful side. South Koreans are not immune to fears and suspicions on the future of the Korean Peninsula. Instinctively, they realize that profound changes in North Korea will require effort from them, possibly for many years, as best illustrated by the German experience. Still today, it is easy to find in Eastern Germany buildings as decayed as those existing in the early 1990s, despite the billions of euros spent by West Germans. As a result, South Koreans need to discuss the best possible concrete options from their own point of view among all those available.

2.

Synopsis of the book

This book is comprised of eight chapters. Chapter 1 introduces the book, emphasizing the importance of the study and clarifying the issues to be covered. Chapters 2 and 3 critically review theoretical debates surrounding the relation between North Korea issue and the issue of regional integration. Chapter 2 examines the relationship between economic transformation and economic integration, which is often discussed for the development of a transition country like North Korea. It first looks at the experiences of European transition countries. When Central and Eastern European (CEE) countries attempted to join the EU after the collapse of socialist systems in the early 1990s, the debate on whether economic integration or economic transformation should come first was intense in those countries. One group argued that the former Soviet Republics should be allowed to join the EU before they had completed the transformation from socialism to democracy, while the other argued that they needed to complete the transition first. Also, when East Germany collapsed, there was another hot debate on whether to follow the big bang approach or the gradual approach. Proponents of the big bang approach were more inclined to immediate unification and preferred that economic integration of East and West Germany precede the economic transformation of East Germany, while proponents of the gradual approach advocated for East Germany to complete its economic transformation before the two countries could be unified. Considering the lessons from these experiences in Europe and also the situation of North Korea, we derive the first principle that economic opening and integration should precede economic reforms and transformation. Chapter 3 examines North Korea’s view on economic opening and regional economic integration. North Koreans have had mixed feelings about this and

6

Introduction

so far the country has adopted a conflicting stance towards economic opening and regional economic integration. Clearly economic opening is considered a significant threat to the stability of its regime. But North Korea also recognizes that regional collaboration and integration will bring direct benefits such as an influx of foreign currency and infrastructure development; this will also bring indirect benefits such as support for a smooth movement towards economic reforms within a politically more acceptable framework. When we suggest that North Korea include the issue of regional economic integration in formulating its external economic policies, it is necessary to consider these mixed feelings. Based on this consideration, we derive the second principle that the strategies for opening North Korea should mitigate the regime’s perception of economic opening as a potential threat to its existence. Chapters 4 and 5 critically examine North Korea’s external economic relations and the progress of East Asian economic integration as a whole. It is necessary to understand the current situation and unique features of North Korea’s external economic relations before seeking a possible strategy for the opening of North Korea to the East Asian and international communities. Thus in Chapter 4, we show trends in North Korea’s external economic relations and explain important features of international trade and foreign direct investment in North Korea. Above all, the North has very limited economic interactions with the international community. The poor record of North Korea’s international transactions reflects its mixed feelings towards the international community that “International economic exchanges are needed, but not liked and actually feared”.5 North Korea still has mainly negative perceptions of economic opening and regional economic integration and fears a threat to the stability of its regime; it therefore has allowed only limited contacts with a few countries, in particular China. Chapter 5 describes the existing regional arrangements in East Asia, including those under hard negotiation. Along with the pursuit of regionalism, various strategies have been proposed for regional integration in East Asia. Although East Asia lags behind Europe with regard to regional economic integration, it is also crowded with many bilateral and multilateral economic arrangements, some of which have served economic development, integration, and globalization very well. We categorize those arrangements into three groups—pan–East Asian initiatives, sub-regional initiatives, and trans-regional initiatives—and explain their main features and challenges. The chapter also shows the potential benefits of regional economic integration to North Korea and emphasize that participation in East Asian regional economic integration is the best option among various approaches to economic opening. Chapters 6 and 7 propose specific and concrete strategies for how North Korea can utilize the regional integration framework for its external economic policies. Assuming that the nuclear issue defines the pace at which North Korea will enter the world trade system, Chapter 6 examines key constraints on the trade policy to be designed and suggests three specific options that meet these constraints. It argues that the unilateral trade liberalization measures required by the absence of a solution to the nuclear issue may be a blessing for North

Introduction 7 Korea because these measures will put its economy on the right economic track. Also the chapter examines the conditions for negotiating beneficial bilateral trade agreements that are made possible by an emerging solution to the nuclear issue and preparations for the World Trade Organization (WTO) accession, which will follow and/or “seal” a final solution to the nuclear issue. Finally, the chapter suggests strategies for closer relations between North and South Korea for the best of the whole peninsula and options for North Korea to participate in the ongoing free trade agreement (FTA) negotiations in East Asia. Chapter 7 suggests strategies for linking the agenda for regional monetary and financial integration to the foreign investment policy of North Korea. A key reason behind the failures of multilateral development projects lies in North Korea’s lack of funds for infrastructure construction and foreigners’ lack of interest in investing in North Korea. A precondition for attracting foreign investment is North Korea’s accession to the international financial institutions such as the International Monetary Fund (IMF), the World Bank, the Asian Development Bank (ADB), and the Asian Infrastructure Investment Bank (AIIB). These institutions have their own funds to support the development of lowincome countries and can also promote private-sector foreign investment. The chapter explains conditions for membership in each institution, evaluates the prospect of North Korea’s membership in those institutions, and discusses its implications. Also, it proposes some ideas for development financing in the East Asian region that North Korea can utilize for the building of its infrastructure projects. After pointing out disadvantages of existing strategies, we propose the establishment of the Northeast Asia Development Corporation. Finally, Chapter 8 concludes the book with a brief summary of main arguments. The chapter emphasizes a few strategies that South Korea and other neighboring countries should take to enhance the possibility of North Korea’s participation in regional economic integration when the proposals suggested in the book are carried forward. It also emphasizes that discussions based on concrete proposals, such as those advanced in this book, are needed not only in regard to the opening policy but also for other policies for economic success, including exchange rate policy, macroeconomic policies, labor market policies, structural policies, and social policies. All of these are needed to promote economic reforms in North Korea and to sustain its economic development.

Notes 1 This section is partly borrowed from Messerlin and Hong (2013, 2014) and modified to fit into the book format. 2 Lankov (2013), p. 117. 3 In a nutshell, the currency change consisted of dividing prices by 100 while keeping wages unchanged. This was a sure recipe for lightening hyper-inflation in a very poor country like North Korea. 4 Lankov (2013). 5 Frank (2008).

2

Theory of economic integration and transformation

When we consider the issue of North Korean economic development, mostly we focus on the questions of necessary transformation reforms and of their sequencing. Another important issue that inevitably arises when the North Korea problem is discussed is the relationship between economic transformation and economic integration. The aspect of integration into the regional economy has been researched to a lesser degree. There were a few situations when serious debate broke out regarding the relation and sequencing between transformation and integration: When the CEE countries wanted to join the EU in the beginning of 1990s; and when Germany attempted to unify two currencies into Deutsche mark (D-mark) after the collapse of East Germany in 1990.

1.

Experience of CEE countries

In the early 1990s, after the collapse of socialist countries in Europe, the main concern was the countries’ transformation from the central planning system to a market economy. Naturally, the debate about sequencing focused on the necessary speed of reforms, i.e. a big bang approach vs. a gradual approach. However, the debate on the juxtaposition between shock therapy and gradualism became meaningless and the requirements for integration with the EU increasingly gained importance. The focus of debate accordingly moved to the sequencing between transformation and integration when CEE countries tried to become members of the EU. The transformation process towards a market economy included three main areas of reform: Macroeconomic stabilization, reforms at the microeconomic level, and creation of an institutional framework.1 A main target of macroeconomic stabilization was price stability (to be achieved by reducing the inflation rate), but it also sought to enhance currency convertibility and reform the financial system by abandoning the soft budget system. Reforms at the microeconomic level basically aimed at introducing market competition through price liberalization, opening up to international trade, privatization of state-owned enterprises, and businesses’ free entry into and exit from the market. Creation of an institutional framework is to solidify a basic infrastructure for a market

Economic integration and transformation

9

economy by ensuring property rights, establishing an efficient government system, introducing a two-tier banking system, and reforming the tax system. These three transformation processes are interdependent and simultaneous progress in all three areas is required to achieve successful reforms. At the beginning, the debate on how to sequence these reforms was divided between two strategies of transformation – the big bang approach vs. the gradual approach. Proponents of the big bang approach argued that the reforms necessary for transformation to a market economy should be carried out all at once, immediately, while proponents of the gradual approach advocated a step-by-step process of transformation. An important argument in this debate was politicoeconomic and concerned the costs of transformation. However in CEE countries, neither approach worked as expected, because the action plans for the three areas of transformation – macroeconomic stabilization, microeconomic reform, and creation of an institutional framework – were not sufficient for reforms and the governments lacked the capacity to implement them. As interest shifted more and more from issues of transformation to those of integration to the EU, the relationship between integration and transformation became a focus of interest. To provide a framework for the economic and political integration of CEE countries to the EU, the Europe Agreements were initiated in the early 1990s. The Europe Agreements aimed for full EU membership of CEE countries in the long run. After Poland and Hungary signed the Agreements in December 1991, other CEE countries followed suit in subsequent years.2 Although the Europe Agreements aimed for the full membership of CEE countries, the huge economic gap between CEE countries and EU member states made immediate expansion of the EU to Central and Eastern Europe impossible. Table 2.1 shows the economic disparities between the EU and CEE countries around the end of 1990s. Per capita income of CEE countries ranged between 1,337 euro and 8,997 euro, and were mostly below 20.0 percent of EU average. Among ten CEE countries, Bulgaria and Romania were at the bottom with 7.0 percent and 8.0 percent of the EU average respectively. Slovenia had the highest per capita income among them with 44.0 percent of the EU average. The economic structure represented by the sectoral composition of the GDP also showed a big difference between the EU and CEE countries. On average, the agriculture sector accounted for only 2.3 percent of GDP in the EU. In three CEE countries, it was over 10.0 percent, and in Bulgaria the agriculture sector contributed 21.1 percent to its GDP. In contrast, the share of the service sector in most CEE countries was much lower than the EU’s 67.0 percent. Only the shares of service sector in Estonia (67.5 percent) and Latvia (65.8 percent) were close to the EU average. Macroeconomic stability (represented by the inflation rate and fiscal balance to GDP) was also worse in most CEE countries, compared to the EU. In the EU, the average inflation rate was 1.3 percent and the average fiscal deficit to GDP ratio was −1.5 percent. In most

10

Economic integration and transformation

Table 2.1 Economic disparities between the EU and CEE counties, 1998 Per capita income (%)

Economic structure (%)

Inflation rate (%)

Fiscal balance to GDP (%)

EU share of exports (%)

1st

2nd

3rd

7

21.1

28.7

50.2

22.3

−0.3

49.7

Czech

24

4.5

41.8

53.7

10.7

−2.2

64.1

Estonia

16

6.2

26.3

67.5

10.5

−2.6

55.1

Hungary

21

5.9

32.7

61.4

14.3

−5.4

72.9

Latvia

12

4.7

29.5

65.8

4.7

1.8

56.6

Lithuania

13

10.1

31.5

58.4

5.1

−0.7

38.0

Poland

18

4.8

36.5

58.7

11.8

−2.6

68.3

Romania

8

17.6

40.7

41.7

59.1

−3.5

64.5

Slovakia

17

4.6

33.3

65.1

6.7

−4.4

55.8

Slovenia

44

3.9

37.7

58.4

7.9

−1.5

69.4

EU15

–

2.3

30.7

67.0

1.3

−1.5

–

Bulgaria

Source: World Development Indicator; Eurostat Note: Percentage of per capita income is compared to EU average. 1st, 2nd, and 3rd denote for agriculture, manufacturing, and service sectors respectively.

CEE countries, the inflation rate was in the double digits, and the fiscal deficit to GDP ratio was worse than the EU average. Even though there was a wide gap between EU member states and CEE countries, CEE countries were closely linked to the EU economy. In their total exports, the EU’s share was very high, mostly over 50.0 percent. An exception was Lithuania, where only 38.0 percent of its exports went to the EU market. But in five out of ten countries, more than 60.0 percent of their exports headed to the EU. The large share of exports to the EU market further encouraged CEE countries to move toward integration with the EU. Since the gap between the EU and CEE countries was still too large at that time, the European Council set up the criteria for accession to the EU at its meeting in Copenhagen in June 1993. The accession criteria, or Copenhagen criteria (after the European Council in Copenhagen in 1993 which defined them), are the essential conditions all candidate countries must satisfy to become a member state. These are as follows. • • •

Political criteria: Stability of institutions guaranteeing democracy, the rule of law, human rights, and respect for and protection of minorities. Economic criteria: A functioning market economy and the capacity to cope with competition and market forces. Administrative and institutional capacity to effectively implement the acquis3 and ability to take on the obligations of membership.4

Economic integration and transformation

11

These accession criteria are the basic requirements for membership negotiations, and mean that only countries satisfied in their reform requirements can join the EU. It may therefore appear that transformation preceded integration in CEE countries. However, the two processes overlapped. The first Copenhagen criteria emphasize the building of institutional capacity, which is the first area of transformation reforms. The second economic criteria for accession to the EU include accomplishing necessary reforms at microeconomic level, which is also a main component of the transformation process. The third Copenhagen criteria cover institutional capacity and macroeconomic stability, which are also targeted by transformation reform processes. Thus, there is considerable overlap between the requirements for transformation of CEE countries and those for the integration to the EU.5 The order in which integration and transformation are accomplished is not predetermined. The Copenhagen criteria emphasize that full membership in an integration area is a result of successful transformation. However, it is not necessary: A CEE country could be allowed early integration with the EU in order to enhance its transformation process. Integration can be seen as a catalyst for economic transformation that could create competition in CEE countries. In

Table 2.2 Transformation vs. integration for CEE countries Transformation

Integration

Macroeconomic stabilization

Price stability Currency convertibility Fiscal system reform: Abandonment of soft budget system.

Political criteria

Stability of institutions guaranteeing democracy The rule of law Human rights Respect for and protection of minorities

Reforms at microeconomic level

Price liberalization Economic opening up Privatization of stateowned enterprises Businesses’ free entry into and exit from the market

Economic criteria

Market economy Capacity to cope with competition and market forces

Creation of institutional framework

Property rights Efficient government system Two-tier banking system Tax system form

Institutional capacity

Implementation of acquis Obligations of membership

Source: Siebert (1999); Piazolo (2000); Authors’ summary

12

Economic integration and transformation

fact, the anticipation of EU membership has helped CEE countries to progress with their reforms. Thus the integration and transformation processes are reinforcing each other.

2.

Experience of German unification

After the collapse of the Berlin Wall on 9 November 1989, West Germany and East Germany were faced with huge problems. The influx of immigrants from East Germany continued, which caused a lack of human capital and reduction of productivity in East Germany and also led to huge fiscal and social burdens in West Germany. Initially, there were strong demands for immediate responses to cope with uncertainty and to promote reforms in East Germany. As the economic and monetary integration of the two countries became a realistic option, hot debates emerged about the optimal strategies for integration. In particular, monetary integration attracted much attention because it symbolically meant the completion of German unification. The first specific suggestion regarding monetary integration between East and West Germany was proposed by Mr. Wolfram Engels, a member of the European Council. He suggested the political unification and introduction of the D-mark as a way to improve the economic situation in East Germany. Beginning in 1990, political pressure for monetary integration increasingly intensified. One of main driving forces for this was the demands by East German people for freedom and equal chances in life.6 Their strident demands were encapsulated in the slogan, “If D-mark does not come to us, we will go to the D-mark”. The social democratic SPD (Sozialdemokratische Partei Deutschlands) politician Ms. Ingrid Matthäus-Meyer considered monetary integration to be an option and proposed this policy on 17 January 1990 as a means to slow the exodus of East German residents to West Germany.7 After that, various proposals were put forward on the formation of a monetary union, the sequencing of reforms in East Germany, and economic integration of the two countries. Broadly speaking, two options8 for monetary integration were suggested – the gradual approach and the instant approach – and there were serious debates on the pros and cons of those options.9 Proponents of a gradual approach argued that reforms necessary to transform the East German economy to a market economy must be promoted first, and that monetary integration of the two countries should be introduced after these reforms.10 This model may have several advantages. Since the East German mark was still in use, the exchange rate could be used as a policy to absorb initial shocks and maintain the competitiveness of East German firms for a time. Another advantage is that during the transition period before integration, more information on the East German economy could be collected, which would enable better policy decisions. Also, throughout the period of adjustment for East Germany, a gradual approach

Economic integration and transformation

13

Table 2.3 Discussions on the German monetary union Date

Important proposals

1 December 1989

Mr. Wolfram Engels (of the Economic Council) suggested the political unification and introduction of the D-mark as a way to improve the economic situation in East Germany.

19 January 1990

Ms. Ingrid Matthäus-Meier proposed an immediate monetary union to cope with East German immigration to West Germany.

19 January 1990

The finance minister of West Germany, Mr. Theodor Waigel, warned that an artificial unification with the East German mark would be risky.

24 January 1990

The Modrow government of East Germany proposed that the East German mark be exchanged with the D-mark until 1992.

24 January 1990

The Bundesbank president, Mr. Hans Dietmeyer, demanded reforms in East Germany as requirements for monetary integration.

26 January 1990

The West German Ministry of Finance proposed a slow, step-by-step integration process.

6 February 1990

The economics minister, Mr. Helmut Hausmann, proposed a three-stage approach incorporating a phase of fixed but adjustable parities for the ostmark.

6 February 1990

Chancellor Helmut Kohl offered immediate negotiations on a German economic and monetary union.

9 February 1990

The Council of Five Economic Experts sent a public letter to Chancellor Kohl and warned that instant monetary unification would have negative effects.

18 May 1990

East and West Germany signed a treaty agreeing on a monetary, economic, and social union.

1 July 1990

The Treaty and German monetary union came into force.

Source: Authors’ own

would help to mitigate much of the cost of transformation and make reforms more palatable. Advisors for gradualism warned that if East and West Germany were integrated without some adjustment period, it would cause many serious problems.11 First, if the D-mark were immediately introduced to East Germany, the wide wage gap between West and East German laborers would become apparent. This would cause East German labor to attempt to reduce the gap by increasing their wages over their productivity, and could lead to the collapse of East German industry and to huge influx of migration into west Germany.

14

Economic integration and transformation

Second, an early integration may damage not only East Germany but also West Germany. The introduction of common currency to East Germany would immediately reveal the income gap between East and West German residents, and East residents would put pressure on the West German government to fill the gap by means of fiscal transfers. This additional fiscal burden would need to be financed by tax increases on West German residents, which would dampen economic activity in West Germany. Moreover, fiscal transfers to East German residents to reduce the income gap would be mostly spent on consumption rather than on constructing infrastructure. Thus huge amount of fiscal support would not help to improve the productivity and competiveness of East German industries. Third, since there was almost no information on the value of the East German mark, an early integration of the two currencies would be likely to cause severe price distortions associated with monetary overhang and price controls. In East Germany, there was no properly functioning market, prices were controlled, and financial flow was not free, therefore the optimal value of the East German mark was very hazy. One of the most important problems at the beginning stage of early integration was to set up the conversion rate between the two German marks. Without much information on the precise value of the East German mark, the conversion rate would be estimated under great uncertainty. A more serious problem was that political factors would likely play a major role in determining the conversion rate. If this were to be the case, residents in East Germany would demand that the value of the East German mark be inflated to reduce wage and income gaps, which would further devastate East German industries. Fourth, an early integration may be irreversible, which would be problematic. Once the two currencies were unified, it would be impossible to reintroduce the East German mark even if overwhelming problems resulted. If the shock of an early union would destabilize the East German economy and hinder economic reforms as well, monetary policy may not be a viable option. In contrast, if the two currencies are circulated together during the transition period, thus delaying their integration, then the governments could try various economic policies and exchange rate systems between the two currencies. A floating exchange system or a fixed but adjustable system are both possible options, and a system leading to a more favorable economic condition could be chosen during the transition period. On the other hand, proponents of immediate integration argued that an early currency union would remove uncertainties about the unification and provide an important symbol of one Germany. It could also lead to rapid macroeconomic stability in East Germany and attract foreign investments. In addition, an early currency union would reduce transaction costs and encourage interregional transactions, speeding up economic reforms in East Germany and guaranteeing the inevitability of unification. They warned that delaying the currency integration would not reduce those problems emphasized by gradualism and that the unavoidable costs of

Economic integration and transformation

15

transformation would increase opposition to reforms. First, one of key arguments for gradualism was that the convertibility of the East German mark should be guaranteed in order to smooth the transition. When movement of goods, capital, and people is free between the two countries, an essential condition for convertibility is stabilization of the East German mark the against D-mark and other foreign currencies. Given that the East German economy had collapsed, no one wanted to hold the East German mark; its plunge in value would lead to further worsening of macroeconomic stability in East Germany. As East Germany becomes more unstable, investors increasingly avoid the country – and the time to economic recovery is further extended. Second, gradualism emphasized that fulfillment of structural reforms before integration would reduce the cost of unification. However, the political and social hardships were actually disrupting economic reform, which was the precondition for monetary integration. If economic reforms were dragged down by worsening disturbance, the economic dependence of East Germany on West Germany would increase, worsening the West’s fiscal burden. Historical experience clearly shows that many planned economies have tried to overhaul their economic structures by introducing a market economy but almost none was successful. It was hard to believe that East Germany would be exceptional enough to overrule past experience. Third, if two currencies were to be circulated under such an unstable situation, this would naturally lead to an overvaluation of D-mark against East German mark. Since everyone wanted to abandon the East German mark, and it was losing its value, speculative attack on East German mark was quite likely to be prevalent and the mark would be crowded out of the market. As the value of East German mark continued to fall against that of D-mark, income and wage gaps between East and West Germany would widen. This would further encourage the migration of East German labor to the West and cause further hollowing out of labor and industry in East Germany. The delay of monetary integration was more likely to render the East German economy torpid rather than to improve its productivity and competitiveness. Fourth, unless a common currency was introduced and two monetary systems were unified while two Germanys were to be unified in a near future, the symbolic implication of unification would be seriously damaged. This would increase uncertainty about the unification, and East German residents’ anxiety regarding the future would increase. When they firmly believed the unification as a break-through in the history and expected a break from the past, the delay of monetary integration would disappoint East German residents. Consequently, political pressure such that “If D-mark does not come to us, we will go to the D-mark” would be more accumulated, which could further destabilize East Germany. The pros and cons of the two strategies are summarized in Table 2.4.

16

Economic integration and transformation

Table 2.4 Early vs. late currency union Early currency union

Late currency union

Pros

Speeding up economic reform Confidence of unification Quick stability of East German currency Reducing transaction cost Attracting foreign capital

Absorbing initial shock Collecting information and making better decision Adjustment time for East German economy

Cons

Loss of buffer policy instrument Irreversibility of commitment Inappropriate rate due to lack of information Instant huge budget burden

Lagging economic reform Uncertainty of unification Drain of East German quality labor to West Germany Speculation on East German currency Lingering support and budget burden

Source: Modification of Table 10.7 in Rhee (2009)

3.

Sequencing of economic integration and transformation

Considering various theoretical explanations and different experiences of the countries involved, the debate could go on forever. Of course, the details of reform measures and sequencing depend on the state of the economy, the political and social situation, and also the people’s attitude towards the unification process. According to Lim and Rhee (2013), policy changes and thus reforms will occur when there is a break in the political-economy equilibrium.12 Then, what are the forces that cause this disruption and change the existing political-economy arrangement? Those forces fall into two categories: Mega trends that gradually but profoundly change the landscape of the political arena, and various shocks that occur relatively abruptly. Notable examples of mega trends include globalization, technological progress, and democratization. Globalization alters the existing equilibrium by adding new players – foreigners – and changing old players’ incentives. As the world becomes more globalized and integrated, domestic residents have more opportunities to contact foreigners and gather more information on other countries. Also, as globalization intensifies competition among countries, socialist countries with inferior competitiveness feel under threat of losing competition. Thus pressure for change by the people will be intensified to utilize new opportunities and to overcome the threat. New products and new systems from technological innovation bring forth new lifestyles, and people will naturally demand new policies and reforms appropriate to the new technologies. Also, although most people benefit from technological developments, that does not mean that the benefits are distributed

Economic integration and transformation

17

evenly. Those at a comparative disadvantage have an incentive to push for new policies to protect them against the inequalities of the technological change. Democratization also affects existing arrangements. As in most socialist countries, the leader and allied politicians of an authoritarian regime tend to form an exclusive coalition with a small number of groups and ignore other societal groups. But as a country democratizes, pressures from various groups increase and it is difficult for the regime to ignore such pressures – especially when they are strong.13 Democratization reduces the power of the privileged few who benefited from the previous policies, and induces economic reforms to reflect a power shift, breaking the status quo. In addition to mega trends, abrupt shocks can shift the balance of power in a country and lead to policy changes and reforms. Abrupt shocks include the collapse of a regime, an economic crisis, a coup d’état, etc. These shocks can undermine the existing system and open possibilities for policy reforms. For example, a regime collapse or an economic crisis can create a consensus that the old system has failed and needs to be replaced with a new one. Thus, the existing balance of power will be eradicated, and those who were previously excluded will seek policies that allow them new opportunities. Since a regime collapse or an economic crisis disorganizes societal groups who benefited from the old arrangement and opposed reforms, the government feels pressure to change existing policies that are believed to have failed and caused the crisis. It is clear that the characteristics of reforms differ considerably from one country to another. Such differences may be caused by the differences between the driving forces across countries. When former socialist countries were stricken by the same shock of regime collapse, however, their responses were somewhat different from each other. This suggests that policy changes and reforms are conditioned by institutional structures and initial conditions of a country. Fisher and Gelb (1991) establishes that the sequencing and measures of reforms in CEE countries crucially depend on the following three conditions. • • •

The extent of their macroeconomic imbalances, both internal and external. The degree of the decentralization of their economic management and extent of the product markets prevailing before reform of the system begins. The extent of private sector activity prior to the reform.14

To derive theoretical implications for the relation between transformation and integration, we need to much extend Fisher and Gelb (1991), because they treated trade reform issues as an element of price reform. Considering the experiences of CEE countries, German monetary unification, and other developing countries15 that have agonized over the sequencing of reforms and integration, we add two more conditions that affect reform measures and the sequencing of transformation and integration.16 • •

The size of a country’s economy; and The industrial structure of a country.

18

Economic integration and transformation

Let’s elaborate the above five conditions. First, the extent of macroeconomic imbalances prevailing before transition has an important bearing on the speed and sequencing of the reform process. Internal imbalances, such as high inflation and monetary overhang, and external imbalances, such as a large deficit and huge foreign debt, are mainly caused by lack of market functioning. If high inflation is severe, stabilization measures are urgently needed. Also, to quickly resolve the internal gap between demand and supply, it would be more effective to import goods than to increase production capacity (which may take very long). Regarding external imbalances, opening up of international trade may worsen current deficits; nonetheless, opening up to foreign trade and investment is desirable because it puts the right price signals in place and allows countries to benefit from larger markets and advanced foreign technologies.17 The success of economic reforms in transition countries depends heavily on the extent to which they open their economies to foreign trade and investment. Second, according to historical institutionalism, an institution offers a particular set of opportunities and actors are expected to gravitate towards certain behaviors that take advantage of these opportunities.18 A country’s institutional legacy – such as the extent of centralization, the characteristics of system, the pattern of development, and its historical background – affect the reform process. If a country is very much centralized, the incentive of economic actors is divorced from market economies and relative prices do not well reflect market conditions. Even though the country needs to implement institutional reforms to transition to a market economy, the past will constrain the future. The more centralized a country, the more necessary it is to promote drastic reforms – and the harder this is to accomplish. Thus it would be desirable to utilize external influence by opening up to overcome the legacy of status quo in a centralized country. Third, the availability of resources also affects the speed and sequencing of the reform process. In many cases, resource-rich countries have ended up poorer than resource-poor countries. Not only have the former shown lower growth rates but also they have shown greater inequality. Since resource-rich countries can easily make money by extracting abundant resources and exporting them to foreign countries, they often tend to not pursue economic reforms and sustainable growth strategies. This is called a “resource curse” and is often observed in less-developed countries with relatively concentrated and undiversified industrial sectors.19 Regarding the sequencing of reforms and integration, a resource-rich country tends to neglect reforms but want a link to the world market to export its abundant resources. Fourth, a country’s economic size also matters for the sequencing of reforms and integration. If a country is large enough, then it can be self-contained and considered as an independent market. Such a country can enjoy many benefits: There are economies of scale in the production of public goods; a larger country is less subject to foreign aggression; a large country can better internalize crossregional externalities by centralizing the provision of public goods; and a large country is better able to provide insurance to regions affected by imperfectly

Economic integration and transformation

19

correlated shocks. Thus a large country tends to have less incentive to seek a foreign market to sell its products, compared to a small country. Fifth, a country’s industrial structure also affects the sequencing of reforms and integration with a world market. When a socialist country that is skewed toward heavy industry begins to transition to a market economy, enormous collapse of heavy industries and increases in unemployment can follow. Unlike China, CEE countries were plagued by an inheritance of overindustrialization under socialism, and had therefore been subject to a sharp downturn in industrial production upon the outset of market reforms.20 If they try to resolve the problem through internal reforms, the shock would be too large to be contained. Thus it would be better to defuse the shock by expanding production capacity and creating job opportunities through foreign investment. Opening up will be helpful for speedy rationalization of industrial structures of those countries. Considering these factors and the conditions of the North Korean economy, we suggest that economic opening and integration should have a high priority in North Korea, anteceding or at least being parallel to economic reforms and transformation, both on theoretical and empirical grounds. As in other socialist countries, one of most serious problems in North Korea will be repressed excess demand and lack of sufficient supply of goods. To avoid economic instability due to this internal imbalance, North Korea needs to import goods by opening trade with foreign countries, even though this may aggravate external imbalance. North Korea is probably the most centralized of the socialist countries and the role of the private sector is severely limited. Thus it will be very difficult to empower the private sector and to expect it to play a role in leading economic reforms. Also, North Korea is relatively small compared to many developing countries, and it needs a larger foreign market to promote a sustainable economic development. Regarding industrial structure, North Korea is over-industrialized, like CEE countries, and hence it is inevitable that there will be a sharp downturn in industrial production at the outset of market reforms. Thus North Korea needs to expand production capacity and create job opportunities by opening up investment to foreigners to absorb shocks following economic reforms. Various experiences of developing countries and CEE countries also suggest that they have a high priority of economic opening and integration over economic reforms and transformation. At the beginning stage of economic development, developing countries have seriously considered two contrasting strategies: Import substituting vs. export oriented. There are many cases for or against those two strategies, and it would be a never-ending debate to determine which is better for economic development. However, historical experiences in developing countries clearly show that the export-oriented strategy has achieved much better performance than the import-substituting one. In a recent meeting,21 African researchers pointed to regional integration as a key driver of economic growth, saying that improved governance and structural transformation in Africa will naturally depend on the advancement of regional integration initiatives. The experience of CEE countries also suggests that integration was very helpful to promote economic reforms. When CEE countries began the

20

Economic integration and transformation

transition, the anticipation of EU membership was a big incentive for them to progress with the reforms. The prospect of uncertain EU accession may jeopardize the zeal for reform in the CEE countries. Thus, to encourage the reform process within CEE countries, it was very important to give them assurance of certain and early membership of the EU.

Notes 1 Piazolo (2000), p. 2. 2 Piazolo (2000), p. 10. 3 “The acquis communautaire, shortened to arcquis, is the body of common rights and obligations that is binding on all the EU member states. It is constantly evolving and comprises: the content, principles and political objectives of the Treaties; legislation adopted pursuant to the Treaties and the case law of the Court of Justice; declarations and resolutions adopted by the Union; instruments under the Common Foreign and Security Policy; international agreements concluded by the Union and those entered into by the member states among themselves within the sphere of the Union’s activities. Candidate countries have to accept the acquis before they can join the EU and make EU law part of their own national legislation. Adoption and implementation of the acquis are the basis of the accession negotiations.” Quoted from European Commission home page. https://ec.europa.eu/neighbourhood-enlargement/policy/glossary/ terms/acquis_en (Accessed February 08, 2018). 4 European Commission home page. https://ec.europa.eu/neighbourhoodenlargement/policy/glossary/terms/accession-criteria_en 5 Piazolo (2000), p. 6. 6 Lehment (1992), p. 89. 7 Fratzscher (2015), p. 368. 8 Lehment (1992) divided various proposals into four groups: a three-stage approach including a phase of fixed exchange rate system; a three-stage approach including a phase of floating exchange rate system; a parallel-currency approach; and a big-leap approach. The first three approaches can be characterized as a gradual approach. 9 Chun and Rhee (2002) use the terms “late currency union” and “early currency union” instead of gradual approach and instant approach, and suggest an early currency union in the case of Korean unification. Kwon (1997) discusses the pros and cons of the two alternatives and offers lessons from other countries in favor of a late currency union. 10 For example, Hausmann (quoted in Die Welt, 1990) proposed a three-stage integration with a fixed but adjustable exchange rate system between two German marks. Quoted from Lehment (1992), p. 90. 11 For example, refer to the public letter sent by the Council of Five Economic Experts to Chancellor Kohl on 9 February 1990. 12 This page is based on Lim and Rhee (2013), pp. 307–310. 13 Bunce (2001). 14 Fisher and Gelb (1991), pp. 68–71. 15 The experience of developing countries is not specifically introduced here. But as Fisher and Gelb (1991) stressed, most reforms required for CEE countries were also faced before in China as well as in Latin American and African countries. Fisher and Gelb (1991), p. 67. 16 The extent of private sector activity prior to reform is somewhat overlapped with the degree of the decentralization of their economic management and extent of the product markets, and is excluded.

Economic integration and transformation 17 18 19 20

21

Fisher and Gelb (1991), p. 78. Hall and Soskice (2001) andThelen and Steinmo (1992). Kim and Rhee (2013), Chapter 23. Woo (1999) argues that in this type of economy where the state sector is dominant, there is little reserve of labor outside the state sector that can provide the engine of growth for a new non-state sector, and gradualism cannot work in that context (Woo, 1999, pp. 5–6). 21 The 12th African Economic Conference, 5 December 2017, Session titled “Deepening Regional Integration towards Effective Governance and Structural Transformation”. www.afdb.org/en/news-and-events/researchers-point-toregional-integration-as-key-driver-of-economic-growth-17671/

3

North Korea’s motives and strategies for external economic relations

North Korea is probably the country that we have the least information on, and it is largely unable to understand North Korea’s reality and intention for external relations. Characterizations of the North Korean regime are diverse, ranging from a “nutcase” to a “shrewd schemer”. To suggest a good idea to induce North Korea to join the international community and participate in regional economic integration, it is essential to understand how North Koreans think of external economic exchange with foreign countries.

1. Perceptions of North Korea Information on North Korea is very limited and not very reliable. However, many stories are floating around because North Korean news is very popular worldwide. Most stories are negative, focusing on the nuclear issue and the country’s autocratic system and economic problems. Stories found not only in media coverage but also in analytic reports by experts on North Korea show similar negative perceptions. Virtually all stories on North Korea have focused on the nuclear development issue. In most countries, public opinion on North Korea is not favorable. According to a recent survey by Fox News,1 93 percent of Americans considered North Korea to be an enemy, while only 34 percent of them called China an enemy. Also, North Korea is ranked at the top of the greatest threats to the US, ranking even higher than ISIS among the American people. Gallup recently released a similar survey result: When respondents were asked “What one country anywhere in the world do you consider to be the United States’ greatest enemy today?” 51 percent of Americans named North Korea, while Russia, China, and Iran were named only 19 percent, 11 percent, and 5 percent respectively. “North Korea dwarfs all other countries” in negative perception.2 Many people think that the only interest of North Korea is to maintain the Kim dynasty, and that it firmly believes possession of nuclear power is the best strategy for survival. A serious problem is that the North Korean regime is irrational and insane, and nuclear weapons in North Korean hands will be a big threat to the stability of not only the Korean Peninsula but also the world – including the US. To develop nuclear weapons and maintain the regime, the

Strategies for external economic relations

23

story goes on, North Korea mobilizes all of its resources by repressing its citizens, leaving them near starvation. North Korea has had problems with chronic food shortages since the 1990s, and this has left an entire generation of North Koreans with stunted growth and a greater susceptibility to health problems. This line of story is particularly emphasized by nongovernmental organizations (NGOs), which are working to improve human rights in North Korea. According to Human Rights Watch,3 North Korea is one of the most repressive countries in the world, with all basic freedoms severely restricted by the totalitarian state: There is no freedom of movement, no freedom of speech, no freedom of information, and no freedom of religion. North Korean residents cannot leave the country without the government’s permission. They even need permission to travel within the country. There is no free media in North Korea. If you criticize the regime, not only you but also your entire family will be sent to a prison camp. In North Korea, the regime is the only source of information; it blocks all other information sources. It is forbidden to own a radio, and there is no access to the internet. There is also no religious freedom – and if you worship a god, you will be sent to a prison camp. In addition, the North Korean people are abused and persecuted. The UN Commission of Inquiry4 finds that abuses and oppression in North Korea are without parallel in the contemporary world. The regime uses various means of abuse, including murder, enslavement, torture, imprisonment, rape and other sexual violence, and forced abortions. North Korea operates secret political prison camps, some of which have existed five times as long as the Nazi concentration camps and twice as long as the Soviet gulags. Torture, brutal beatings, forced labor, and death are commonplace in those camps. In addition to prison camps, collective punishment and public execution are also used to threaten and silence dissents. In North Korea, if someone is punished for crimes against the regime, then three generations of the person’s family can be punished together. Moreover, when someone is executed for a variety of crimes, whole communities are brought out to watch. Similar perceptions on North Korea are also observed in South Korea. In South Korea, the perception of North Korea has worsened since the mid-2000s. According to PeaceNetwork,5 a peace movement organization in South Korea, in 2007 79.9 percent of South Korean people had positive impressions of North Korea and 17.4 percent had negative impressions. This perception changed dramatically in 2015: Favorable impressions sharply declined to 51.0 percent, a drop of 29.9 percentage points, while the unfavorable impressions rose to 40.2 percent, an increase of 24.8 percentage points.6 Very recently the perception seems to have reversed, and South Korean people view North Korea more unfavorably than favorably. The results of a survey on South Koreans’ perception of North Korea, recently released by the National Unification Advisory Council,7 shows that 52.4 percent of participants had an unfavorable impression of North Korea, while only 39.5 percent viewed it favorably (Figure 3.1). There are many reasons behind this worsening of South Koreans’ perceptions of North Korea: Several nuclear tests, frequent missile launches, a torpedo attack on the Cheonan (a South Korean

24

Strategies for external economic relations (unit: %)

90 80 70 60 50 40 30 20 10 0 2007

2008

2009

2010

2011

positive

2012

2013

2014

2015

negative

Figure 3.1 South Koreans’ perception of North Korea Source: http://peacekorea.org/zbxe/1819488 Note: The author modified this figure.

warship), bombardment of Yeonpyeong Island, violation of the denuclearization process, purge of opposition groups, strengthening of repressive politics, etc. This worsening trend of perception has led many to conclude that North Korea is irrational and untrustworthy, and that North Korea’s possession of nuclear weapons will be fatal to South Korea. If South Korea and other countries provide billions of dollars in aid to such a horrible rogue country, it would not be spent to feed North Korea’s people and develop its industry. Rather it would be all diverted to the development of nuclear weapons and to increase military expenditures, which would further increase the threat to South Korea. Thus those with negative perceptions of North Korea strongly oppose unilateral and unconditional assistance. Some even say that the North Korean regime is not a country but a rogue and insane group.8 In contrast to this conventional wisdom on North Korea, which spans political parties and dominates much of the public opinion, there are other observers who consider North Korea not crazy but all too rational. They emphasize that North Korea has survived and persisted through the fall of the Soviet Union, socialist countries in Eastern Europe, and many authoritarian regimes. In the realm of international affairs, surrounded by prosperous South Korea and the world’s most powerful countries – including the US and China – the best insurance and survival strategy is having a nuclear capacity. Thus “the right way to look at North Korea is as a smart, rational, calculating government that is functioning shrewdly given its priority of regime survival”.9

Strategies for external economic relations

25

Some even say that it is wrong to view that North Korean government officials are nutcases and that the people are robots, sporting lapel-pin pictures of their Dear Leader and regularly attending mass rallies. They are rather “a diverse group, from hidebound apparatchiks to bureaucrats who teach themselves English by listening to foreign radio broadcasts”.10 Regarding foreign affairs, many North Korean officials take a realist and non-ideological view. They have deep knowledge of the outside world and well understand what their national interests are, and try hard to protect them. Unlike the general public’s view, most experts – who have watched North Korea for years, and even lived in the country – believe that North Korea is not crazy but rational. While there never cease to be those in the media who are eager to proclaim that North Korea’s leaders are crazy, all serious observers of the Pyongyang regime tend to insist that, quite to the contrary, they can detect a perverse logic and clear pattern of behavior from North Korea.11 If a state follows its perceived self-interest, it is called rational; if it does not follow its self-interest, it is believed to be irrational. When a state is irrational, its leaders are not able to figure out the state’s own interests, and make the state behave so much unfocused that it cannot pursue its interests with consistency. If we carefully observe North Korea’s actions, it seems to base its behavior on well-calculated self-interest in order to perpetuate the regime. “Rational actors have clear goals and know how they want to get there based on reality”, and “[The North Korean leader] hasn’t demonstrated anything that would make one reconsider his rationality”.12 Scholars ascribe North Korea’s seemingly deranged behavior to the “madman theory”: North Korea intentionally employs a posture of irrationality and belligerence as a means of trying to intimidate its adversaries. Some even concludes that “the regime, for all the crudity of its politics, remains a master of the diplomatic stroke”.13 While pundits share the view that North Korea is not crazy but rational, they also show a wide spectrum of perceptions on strategic intentions that North Korea is pursuing. Scobell (2005) surveyed the views of leading analysts of North Korea regarding Pyongyang’s strategic intentions and categorized them from hard to middle to soft line. Hardliners view the strategic intentions of North Korea as extremely aggressive and believe that North Korea is pursuing the unification of the Korean Peninsula on its own terms. Thus North Korea wants to possess conventional and unconventional capabilities to conquer South Korea, and it will never give up nuclear weapons. They argue that the North Korean regime will try to sustain itself by extorting aid through unremitting threats of war. The middle-line view is that North Korea wants to build a strong, independent, and autonomous state, comparable to South Korea. To accomplish this, it will undertake drastic economic reforms and become an integral part of the

26

Strategies for external economic relations

world economic system. It will cautiously begin reducing its military capabilities and nuclear weapons, but it will not give up the whole nuclear program. Softliners are the most benign and view that North Korea’s paramount goal is to ensure the protection of its current regime. Even though the regime is still reluctant to give up its nuclear program, it is willing to negotiate if it is assured that the US and South Korea do not threaten it. There are many reasons why not only the general public but also experts have different views on North Korea and its intentions. First, and most important, is that information is very limited – and even that limited information is not reliable. A few sources of information include the official media, foreign tourists, diplomats, and journalists in North Korea, and North Korean defectors. It is very hard to expect that the official media and foreign visitors would provide reliable information on North Korea: They are all tightly controlled in North Korea, and only a bit of information allowed by the North Korean government is spread to the residents and the outside world. Foreign visitors are always accompanied by surveillants, their contacting of local people is supervised, photography is heavily restricted, and the media coverage is tightly regulated. Thus, reporting on North Korea is analogous to the parable of the blind men and an elephant; the range of perceptions on its intention is so wide and various. The second and the third reasons are related to the bias problem. Second, the limited information that we have may be biased and our own biases may affect the information that we select. In fact, there are only a few foreigners who have visited North Korea and have had even limited access. As a result, most stories of North Korea may rely on speculation and scanty information gleaned from defectors. A problem here is that even though they are a key source of first-hand information on North Korea, there is growing skepticism about the accuracy of their accounts.14 The very fact that they are defectors from North Korea may indicate a sample bias problem. Moreover, they have only limited experience and their stories are often inconsistent with each other. Many different stories and false analyses based on their stories are floating around without reliable fact-checking. Third, another problem of bias is that even with the same information, our interpretations are often different due to our political bias: Some even say that incorrect information is sometimes intentionally released for political reasons. For example, when North Korea struggles with severe starvation, some may reproach North Korean leaders and warn that North Korea will increase the threat to receive more aid from South Korea and other foreign countries. In contrast, others may argue that this is a good chance to improve the relation between South Korea and North Korea, because North Korea needs South Korea’s help to address the ongoing crisis. Even with the same information, different groups show different analyses and a variety of possible prospects. Since stories of North Korea with very limited information have a tendency to go viral, if false and incorrect information with political bias is spread, it will cause further confusion and can escalate into chaos.

Strategies for external economic relations

2.

27

North Korea’s motives for external economic relations

We just saw that it is very hard to understand what North Korea wants to do, and that perceptions of North Korea are very diverse. Experts share the view that North Korea is not crazy, but they differ in their analysis of the country’s strategic intentions. Even though we narrow down our focus to the issue of economic exchange and cooperation between North Korea and foreign countries, the earlier observation will be the case again: It is very hard to figure out North Korea’s motives and strategies for economic exchange and cooperation. A hardliner shows a very hawkish view, saying that North Korea’s external economic exchange is “the key source of money to develop the worst deadly weapon in the history”.15 In contrast, a moderate liner believes that external economic exchange is needed to sustain the North Korean economy. To purchase oil and key products for both production and consumption sectors, North Korea should export raw materials such as coal to earn hard foreign currency. Some even say that North Korea desperately needs external economic transactions to import key parts and components that are needed to transform and upgrade its economic structure and to improve its productivity. To better understand the motives of North Korea’s external economic relations, we should recognize that the motive behind the economic activity of North Korean people is different from that of capitalist countries. What is common sense to those in capitalist countries may not be the case to people who have grown up under classical socialist governments. In capitalist countries, the private sectors are the main actors, and if economic activity is not profitable and sustainable, it eventually evaporates. In North Korea, the economic motive also exists both at the individual and the collective levels. Unlike capitalist countries, however, the economic motive is clearly subordinated to the political one, and even if economic activity is not profitable, it is nonetheless maintained. The same story applies to the motive of external economic relations in North Korea. The firms that are involved in international transactions are owned by the state. They are not run by the motive of individual companies, but directed by the state. Thus their external economic transactions reflect the political motives of the state rather than those of individual companies. This is quite different from the basic motives of international transactions in capitalist countries. In capitalist countries there are three fundamental motives of international transactions: Comparative advantage, economies of scale, and international borrowing and lending.16 First, international trade benefits countries by allowing them to export goods in which they have comparative advantage and import goods in which foreign countries have comparative advantage. If a country has a lower opportunity cost of producing a good than other countries, the country is called to have a comparative advantage in producing the good. Differences across countries in labor, physical capital, natural resources, productivity, and technology cause comparative advantages among the countries. Thus,

28

Strategies for external economic relations

as long as countries are different from one another, they have comparative advantages in different sectors and have motives to trade with each other to enjoy the benefit gained from international trade. Second, international trade benefits countries due to the effect of economies of scale. If output increases at a higher rate when we add inputs for production at a certain rate, this is referred to as economies of scale or the increasing returns to scale. If a firm or an industry has economies of scale, a larger scale leads to more efficient production because the cost per unit declines as we increase production. Without international trade, a country should produce a number of goods needed for its consumption using the given amount of available resources. This limits the amount of production for each good, and the country may not enjoy the effect of economies of scale. International trade permits the country to produce a smaller number of goods without sacrificing variety in consumption. The amount of production for each good is increased, which leads to the effect of economies of scale. Thus, with international trade, the country can take advantage of economies of scale, while it cannot if it produces everything for itself without international trade. Third, countries can also benefit from transactions of financial resources. Financial transactions help savers transport current surplus income into the future and borrowers access future earnings now so that both savers and borrowers can be better off. They can also act as efficient allocators of credit resources, channeling investment funds to uses yielding the highest rate of return. This will enhance efficiency and accelerate growth of an economy. Another benefit is that financial transactions can provide a safety net, because financial markets provide vehicles for trading, pooling, and diversifying risks. Thus through financial transactions, the sharpest ups and downs of our lives can be smoothed away, making an uncertain world more predictable. International financial transactions further expand the opportunity sets, which can bring further benefits. North Korea is not actively promoting external economic exchanges to enjoy the aforementioned benefits, because it has a different perception of international transactions. North Korea clearly recognizes that “they are needed, but not liked and actually feared”.17 There are many reasons behind North Korea’s perception of external economic exchanges. Socialist countries have a strong ideology that perceives the world as divided into antagonistic classes – the labor and the bourgeoisie – and that capitalists exploit the labor class.18 According to this ideology, conducting economic exchanges with capitalist countries is equivalent to exploiting the labor class and should be avoided. A fear of ideological contamination adds to these reasons for North Korea’s volatile and unexpected behavior: The most serious lesson of the collapse of socialism in several countries is that the corruption of socialism begins with ideological corruption, and that a breakdown on the ideological front results in the crumbling of all

Strategies for external economic relations

29

socialism’s fronts and ends in the total ruin of socialism. . . . Giving priority to ideological work is essential for accomplishing socialism.19 When North Korea explained the demise of CEE countries, they emphasized three major reasons.20 The first and most important reason was the lack of spiritual preparedness to resist material temptations associated with decadent capitalist culture. The lack of military capacity to defend themselves and the failure of leadership succession were the other two reasons. In addition to this consideration of socialist countries, in North Korea the idea of nationalism is also an important reason behind its perception of international economic transactions. In order to understand the creation of nationalist ideology, we need to look at the history of North Korea. Kim Il-sung, the founder of North Korea, is revered by North Korean people as a nationalist hero who led the campaign against Japanese imperialism. This still resonates in its political propaganda that exhorts the North Korean people to stand resolute against US imperialism. After World War II, North Korea received moral and material support from China for a long time. The Soviet Union also provided North Korea with economic and technical support, including military technology. This international support system made North Korea economically dependent and gave China and the Soviet Union political influence over North Korea. It is in this context that Juche, self-reliance, emerged as the guiding ideology.21 Based on this ideology, North Korea has tried to establish a system of self-containment and to maintain its existence independent of the external environment. Given North Korea’s ambivalent position on international transactions, the powerful capitalist encirclement, and the reality that North Korea is nearly absent of leverage that can be used to coerce the other side into accommodating its wishes in the case of bilateral negotiations, North Korea desperately needs a multilateral international strategy to make it strong in negotiations. The strategy should start with the recognition that North Korea is encircled by superpowers and the prosperous South Korea. If North Korea tries to build one-to-one bilateral relationships with one of countries, it is likely that North Korea will be in a weak position. Thus when North Korea wants to have an external relationship, it will try to create another bilateral relationship so that the latter can be used to balance the powers surrounding it. Figure 3.2 shows such a strategy. Suppose there are two superpower countries, such as the US and China, surrounding North Korea. When North Korea tries to establish an external relationship with Partner 1 only, there is a huge power gap between North Korea and Partner 1, and North Korea may have little leverage in the bilateral relationship. If North Korea simultaneously tries another external relationship with Partner 2, which drags North Korea in the opposite direction, those two powers can be offset with each other. Even though North Korea’s power is small, if the powers of Partner 1 and Partner 2 are offset with each other, then North Korea may have enough leverage in those external relationships. Through involving and balancing those superpowers, North Korea can determine the actual direction of movement almost at its will.

30

Strategies for external economic relations

Bilateral

Partner 1

*Power gap; little leverage

North Korea

Multilateral

*Power gaps offset; sufficient leverage

*Power gap; little leverage

Bilateral

Partner 2

Figure 3.2 North Korea’s strategy for international transactions Source: Authors’ own

3.

North Korea’s strategies for regional economic integration

It should be one of the most difficult things to understand North Korea: The information is very limited and it shows very volatile and seemingly inconsistent attitudes. Naturally outsiders’ observations of North Korea are quite different from one another. These wide-ranging perspectives on North Korea have in common the following observations. First, the North Korean regime is a totalitarian dictatorship governed by the sole leadership of Kim’s family, who stand above the party and the state that the North Korean people are required to obey. North Korea may have a state-run planned economy in common with other socialist countries, but the Kim family’s dynastic succession is unique. Second, the Juche (selfreliance) ideology is prescribed as the main guiding principle of all policies. The Juche includes ideological autonomy, political independence, economic selfsustenance, and self-reliance in defense.22 Kim Jong-Il introduced Son-gun

Strategies for external economic relations

31

(military first) as another guiding principle, but Juche is more fundamental and is unique to North Korea. The spirit of the Juche idea continues to live on today. Third, the socialist ideologies that had once helped sustain North Korea’s society are gradually waning. The economic crisis of the 1990s had an especially big impact on North Korea, and there are growing signs that the social system now revolves more around the exchange of money and information.23 Although North Korea has steadfastly maintained its regime under significant internal and external threats, it is certain that North Korea cannot overcome economic problems that confront it by depending on its socialist planned economy and self-reliance policies alone. Here North Korea is in a big dilemma. To ensure the regime’s survival, North Korea must engage in reforms needed to reverse economic deterioration and improve the quality of life. However, the implementation of any such reform – including opening the economy – would endanger the leadership and bring the collapse of the regime itself. For fear of this risk, North Korea has not made any move towards change and has clung to its nuclear program. Considering the internal and external situations that have made North Korea hesitant to make reforms and open external transactions, experts share the view that North Korea is not crazy and exhibits remarkable skill for utilizing the surrounding international environment. From North Korea’s strategies for external economic relations, three inferences can be drawn.24 First, North Korea would prefer to have international transactions with a country of a big stake in the Kim regime’s survival in terms of power. Even though a powerful country may have more potential to be a real threat, the survival of Kim’s regime can be ensured only with the help of major powers. Second, North Korea would prefer multilateral relationships over bilateral ones. Once it emerges from isolation and starts participating in international transactions, North Korea will face many conflicting interests with other countries. Thus multilateral relationships would better for North Korea so that it can have room for alliances, thus preventing direct confrontation in bilateral relationships when interests conflict. Third, formal and institutionalized cooperation frameworks are preferred for North Korea over informal ones. A formal and institutionalized framework is “a source of prestige, allows to retreat behind negotiated clauses in case of disagreement, and corresponds with the formalized power structure in North Korea itself”.25 Based on these analyses, some suggest that the Association of Southeast Asian Nations (ASEAN) would be an ideal partner that would support North Korea’s interests.26 North Korea has well-developed bilateral relationships with many member states of the ASEAN, and it has shown a friendly attitude towards the group. When tension is very high on the Korean Peninsula, North Korea has often asked ASEAN to act as a mediator in the crisis. For example, during the ASEAN Summit in April 2017, North Korea sent a letter of request to the ASEAN chairman (Filipino president Rodrigo Duterte) to prevent nuclear holocaust by providing an acceptable proposal. “Indeed, the ASEAN is the last remaining diplomatic bridge between Pyongyang and the broader Asian neighborhood”.27

32

Strategies for external economic relations

However, ASEAN’s role is very limited in inducing North Korea to the international community so that it can benefit from international transactions. The organization is too small to influence the future of the North Korean regime. Among ASEAN+3 members – ASEAN ten countries plus Korea, China, and Japan – the main sources of potential benefit that North Korea can gain by participating in regional economic cooperation will be three Northeast Asian countries rather than the ten ASEAN countries. ASEAN is a multilateral alliance, and one of its core principles – noninterference – may be attractive to North Korea. But this principle suggests that the ASEAN cannot provide the prestige of a formal and institutionalized cooperation framework, which is one of North Korea’s preferences for external exchanges. Thus, it would be better for North Korea to participate in a regional arrangement in which key stakeholders are involved in rather than the ASEAN. Regarding regional economic integration in East Asia, North Korea still has mixed feelings and so far adopted a bipolar stance towards it. Participation in regional economic integration presumes the opening of its economy and is considered as a threat to the regime’s stability. At the same time, North Korea recognizes that regional collaboration and integration would bring the direct benefits of foreign currency and infrastructure development as well as the indirect benefits such as support for a smooth movement towards economic reforms within a politically more acceptable framework. If contacts are carried out within a regional framework, less ideological confrontation is probable, since the contacts are less unusual and more routine business. To induce North Korea to join in a process of regional economic integration, we need concrete strategies to mitigate its perception of economic opening as a potential threat so that North Korea can expand its external economic relations with neighboring countries and that it can sustain its reforms without interruption.

Notes 1 Fox News (2017), 15 May. www.foxnews.com/politics/2017/05/25/fox-newspoll-is-russia-friend-or-foe-voters-say-foe-think-trump-says-friend.html 2 Brenan (2018). 3 Human Rights Watch (2018), 5 June. www.hrw.org/asia/north-korea 4 United Nations Human Rights Council (2014). 5 PeaceNetwork (2016), 29 April. http://peacekorea.org/zbxe/1819488 6 Similar results can be found in a survey by the Institute for Peace and Unification Studies at Seoul National University. ChosunIlbo (2015), 10 August. http:// news.chosun.com/site/data/html_dir/2015/08/10/2015081000330.html 7 Yonhapnews (2016), 5 June. www.yonhapnews.co.kr/bulletin/2016/06/05/ 0200000000AKR20160605034000014.HTML 8 Fred Warmbier, quoted in Voice of America (2018), 20 June. https://www. voakorea.com/a/4445865.html 9 Zakaria (2017). 10 Wit (2016). 11 Scobell (2005), p. 8.

Strategies for external economic relations

33

12 Wall Street Journal (2017), 5 December. www.wsj.com/articles/why-the-u-sconsiders-north-koreas-kim-a-rational-actor-1512497497 13 Economist (2018), 17 February. www.economist.com/news/asia/21737063-itdoes-little-alter-fundamental-crisis-detente-korean-peninsula-relief 14 Wikipedia. https://en.wikipedia.org/wiki/Media_coverage_of_North_Korea 15 Joins (2017), 22 September. http://news.joins.com/article/21960685 16 Krugman, Obstfeld, and Melitz (2015), ch.1. 17 Frank (2008). 18 Kornai (1992). 19 Kim Jong-il (1995); requoted from Frank (2008). 20 Park, H. S. (2000), p. 507. 21 Park, H. S. (2000), p. 505. 22 Isozaki (2017), pp. 15–16. 23 Institute for Unification Education (2014), p. 17. 24 Frank (2008, pp. 14–16) suggested five characteristics of ideal foreign partners for North Korea: small states, geographically distant countries, autocratic systems, multilateral relationships, and formal and institutional cooperation. I agree with him on two of them, and suggest three preferences for North Korea by including those two and one of my own. 25 Frank (2008), p. 16. 26 Frank (2008, 2017). 27 Asia Times (2017), 6 October. www.atimes.com/article/north-korea-crisischance-asean-shine/

4

North Korea’s external economic relations1

North Korea has so far had limited economic interactions with the international community. The poor record of North Korea’s external economic transactions reflects its mixed feelings towards the international community. North Korea still has mainly negative perceptions of external economic relations and greatly fears the threat to the stability of its regime; and has allowed only limited contacts with specific countries, in particular China.

1. Foreign trade 1.1.

Overall trends

Figure 4.1 shows trends in North Korea’s foreign trade, including inter-Korean trade between South Korea and North Korea since 1990. Its trade volume sharply declined from US$ 4.2 billion in 1990 to US$ 1.7 billion in 1998. The collapse of the former Soviet Union and CEE countries at the beginning of the 1990s was a main cause of this downward spiral. Annual trade hovered around US$ 2.0 billion in the following years to the end of the 1990s. Despite its overall poor record with international transactions, trade has continuously increased since the 2000s, which suggests that North Korea also recognizes the necessity of international economic transactions.2 With the beginning of the new millennium, the amount of trade skyrocketed due to increased activity with South Korea and China: It surpassed US$ 3.0 billion in 2001 and reached US$ 4.06 billion in 2005, surpassing the US$ 4.0 billion level in 15 years since 1990. In the aftermath of the global financial crisis Pyongyang saw its trade figures temporarily fall in 2009, but the numbers rose nearly to US$ 10.0 billion in 2014 before declining to US$ 6.9 billion in 2016. This indicates that the country is increasingly becoming dependent upon the external world, despite its image of a hermit kingdom. However, the increased volume of trade is still negligible. North Korea’s total trade volume is equivalent to less than 1.0 percent of that of the South in 2016. When it is compared to China and Vietnam, which are successfully proceeding with economic transformation, the amount of exports per capita was similar to that of China and Vietnam in the mid-1990s. But the current exports per capita

External economic relations

35

(unit: US$ million) 12,000 10,000 8,000 6,000 4,000 2,000

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

0

export

import

total

Figure 4.1 Trends in North Korea’s foreign trade Source: KOTRA, North Korea Statistics

of North Korea recorded US$ 120.8 in 2016, equivalent to only 7.6 percent of China and 5.9 percent of Vietnam. Meanwhile, the trade-to-GDP ratio is 21.9 percent in 2016, which is considerably lower than China’s 37.0 percent and Vietnam’s 184.7 percent. Observing the long-term trend, we can find a notable feature in North Korea’s trade since the 1990s. Besides its small trade volume, the trade balance of North Korea is persistently in deficit since 1990, as shown in Figure 4.2. The trade deficit stayed lower than US$ 1.0 billion in the 1990s. With the expansion of trade in the 2000s, the trade deficit also expanded and reached a record high of US$ 1.5 billion in 2008. While the foreign trade balance improved a little, the trade deficit remains around US$ 1.0 billion. Even though US$ 1.0 billion may look small, the trade deficit is too high for North Korea to fill the gap. Considering that North Korea does not have a convertible currency and has virtually no legal access to international finance, it is puzzling how the country can have such a persistent trade deficit. This strongly suggests that North Korea must have other sources of income in addition to the exports listed in the official data.3 An example of other licit trade sources includes transfers or remittances and fees that North Korea receives for sending its labor abroad or to special economic zones (SEZs) such as the Kaesung Industrial Complex (KIC). In addition, illicit trade in arms, drugs, and counterfeit notes is believed to be a further source of funds to cover the trade deficit.

36

External economic relations (unit: US$ million) 0 -200 -400 -600 -800

-1,000 -1,200

-1,600

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

-1,400

trade deficit

Figure 4.2 North Korea’s trade deficit Source: KOTRA, North Korea Statistics

1.2.

Geographical and sectoral distribution

Another notable feature of North Korea’s trade is that it is massively dependent on China in regard to geographical distribution. As shown in Table 4.1 and Figure 4.3, in the early 2000s, the shares of South Korea, China, and Japan in North Korea’s total foreign trade were similar to each other, and their sum accounted for more than 60 percent of North Korea’s total trade. North Korea’s trade dependence on South Korea and China further increased when North Korea’s trade with Japan nearly halted after Japan’s trade sanctions against North Korea in 2006, due to the country’s abduction of Japanese citizens and its nuclear testing.4 South Korea was an important trading partner until 2015 before the KIC was shut down in February 2016. In North Korea’s total trade, China and South Korea accounted for 63.7 percent and 30.3 percent respectively in 2015, but the numbers changed to 88.2 percent and 4.8 percent in 2016. Meanwhile, apart from trade through the KIC, inter-Korean trade has practically stopped since 2011 due to sanctions that followed North Korea’s torpedo attack on the South Korean Navy’s warship Cheonan and its shelling of Yeonpyeong Island. The total amount of inter-Korean trade reached US$ 1.71 billion in 2011 and US$ 1.97 billion in 2012, respectively. However, excluding KIC transactions, the amount of trade was only US$ 3.9 million in 2011 and US$ 0.8 million in 2012.

Table 4.1 North Korea’s foreign trade: Share of South Korea, China, and Japan (unit: %) China

South Korea

Japan

Combined

2000

20.4

20.5

19.4

60.3

2001

27.6

15.1

17.8

60.5

2002

25.4

22.1

12.7

60.2

2003

32.8

23.2

8.5

64.5

2004

39.0

19.6

7.1

65.7

2005

38.9

26.0

4.8

69.7

2006

39.1

31.1

2.8

73.0

2007

41.7

38.9

0.2

80.8

2008

49.5

32.3

0.1

81.9

2009

52.6

33.0

0.1

85.7

2010

56.9

31.4

0.0

88.3

2011

70.1

21.3

0.0

91.4

2012

68.5

22.4

0.0

90.9

2013

77.2

13.4

0.0

90.6

2014

69.0

23.5

0.0

82.5

2015

63.7

30.3

0.0

93.7

2016

88.2

4.8

0.0

93.0

Source: KOTRA, North Korea Statistics

(unit: %) 100 90 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 China

South Korea

Japan

Figure 4.3 North Korea’s trading partners Source: KOTRA, North Korea Statistics

Russia

Thailand

Others

38

External economic relations (unit: %)

100 90 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 China

South Korea

Japan

Russia

Thailand

Others

Figure 4.4 North Korea’s exports, by destination Source: KOTRA, North Korea Statistics

While trade (both exports in Figure 4.4 and imports in Figure 4.5) with China has steadily increased and North Korea’s dependance on China has grown, its trade with other trading partners has significantly declined. In 2016, trade with China reached US$ 6.06 billion, which accounted for 88.2 percent of North Korea’s total foreign trade. Trade with all other partners other than China and South Korea was only US$ 348.6 million in 2016, accounting for 7.0 percent of North Korean trade. Since 2016, after the shutdown of the KIC, inter-Korean trade has almost stopped, and it is not an exaggeration to say that China has become North Korea’s sole trade partner since then. Regarding sectoral distribution, North Korea’s trade is heavily concentrated on a few products on both the export and the import sides, and this concentration is ever intensifying. Over the past years, North Korea’s exports have been dominated by mineral products, followed by apparel and clothing, non-ferrous metals, and fishery products. Underground resources consistently account for around 50.0 percent of total exports since 2000s, reaching 50.3 percent in 2016 (Figure 4.6). This reflects the fact that China is the main market for North Korea’s exports; major export items to China are mostly composed of underground resources such as minerals, coal, and iron ore. As for the items heading for South Korea, the share of consumer goods made up 64.8 percent in 2005 when the KIC began its operation, and 82.9 percent in 2015 just before it was shut down. The high proportion taken up by consumer goods results from the nature of inter-Korean trade transactions: The general and processing trade that

(unit: %) 100 90 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 China

South Korea

Japan

Russia

Thailand

Others

Figure 4.5 North Korea’s imports, by source countries Source: KOTRA, North Korea Statistics

(unit: %)

14.4 2.6

6.9

42.3

8.0

25.8

HS27

HS62

HS26

HS03

HS72

others

Figure 4.6 Distribution of North Korea’s export products, 2016 Source: KOTRA, North Korea Statistics Note: HS27, HS62, HS26, HS03, and HS72 respectively refer to coals and mineral oils, apparel and clothing, other minerals, fishery products, and iron.

40

External economic relations (unit: %)

11.8 8.9

7.6 59.1

7.0 5.6

HS27

HS85

HS84

HS87

HS39

others

Figure 4.7 Distribution of North Korea’s import products, 2016 Source: KOTRA, North Korea Statistics Note: HS27, HS85, HS84, HS87, HS39 respectively refer to coal and mineral oils, electrical and electronics, machinery and metals, cars and car parts, and chemical products.

took place in the KIC was centered on light industry articles, including apparel. However, with inter-Korean trade activities (except the KIC) practically suspended since 2011, North Korea’s export dependence on China and the share of primary goods in its total exports to China have mushroomed. The fact that underground resources account for the largest share in the total exports demonstrates the underdeveloped structure of North Korea’s export industry. On the import side, mineral oils such as crude oil have taken the largest share, followed by electric and electronics, machinery and metals, and chemical products. The sum of these still accounts for more than 30 percent of the total imports of North Korea (Figure 4.7). One thing to note is that in recent years imports of textile products have rapidly increased in trade with China. This also reflects the massive dependency of North Korea’s trade on China. As North Korea’s exports of textile products to China increase, imports of textile fibers and fabric from China have also increased. This sector in particular began to grow after trade sanctions suspended inter-Korean trade, of which textiles were a large segment.

2. Foreign direct investment Investment is much more sensitive to non-economic factors than foreign trade, and many development projects – including the UN Development Programme, the Korean Peninsula Energy Development Organization, SEZ projects, and intercontinental cooperation projects – have been inconsistent, without many beneficial

External economic relations

41

results. Nevertheless, North Korea has developed many policies to induce foreign investment. In September 1984, the first legislation to attract foreign capital, the Joint Venture Act, was enacted; in December 1991, the Foreigner Investment Act was established. Since 1991, North Korea has expanded its policies and has begun to set up SEZs such as the Rajin–Sunbong free trade zone and the KIC. As with other statistical data, North Korea does not release official data on the inbound flow of foreign capital; in addition, the credibility of estimates made public by international organizations such as the UN Conference on Trade and Development (UNCTAD) has been in question due to limited calculation methods. Since the mid-2000s, China’s Ministry of Commerce, North Korea’s largest investor, has released statistical data on its investments in the longstanding ally.5 However, it is widely known that a large amount of investments by Chinese governmental agencies and state-owned companies are unofficial; small-scale investments are said to be made without the approval of the Ministry of Commerce. Despite such shortcomings, the data regularly published by the UNCATD and China’s Ministry of Commerce provide a rough account of foreign investments into North Korea. Before 1991, foreign direct investment (FDI) to North Korea was very restricted, and only some investment was made by North Korean residents in Japan. North Korea began to encourage foreign capital beginning in the 1990s, when its alliance with the Soviet Union and socialist countries was broken due to the collapse of the Soviet bloc. During the 1990s, the FDI inflow slowly increased. But inflow plummeted after North Korea’a nuclear test and subsequent UN sanctions in 2006 (Figure 4.8).

(unit: US$ million) 1000 800 600 400 200 0 -200

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

-400

Stock

Flow

Figure 4.8 Foreign investment in North Korea Source: UNCTAD

42

External economic relations

Table 4.2 Foreign investment in North Korea, by country (unit: US$ million) 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Belgium

–

–

China

–

–

France

–

– 1

14

–

– 7

–

1

–

–

–

41

6

12

56

109

−8 –

–

–

–

–

–

91

1

–

–

–

8

–

–

−1

–

–

3 1

3

12

Germany

−20 6

−1

51

−12 −247 –

Italy

–

–

–

–

–

–

Luxembourg –

–

–

–

–

6

−4

–

11 18

– 1

–

–

1 –

Source: UNCTAD

As in the case of international trade, China has emerged as the top investor in North Korea since the mid-2000s (Table 4.2). Around 2000, China began encouraging local companies to invest overseas. In line with Beijing’s overseas investment policy, Chinese corporate investments in North Korea have covered a wide range, including industrial infrastructure, distribution, and manufacturing. Of the total foreign investments in North Korea in 2012, which amounted to US$ 227.8 million,6 China accounted for 47.9 percent, or US$ 109 million. Woo (2007), a research fellow at the Chinese Academy of Social Sciences in Liaoning Province who examined China’s investments in North Korea, including unofficial transactions, reported that China invested in North Korea more than US$ 53.69 million in 2005 and US$ 58.74 million in the first half of 2006. The figures amount to about five times more than official statistics. European countries are not fully absent, but their role is only marginal in foreign investment in North Korea. Although China’s investments in North Korea are said to reach more than US$ 100 million annually, the amount pales in comparison to foreign investments in other developing countries. For instance, while pushing ahead with economic reforms, Vietnam aggressively wooed foreign investors and attracted annual investments of US$ 760 million between 1991 and 1995 and US$ 1.773 billion between 1996 and 2000, respectively. Thus foreign investment in North Korea is still far too limited to have a substantial impact on the country.

3.

Special economic zones

As a part of its strategy to open up the economy, North Korea began to establish SEZs in the 1990s.7 SEZs are government-designated areas where investment by foreign countries is allowed and there are 27 SEZs in North Korea (Figure 4.9). Among the early economic cooperation projects in which North Korea was involved, two cases deserve attention from the perspective of Northeast Asian regional cooperation: The Tumen River Area Development Program (TRADP) and the related Rajin–Sunbong SEZ development.

North Hwanghae Province

South Phyongan Province

South Hwanghae Province

North Phyongan Province

Source: Institute for Unification Education (2017), p. 211

Ryanggang Province

Orang Agricultural Development Zone

Chongjin Economic Development Zone

Rason Special Economic Zone

Pukchong Agricultural Development Zone

North Hamgyong Province

Kyongwon Economic Development Zone

Kaesong Industrial Zone

Provincial-Level Economic Development Zone

Central-Level Economic Development Zone

Special Economic Zone

Wonsan-Mount Kumgang International Tourist Zone

Sinphyong Tourist Development Zone

Hyondong Industrial Development Zone

Hungnam Industrial Development Zone

South Hamgyong Province

Kangwon Province

Jagang Province

Figure 4.9 SEZs and economic development zones in North Korea

Kangryong International Green Demonstration Zone

Songrim Export Processing Zone

Waudo Export Processing Zone

Jindo Export Processing Zone in Jindo

Unjong Cutting-Edge Technological Development Zone

Chongnam Industrial Development Zone

Sukchon Agricultural Development Zone

Hwanggumphyong-Wihwa Islands Special Economic Zone

Sinuiju International Economic Zone

Amnok River Economic Development Zone

Chongsu Tourist Development Zone

Wiwon Industrial Development Zone

Manpo Economic Development Zone

Hyesan Economic Development Zone

Mubong Special Zone for International Tourism

Onsong lsland Tourism Development Zone

44

External economic relations

The TRADP, which is symbolic of the region’s economic cooperation efforts, began in the early 1990s in the form of a multilateral collaboration involving the two Koreas, China, Russia, and Mongolia. It was regarded as a highly feasible project because all the parties involved were strongly motivated. North Korea needed to prop up its economy in the wake of the Soviet bloc’s demise. China wanted to narrow the economic development gap between its coastal areas and northeastern provinces. Russia also wanted to develop the far-eastern Maritime Province of Siberia and inland areas. All of the East Asian countries were searching for ways to escape economic doldrums. However, the TRADP failed to achieve any tangible progress. At the turn of the century, China and Russia announced separate, competitive investment plans, but without success. In 2005, the TRADP was converted into the Greater Tumen Initiative (GTI) to expand the development area, but it failed to make any headway. The Rajin–Sunbong SEZ was established in 1992 to promote economic growth through foreign investment. It is similar to the SEZs set up in China, Vietnam, and elsewhere to pilot market economies in a designated controlled area. Chinese and Russian companies were the first to invest in the economic zone, and Mongolia joined later. Before 1991, the SEZ was used by the Soviet Union as an alternative warm-water port. China wanted to make investments in the port to improve its access to the East Sea. As in the case of the TRADP, both multilateral and independent efforts for the Rajin–Sunbong SEZ development project were also fruitless. The failure of the TRADP can be traced to an absence of specific means to raise necessary funds in the first place, and the failure to attract inbound foreign investments. The same applies to the Rajin–Sunbong SEZ project. The latter project was also hobbled by North Korea’s unfavorable political and economic environment for foreign investors and its excessive dependance on offshore investments for infrastructure construction: The conditions for encouraging investment were not satisfied. The exclusion of South Korean firms that expressed great interest in the development of the area also served as a negative factor. The unsatisfactory outcomes of North Korea’s economic cooperation at bilateral and multilateral levels, and its excessive dependance on China, were the result of North Korea’s failure to attract much-needed foreign investments due to political issues such as the country’s nuclear ambitions. Even if these political issues are addressed, however, there would still remain other obstacles such as a hostile investment environment and poor infrastructure, a prerequisite for the attraction of foreign investment. Therefore, there is a slim chance that North Korea will see foreign investment inflows other than those from China for some time to come. In addition, North Korea will likely prevent any South Korean companies from participation in the development of the North Korea–China borderland areas – as it did in the Rajin–Sunbong development project. Meanwhile, in spite of the political and economic obstacles, China has continued to invest in North Korea as long as there are benefits to its national interests. Since the mid-2000s, while pushing ahead with development of the three northeastern provinces, the Chinese government has tried to link its development projects in the Chang-Ji-Tu, Rajin–Sunbong, Dandong, and Hwanggumpyong areas. In this context, China’s investment in North Korea

External economic relations

45

will continue for years to come, centering on these areas, along with exploitation of underground resources. In addition to these early attempts at establishing SEZs, two more cases deserve attention from the perspective of inter-Korean economic cooperation: The KIC and Mount Kumkang. The KIC was a SEZ in North Korea, located 43 miles north of Seoul and 106 miles southeast of Pyongyang, just across the demilitarized zone (DMZ). The purpose of the KIC was to develop an industrial park in which South Korean businesses – in particular small and medium companies – could manufacture products using cheap North Korean labor, help North Korea to reform its economy, and ease tensions between two Koreas. The KIC was initiated by the Hyundai Group in 1998 and opened in June 2004. South Korean companies operating in the KIC enjoyed preferential treatment. They received special tax breaks and were provided loans with low interest rates. From North Korea’s perspective, the KIC was also attractive as a source of hard currency. The infrastructure – including the industrial park itself and the supporting zone of residential areas, hospitals, and shopping centers – was also expected to be a big benefit for North Korea. The original master plan of the project was to evolve in three stages (see Table 4.3). The first phase, in 2002–2007, was planned to encompass 800 acres, with 300 South Korean companies operating and employing 100,000 North Korean workers in the KIC. In the second phase, in 2007–2009, the zone was to be further expanded and opened to non–South Korean investors, including 800 South Korean companies and 200,000 North Korean workers. When the third phase was completed in 2012, the zone was expected to encompass 6,400 acres, include 1,500 South Korean companies, and employ 350,000 North Korean workers. At the beginning, only 11 companies operated at the KIC. As of December 2015, shortly before the KIC was shut down, there were 125 tenant companies, 123 of which were engaged in production activities, while two had suspended their operations.8 The number of North Korean workers was 54,988, and the average monthly wages in 2015 were about US$ 188. The annual output for 2015 was US$ 563.3 million, and the accumulated output up to 2015 reached US$ 3.2 billion. Among the products, textiles topped the list, followed by electrical and electronic products, machinery and metals, and chemicals (see Table 4.4).

Table 4.3 Three phases of the KIC plan Phase I Phase II (2002–2007) (2007–2009) 2,000: Industrial zone 800: Supporting zone

Phase III (2009–2012)

Land (acres)

800

South Korean companies

300

800

1,500

North Korean 100,000 workers

200,000

350,000

Source: Ministry of Unification, South Korea.

4,800: Industrial zone 1,600: Supporting zone

2010

2011

2012

2013

2014

2015

Total

–

Source: Ministry of Unification, South Korea (2016), p. 90

34

75

1,469

1,941

1,570

4,187

3,199

1,941

4,943

2,401

1,158

4,539

33,851

23,974

23,627 96,564

6,010

2,293

2,773

10,530

3,052

3,535

67,699 124,658

74,628

233,599

24,190

12,866

25,624

615,484

524,571

14,906 73,737 184,779 251,422 256,475 323,323 401,848 469,500 223,784 469,965 563,297 3,233,036

–

1,313

2,668

93,836

16,040 31,653

Total

–

70

2,003

97,221

30,337 65,861

–

–

976

59,147

28,636 52,617

Other

–

–

37,584

32,092 48,637

–

47,162

26,179 37,312

–

39,027

21,785 49,250

Pulp and lumber

1,108 14,191

Electrical and electronics

41,947

Food

1,768 10,900

5,250 20,853

Chemicals

–

2009

18,262

2008

85,543 132,179 152,050 179,235 215,676 269,383 134,142 292,588 301,332 1,796,703

2007

(unit: US$ thousand)

6,780 27,793

2006

Machinery and metals

Textiles

Year 2005 Category

Table 4.4 Production of KIC companies, by sector

External economic relations

47

The project was frequently modified and interrupted subject to political tensions caused by missile tests, nuclear threats, and other military incidents provoked by North Korea. In 2009, entry into the KIC was temporarily prohibited when North Korea imposed restrictions on the KIC, blaming US–South Korean military drills. In May 2010, a South Korean warship, the Cheonan, was sunk in the Yellow Sea allegedly by a North Korean torpedo, killing 46 sailors. In late 2010, North Korea dropped bombs onto Yeonpyeong Island, killing four South Koreans. The KIC was not shut down in 2010, despite these two violent incidents: Although North Korea severed ties with South Korea and closed its Consultative Office, existing production activities in the KIC were maintained. In April 2013, North Korea halted all operations at the KIC by withdrawing all North Korean workers, again blaming a joint military exercise by the US and South Korea. The KIC was reopened in September of that year. In February 2016, when South Korea announced that it would halt operations in the KIC in response to a rocket launch by North Korea, North Korea expelled all South Korean workers and froze all South Korean assets and equipment in the KIC. In protest, the South Korean government announced it shut off the supply of electricity and water into Kaesong that supported the factory zone, and the KIC has been closed since then. Mount Kumgang International Tourist Park is a special administrative zone of North Korea, located on the eastern seacoast of Kangwon province. The project came out of an agreement between Hyundai founder Mr. Chung Juyoung and Kim Il-sung to create a tourist resort for South Koreans inside North Korea. Beginning in 1998, South Koreans and other foreign tourists were allowed to visit Mount Kumgang. In 2002, North Korea established the area around the mountain as a special international tourist zone, separating it from Kangwon province. Since 1998 more than 1 million South Koreans have visited the resort, and it was another big source of hard currency for North Korea. The project was reported to annually bring to North Korea US$ 72 million in rent and US$ 10 million in tourist spending. In July 2008, a South Korean tourist was shot and killed, and the South Korean government immediately suspended tours in the park. In August of that year, the North Korean government expelled South Korean workers from the resort, and the park has been closed since then.

4.

Main features of North Korea’s external economic relations

The previous observations of North Korea’s external economic relations lead to the following conclusions. First, North Korea’s economic transactions with foreign countries are still very limited. In terms of volume, its trade and FDI inflows are minuscule. The current structure of North Korea’s external economic relations is a byproduct of the Soviet bloc’s collapse, which crippled its industrial foundations, and international sanctions over Pyongyang’s nuclear program, which have stifled its access to foreign hard currency and to export

48

External economic relations

markets. In addition, North Korea’s international credit rating dropped after its default on external debt in the 1980s. These limited external transactions may reduce the exposure of North Korea’s economy to external influences, but the potential impact of trade and foreign investment on the economic development is also limited. Second, North Korea’s external economic relations are heavily concentrated, geographically on China and sectorally on underground resources and light manufacture. Ironically this polarization of trade and FDI inflows makes North Korea more dependent on a specific foreign country. Under Juche, its self-reliance philosophy, North Korea tries to produce a little of everything that it needs and to make it more economically self-sufficient. As various sanctions prohibit its economic interactions with the outside world, the self-reliant economy as promoted by the ruling Kim family is being forced into heavy dependency on China. Two factors explain North Korea’s failure to expand trade and draw foreign investment and its heavy dependency on China: An unfavorable economic and investment environment, including a backward industrial infrastructure, inadequate legal institutions, and a rigid bureaucratic system; and great investment risks resulting from sanctions imposed by the international community for its nuclear program. The North’s heavy dependency on China for economic exchange and cooperation is undesirable not only for North Korea itself but also for South Korea, because the South needs to build far closer economic ties with the North to achieve the ultimate goal of unification in the future. Third, those limited external economic transactions are fluctuating, and this volatility is revealed in foreign investment inflows. For example, when North Korea carried out a nuclear test in 2006, trade still continued while foreign investment suddenly stopped. The structure of North Korea’s external economic transactions explains this volatility. North Korean exports mainly include low-end products including natural resources and manufacturing products at a primitive level, which tend to be very sensitive to business cycle. This is similar to the experience of Latin American countries after the global financial crisis. A more critical reason behind such volatility is that North Korea’s external economic relations are dictated by political considerations. When the political mood turns sour, international transactions of North Korea are practically frozen. In the case of North Korea, external economic relations have not been instrumental for enhancing competitiveness, nor have they been part of a development strategy; instead, they are just used to collect hard currency or to meet basic needs. North Korea needs a supportive international environment for economic reforms and modernization based on economic openness, which is the only option to prevent a further deterioration of the domestic economy and a destabilization of the regime. To achieve this goal, it is crucial for North Korea to overcome structural problems in its external economic relations. Above all, it needs to expand the magnitude of external economic transactions with more countries and include a greater variety of products. Only then can trade and foreign investment provide meaningful impetus and momentum to North Korea’s economic development.

External economic relations

49

This could also reduce its geographical and sectoral concentration and its high volatility of external economic relations. Essentially, North Korea must start over by nurturing its export industry, and it must create favorable economic and investment environments by improving its basic industrial infrastructure and legal institutions as well as reducing the investment risks that are related to international sanctions. In addition to adopting these policies, North Korea needs to resolve political issues such as addressing its nuclear program and promoting economic reforms. When solutions to political issues begin to emerge, carrots such as financing for regional development projects should be extended to North Korea so that it can develop new export markets and invite foreign investment9 by taking advantage of the economic cooperation framework established by East Asian countries. By doing so, Pyongyang could be coaxed to join the regional economic integration process that is taking place in East Asia. In sum, to expand external transactions and boost the economy, what is most needed is to reduce North Korea’s negative perception of external economic relations and its fear of the threat to the stability of it regime. If North Korea can change its attitude toward the international community from “international economic exchanges are needed, but not liked and actually feared” to “international economic exchanges are needed, and not feared”, North Korea can easily expand international trade and attract foreigners’ investment. By doing so, the structural problems in North Korea’s external economic relations can be mostly overcome, and its development projects can be sustained without interruption.

Notes 1 This chapter is partly from Chun and Rhee (2012) and has been updated. 2 Frank (2008). 3 Frank (2015b). Haggard and Noland (2007) also extended the traditional format of balance of payments to include illicit activities such as counterfeiting that do not appear in conventional balance of payments accounting of North Korea. 4 Japan had been North Korea’s second-largest trading partner for the 1990s through the early 2000s before the trade sanctions were imposed. 5 Ministry of Commerce of the People’s Republic of China, “Annals of the Chinese Ministry of Commerce”, Annual Report, various issues. 6 As shown in Table 4.2, 2012 is the last year when FDI data for individual countries are available. 7 North Korea announced 14 new SEZs in 2013, seven in 2014, and three in 2015. None were announced in 2016, and in 2017 the Kangnam Economic Development Park was announced. www.nkeconwatch.com/category/economic-reform/ special-economic-zones-2/economic-development-zones-2017/ 8 Ministry of Unification, White Paper on Korean Unification (2016). 9 Brown (2018).

5

Progress of regional integration in East Asia1

To find strategies for incorporating North Korea in East Asian regional economic integration, it is necessary to provide a description and an anatomy of existing regional arrangements in East Asia, including those under hard negotiation. Along with the progress of regionalism, various strategies have been proposed for regional integration in East Asia. There are mainly two forces behind regional integration efforts in East Asia. One is the expansion of the East Asian economy itself. For decades, East Asia has been the fastest growing region in the world, leading the world economic growth. To boost and sustain economic growth by increasing regional transactions and investments, East Asian countries have promoted collective regional arrangements that have further expanded and deepened regional economic interdependence. International financial crises, including the Asian crisis and the global financial crisis, have also served as a catalyst for regional integration. East Asian countries have tended to suffer from international financial crises, regardless of their origin. As Randall Henning said, “Regionalist movements are intimately connected to economic and financial crises”.2 East Asian countries were led to conclude that in order to avoid the detrimental effects of international financial crises, they must protect themselves through regional collective action. Still, East Asia continues to lag behind Europe with regard to regional economic integration. Nonetheless, East Asia is crowded with many bilateral and multilateral economic arrangements, some of which have served economic development, integration, and globalization very well, while others have often been nominal. The progress of East Asian integration is mostly market driven, and regional arrangements have been results of spontaneous responses to market forces and financial crises. Even though “[East] Asian integration is gaining momentum through enhanced cooperation between governments, firms, and people . . . the road ahead is long and full of challenges”.3

1.

Pan–East Asian initiatives

1.1.

Regional trade agreements

Although regional trade agreements involving East Asian countries have proliferated, the region-wide trade integration agenda has been sluggish within the context of East Asia. Only ASEAN has shown some progress in signing all regional countries.

Progress of regional integration 51 The ASEAN–China FTA has the important position as the first such ASEAN+1 FTA ever concluded. Considering the increasing strategic value of the ASEAN, China was generous to provide preferential market access for ASEAN products. It even started to implement special treatment before the whole agreement went into force, especially under the name of “Early Harvest”, which was originally devised to provide ASEAN member countries enough motivation to participate in the negotiation. ASEAN countries no longer regard closer trade and investment ties with China as pathways to becoming dependent on the Chinese economy. More and more, a closer economic relationship with China has been considered an additional vehicle to common prosperity for both the ASEAN and China. The recent emergence of China as the largest and most important trading partner for almost all ASEAN member countries has played a crucial role in this changed posture towards China. China, for its part, was pragmatic enough to acknowledge ASEAN’s role in East Asian regional integration.4 That is to say, the economic interests of the ASEAN were well-matched with the strategic interests of China when negotiating the bilateral FTA. However, the quality of this bilateral FTA is not high, considering that it is an FTA between the developing ASEAN and a not-fully advanced China. The relatively low quality of the agreement notwithstanding, the ASEAN– China FTA is expected to play an important role, considering the high economic and strategic stakes China has traditionally been possessing in the ASEAN. In an emergency response to this FTA, Japan initiated its own trade agreement with ASEAN. Japan feared losing its leadership role in helping ASEAN economies ensure the potential of a sustainable development. It was therefore also quite generous in giving concessions to the members. In fact, the Japanese government launched an initiative establishing an East Asian Community (EAC), and proposed it as a region-wide integration mechanism. The EAC was not supported by the US and encountered a number of obstacles. This initiative soon gave way to a more affirmative and aggressive regionalism strategy, which eventually led Japan to participate in Trans-Pacific Partnership negotiations. The ASEAN–Japan FTA, therefore, can be regarded as an emergency response that assumed only a temporary strategic position in Japan’s grand regionalism strategy. The ASEAN–South Korea FTA was born under similar geopolitical circumstances as the ASEAN–Japan FTA. Therefore, the former shows similar shortcomings as the latter: The low level of liberalization, and the one-sided concessions provided by South Korea, etc. After this FTA went into force, South Korea has been making efforts to upgrade the liberalization effects by supplementing this collective FTA with individual FTAs with a few strategic partners, such as Vietnam and Indonesia. Also to be noted is the fact that all the three ASEAN+1 FTAs show relatively low levels of liberalization specially from the side of the ASEAN. This suggests that those FTAs may have been prompted by the competitive strategies from the three Northeast Asian countries that sought to secure the ASEAN as a trading partner, rather than ASEAN’s leadership in the region.5 As the three ASEAN+1 FTAs have existed for a while, an interesting question also arises as to whether the region-wide integration for East Asia would be

China

⇒ China eq. $ 3bil ⎞ ⇒ Japan eq. $ 3bil ⎠

Republic of Korea

2

Japan ⇒ Korea $ 10bil Korea ⇒ Japan $ 5bil Japan ⇒ Korea eq. $ 3bil+s Korea ⇒ Japan eq. $ 3bil

eq. US$ 21 bil

⎞ ⎠

Source: Ministry of Finance, Japan

US$ 3 bil

US$ 4 bil

1/ 2/ 3/ 4/ 5/ 6/

as of Apr. 2009

Singapore

Vietnam

Indonesia

Myanmar

Lao PDR

Philippines

Cambodia

Malaysia

Brunei

Thailand

ASEAN Swap Arrangement (ASA) US$ 2 bil

Local currency swap between Japanese YEN and Chinese YUAN. Local currency swap between Chinese YUAN and Philippine PESO. Local currency swap between Chinese YUAN and Korean WON. Local currency swap between Japanese YEN and Korean WON. The maximum amount is increased to US$ 20 billion equivalent until the end of October 2009. The sum of US$ 90.0 bil does not include the ASEAN Swap Arrangement (ASA)

US$ 4 bil

US$ 12 bil

(Japan ⇒ Indonesia $ 12bil)

US$ 2 bil

⎛ Korea ⇒ Thailand $ 1bil ⎞ ⎝ Thailand ⇒ Korea $ 1bil ⎠

⎛ Korea ⇒ Malaysia $ 1.5bil ⎞ ⎝ Malaysia ⇒ Korea $ 1.5bil ⎠ ⎛ Korea ⇒ Philippines $ 2bil⎞ ⎝ Philippines ⇒ Korea $ 2bil⎠ ⎛ Japan ⇒ Singapore $ 3bil ⎞ ⎝ Singapore ⇒ Japan $ 1bil ⎠

⎛ Korea ⇒ Indonesia $ 2bil ⎞ ⎝ Indonesia ⇒ Korea $ 2bil ⎠

US$ 4 bil

(China ⇒ Indonesia $ 4 bil)

US$ 4 bil

eq. US$ 2 bil 2/

US$ 6.5 bil

US$ 9 bil

⎛ Japan ⇒ Thailand $ 6bil ⎞ ⎝ Thailand ⇒ Japan $ 3bil ⎠

⎛ Japan ⇒ Philippines $ 6bil ⎞ ⎝ Philippines ⇒ Japan $ 0.5bil⎠

Japan ⇒ Malaysia $ 1bil

US$ 1 bil

(China ⇒ Philippines eq. $ 2bil)

(China ⇒ Malaysia $ 1.5bil)

US$ 1.5 bil

(China ⇒ Thailand $ 2bil)

US$ 2 bil

Figure 5.1 CMI currency swap arrangement

⎛ ⎝

1

⎛ China ⇒ Korea eq. $ 4bil ⎞ ⎝ Korea ⇒ China eq. $ 4bil ⎠

eq. US$ 8 bil 3/

⎛ Japan ⎝ China

eq. US$ 6 bil

1/

Japan

Total : US$ 90.0 bil6/

Progress of regional integration 53 possible by merging the three FTAs. With three ASEAN+1 agreements in place, emerging discussion on the creation of an East Asian Free Trade Agreement (EAFTA) including all ASEAN+3 countries can be regarded as a next step to a region-wide FTA.

1.2.

Monetary and financial cooperation

The Asian crisis spurred monetary and financial cooperation among East Asian countries who sought to protect themselves against financial crises and to develop regional financial markets so that their money would circulate within the region.6 The most notable achievement was the Chiang Mai Initiative (CMI). The CMI is a regional currency swap arrangement among the ten members of the ASEAN and three Northeast Asian countries (China, Japan, and Korea). The initiative began as a series of bilateral swap arrangements after the ASEAN+3 countries met on 6 May 2000 in Chiang Mai, Thailand, at an annual meeting of the ADB. East Asian countries started this initiative to manage regional shortterm liquidity problems, and to facilitate the work of other international financial arrangements and organizations like the IMF. The total amount under the bilateral swap agreements (BSAs) reached US$ 90 billion with 16 BSAs in 2009. Although it was undeniably an important first step in establishing regional monetary and financial integration, the CMI is far from truly being such a regional arrangement. First, the total amount of the financial arrangement was too small and needed to be increased, since only large financial arrangements could serve as a deterrent to future financial crises. Second, the agreed swap arrangements were incomplete and insufficient for coping with a currency crisis because of the absence of an independent monitoring and oversight system and the consequential linkage to IMF facilities. Third, the arrangements were bilateral, not multilateral. Thus, to improve the efficiency and effectiveness of the financial arrangement, the network of bilateral swaps should be organized into a multilateral arrangement, which may eventually lead to the establishment of an institution such as an Asian Monetary Fund.7 In May 2005, the ASEAN+3 finance ministers reached a set of major agreements to improve the effectiveness of the CMI and endorsed the Multilateral Swap Arrangements (MSAs). At a meeting in Bali, Indonesia, in May 2009, ASEAN+3 finance ministers reached an agreement on all the main components of CMI multilateralization (CMIM), including contribution sizes per country, borrowing accessibility, and an oversight mechanism. Its total size was set at US$ 120 billion, and the initial capital contribution was made mostly by South Korea (16 percent), China (32 percent), and Japan (32 percent) while the ASEAN contributed 20 percent (Table 5.1). There is no question that substantial progress has been made, but there is still a lot more to be done. Above all, the total size and individual borrowing amount are very limited and may not be enough to cope sudden disruptions of capital movement. Also, the IMF conditionality is still binding: A crisis-affected member requesting short-term liquidity support may immediately obtain financial

54

Progress of regional integration

Table 5.1 CMIM contribution and borrowing amount

South Korea

Financial contribution

Borrowing amount

US$ billion (A)

US$ billion (B)

192

(%) 16.0

192

B/A 1

China (include Hong Kong)

384

32.0

192

0.5

Japan

384

32.0

192

0.5

960

80.0

A3 subtotal Big 5

576

–

Indonesia

47.7

3.97

119.25

2.5

Malaysia

47.7

3.97

119.25

2.5

Thailand

47.7

3.97

119.25

2.5

Singapore

47.7

3.97

119.25

2.5

Philippines

36.8

3.07

Subtotal Small 5

19.0

569

2.5 –

Brunei

0.3

0.02

1.5

5

Cambodia

1.2

0.10

6

5

Laos

0.3

0.02

1.5

5

Myanmar

0.6

0.05

3

5

Vietnam

10.0

0.83

50

5

1.0

62

–

20.0

631

–

1,207

–

Subtotal ASEAN subtotal Total

227.6

92

12.4 240 1,200

100

Source: Ministry of Strategy and Finance (South Korea)

assistance for the first 20 percent of the borrowing accessibility amount, and the remaining 80 percent would be provided within the IMF agreement. The linking of the CMIM to an IMF program, especially the small IMF de-linked portion, is regarded as an impediment to countries in urgent need of international liquidity when they approach the CMIM for financial support. In addition, the stigma effect that is related to IMF assistance may also be applied to the CMIM.8 Finally, the CMIM is not a permanent fund and liquidity provision may not be guaranteed under a crisis. To resolve these problems, the CMIM has been further reinforced since the global financial crisis. A few notable achievements are the followings: The size has been doubled to US$ 240 billion; the IMF de-linked portion has been raised to 30 percent of each member’s quota; the maturity and supporting period has been extended; and a crisis prevention facility by the name of CMIM Precautionary Line (CMIM-PL) has been introduced.9 The Asian Bond Market Initiative (ABMI) involves a variety of efforts led by ASEAN+3 countries to create regional bond markets through the creation of

Progress of regional integration 55 new securitized debt instruments. This initiative was originally proposed by Thaksin Shinawatra, the prime minister of Thailand, in 2002, and was approved at the ASEAN+3 Finance Ministers’ Meeting in August 2003 in Manila. Working groups were established to actively promote the ABMI in order to meet regional needs for medium-and long-term financial resources. The ABMI mainly focused on facilitating access to bond markets for a wide variety of issuers, and enhancing the market infrastructure necessary to foster regional bond markets in East Asia. The ABMI showed little tangible progress at the beginning, and more specific action plans were needed for further development of well-functioning regional bond markets. In May 2008, the ASEAN+3 finance ministers agreed on the new ABMI roadmap. To implement the new roadmap, ASEAN+3 countries established the working structure: A steering group, four task forces, a technical assistance coordination team (TACT), and an ad hoc working team. Specifically, the task forces were charged with identifying and addressing the major issues in four key areas: Promoting the issuance of local currency-denominated bonds (supply-side), facilitating the demand for local currency-denominated bonds (demand-side), improving the regulatory framework, and improving the related infrastructure. Furthermore, a steering group were established, while the TACT continued to exist given the importance of technical assistance in decreasing the disparities in bond market development levels among member countries.10 In 2009 the ASEAN+3 finance ministers stressed the importance of local currency bond markets in recycling regional savings within the East Asian region. Following continual calls to establish the necessary infrastructure for regional bond markets, they agreed to create the Credit Guarantee and Investment Mechanism, which was later renamed the Credit Guarantee and Investment Facility. Its main purpose was to provide credit guarantees to domestic and cross-border issuers seeking to meet their funding needs in local currencies. The ABMI later set up the Asia Bond Market Forum, which undertook an in-depth analysis of regional bond markets and cross-border bond issues and investment. So far, the ABMI has fallen short of expectations to secure a critical mass for a successful launch and ensuing cooperation. There have been few local currencydenominated bonds so far and little institutional-building for issuing bonds of regional, if not global, acceptance. A lack of financial infrastructure and marketdriven growth resulted in lukewarm participation by private market participants. More fundamentally, East Asia still does not have a fully convertible currency, with the exception of the Japanese yen – but it still cannot be a full-fledged vehicle currency, due to its chronic political and economic problems. The focal needs of the ABMI have not been correctly identified and put on the table.11 To overcome the ABMI’s limits and support its progress, several specific strategies are proposed. For example, Asian Prime Collateral Forum (APCF), was established under ABMI Task Force 4. The APCF is a regional forum to get the bonds issued within the ASEAN+3 region recognized as prime collateral in the global market. The forum was launched in 2016, and has the following objective: Provide opportunities to exchange knowledge, expertise, and

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experience on the prime collateral issues among the global and regional financial market experts; assess existing criteria of prime collateral and identify the requirement to expand the pool of eligible collateral; and explore ways to achieve the goal of gaining global recognition for Asian bonds as prime collateral.12 Another important mechanism for macroeconomic monetary policy cooperation is the Economic Review and Policy Dialogue (ERPD), established in 2000. This was designed to protect against irregularities, provide opportunities for authorities to take remedial policy action as preventive measures, and enable swap-providing countries to make swap activation decision. In particular, the ERPD assesses global, regional, and national economic conditions; monitors regional capital flows and currency markets; analyzes macroeconomic and financial risks; looks at how to strengthen banking and financial system conditions; and gives East Asia a unified voice in discussions on reforming the international financial system.13 Although the ERPD process has gradually improved over time, it has not been as effective as initially expected due to the insufficient infrastructure for such oversight. Cooperation through the ERPD was still mostly limited to information exchange. There was little or no discussion on the adoption of common regimes or binding policy coordination agreements in East Asia. The global financial crisis prompted authorities to establish a new regional oversight unit. In May 2010, the ASEAN+3 Finance Ministers agreed to establish the ASEAN+3 Macroeconomic Research Office (AMRO), with a small initial professional staff, to work with the ASEAN Secretariat and to monitor and analyze the regional economies and support the CMIM mechanism. The AMRO shares objectives similar to those of the ERPD and is expected to report on overall macroeconomic conditions and financial assessment of the ASEAN+3 countries. The AMRO’s establishment was a watershed event in ASEAN+3 oversight and the operation of the CMIM. As agreed in the Bali meeting, the AMRO was established in Singapore as a private corporation “to monitor and analyze regional economies and to contribute to early detection of risks, ensure the swift implementation of remedial actions and assist in the effective decisionmaking of the CMIM”.14 The AMRO Agreement came into effect in February 2016, and it has become a legal entity as an international organization and a permanent institution in the ASEAN+3 region. Figure 5.2 shows a brief chronology of various initiatives for East Asia’s financial integration. A proposal for further development of the ABMI and AMRO was to make better use of a regional currency unit. The Asian Currency Unit (ACU) was proposed to comprise a basket of Asian currencies, similar to the European Currency Unit, and was suggested to stabilize and develop the regional financial market. The discussion started in Japan, where in 2000 the Kobe Project made some progress circulating the proposal; the ACU exchange rate was announced in November 2005. The ASEAN+3 research group began a full-scale study on the composition of a regional currency unit, oversight mechanism, and possible applications of the ACU. The ACU can be used as a divergence indicator for macro cooperation and monitoring of an individual East Asian currency vis-à-vis other regional

ABMI: Credit Guarantee Investment Facility

AsianBondsOnline website launched

ASEAN Trading Link

New ABMI Roadmap signed

AMRO established

ASEAN Exchanges website launched

ASEAN Financial Integration Framework

Asian Bond Fund 2

AMRO becomes an international organization

Implementation of ASEAN Banking Integration Framework

ASEAN+3 Multi-Currency Bond Issuance Framework

ASEAN Framework for Cross-Border Offering of Collective Investment Schemes

Cross-border Settlement Infrastructure Forum

Source: ADB (2017), p. 128

Figure 5.2 Chronology of Asia’s financial integration initiatives

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

ASEAN+3 Finance Ministers’ Process

ASEAN Surveillance Process

Asian Bond Market Initiative (ABMI)

ASEAN+3 Research Working Group

Asian Bond Market Forum

CMI replaced by CMI Multilateralisation

ASEAN Capital Markets Forum

Asian Bond Fund 1

Economic Review and Policy Dialogue

Chiang Mai Inititative (CMI)

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Table 5.2 Sequences for monetary and financial integration using the ACU Step

Stage I

Stage II

Target

Policy cooperation and Activation of ACU infrastructure building and exchange rate coordination

Policy Issues

Establishment of Asian Fund Introduction of emergency liquidity facility Institutionalization of policy dialogue Introduction of information-sharing system Introduction of ACU ACU-based bond issuance and infrastructure-building

Introduction of Asian Exchange Rate Mechanism Introduction of credit extension system for intervention Use of private ACU Introduction of macroeconomic adjustment and cooperation system

Stage III Introduction of a single regional currency and financial integration Introduction of a regional central bank Switch of national currencies to common currency Integration of financial services and system

Source: Chai et al. (2008)

currencies and collective movement of East Asian currencies against the US dollar or the euro. In addition, ACU-denominated bonds can be issued and used as valid assets for foreign reserve management. The use of the ACU at an official level also leads to its private use, in particular, promoting an ACUdenominated bond market in East Asia, which is indispensable for eliminating the underlying causes of regional financial instability. Also, the ACU can become a supplementary framework for the development of regional financial markets in East Asia. For example, it can serve as a useful instrument for the introduction of a regional settlement system to link East Asian financial markets; it can also serve as a swap arrangement and oversight mechanism to improve the efficiency of the CMIM.15 Table 5.2 shows sequences of how these ideas for monetary and financial integration using ACU can implemented at each stage. However, not much progress has been made with the idea of the ACU, because the issue is still relegated to the back burner, with nobody taking responsibility for its development. In fact, most discussion still reflects the reality that sovereign interests are given priority in a globalized world, especially in East Asia where dollar dependency remains predominant.16

2. Sub-regional and trans-regional initiatives Despite subsequent efforts to promote regional economic integration in East Asia, region-wide integration efforts may not have been as effective as expected when backgrounds and interests differ greatly among countries in the region,

Progress of regional integration 59 and visible improvements have yet to be made. Other efforts have been made in two directions: Sub-regional and trans-regional.

2.1.

Sub-regional initiatives

Trade arrangements At a sub-regional level, a number of regional integration initiatives for Northeast Asia have been put on the table, mainly in the form of bilateral and/or trilateral FTAs among the three countries in the region (China, Japan, and South Korea). South Korea–Japan FTA, South Korea–China FTA and China–Japan FTA, as well as China–Japan–South Korea FTA have been proposed or negotiated among them. The idea of a South Korea–Japan FTA was raised by South Korean President Kim Dae Jung at the South Korea–Japan summit meeting in October 1998. However, it has been at a stalemate since November 2004, after six rounds of official negotiations. In fact, the launching of official FTA negotiations has not been an easy task, especially if one takes into consideration the historical legacies of Japanese colonial rule, territorial disputes, and history textbook disputes, etc. It was, therefore, a bold policy initiative for the two countries’ governments to discuss and even begin negotiations for a bilateral FTA in the early 2000s. The need to respond to the rise of China may be attributed as one of main contributing factors to this new movement towards improving the South Korean– Japanese bilateral relationship. Having started with a grand vision of making the FTA a milestone of future South Korea–Japan relations, in the beginning the initiative was welcomed by many societal groups such as businesspeople, academics, and a substantial number of politicians. However, this initially favorable mood was burdened by a number of political factors. Unless the Japanese government changes its right-wing political stance towards the Dokdo and history textbook disputes, the stalled FTA negotiations are unlikely to resume in the near future. Japan’s participation in the Trans-Pacific Partnership (TPP) agreement is another hindrance to the re-launch of a South Korea–Japan FTA, mainly because Japanese interest in this agreement has been diluted. The idea of the South Korea–China FTA came from a joint declaration by South Korean President Roh Moo Hyun and Chinese President Hu Jintao in November 2004. Negotiations for an FTA between two countries began much later, in May 2012. In contrast to the South Korea–Japan FTA, the negotiations on the South Korea–China FTA proceeded quite well. These official negotiations were based on a jointly undertaken feasibility study during 2005– 2006, which was followed by a four-year tripartite study conducted among the two countries’ government, business, and academic sectors. China, which had experience with FTA negotiations with ASEAN, Hong Kong, and Macau, as well as Taiwan, became very progressive in making an FTA deal with South Korea. With China having emerged as the largest market for South Korean export products over the past years, South Korea was favorably inclined towards an FTA with China. Though some issues, such as the sanitary quality of Chinese

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agricultural products and market-access threats from low-priced manufactured goods from China, caused some concerns on the South Korean side, the general acceptance of the FTA was relatively high in South Korea. The very fact that South Korea has been making trade surpluses vis-à-vis China for the past two decades consecutively was one of its selling points. The FTA was signed in June 2015, and went into force in December that year. The China–Japan FTA, in fact, is the one with the least progress. Japanese consumers have displayed a sizable antipathy toward low-price, low-quality products, and unsanitary agricultural goods from China. The traditionally protectionist Japanese farmers are also alarmed by potential large-scale market penetration from China. In addition, the Japanese business community expects that – considering the high Chinese trade barriers – any market access gains would not be high enough to compensate for the losses expected from Japanese liberalization measures. In addition to these economic concerns, the leadership rivalry between the two countries has been one of main obstacles to the launch of FTA negotiations, as well. Therefore, policy-making for this FTA deal has been proceeding slowly in both countries, and the China–Japan FTA is still in its infancy. In addition to these three bilateral initiatives, there is a sub-regional FTA initiative for Northeast Asia as a whole. In fact, this trilateral FTA initiative among Korea, China, and Japan had been feasibility-studied by the three countries’ think tanks throughout 2003–2009, and had been under a joint study involving the government, business, and academic sectors in the period of 2010–2013. The official decision to begin negotiations was made at the end of 2012. Since the beginning of 2013, the three countries involved have been undertaking official negotiations. Currently, there are both positive and negative signals for the Northeast Asian FTA negotiations. The official participation of Japan in the TPP negotiation could have a negative impact on the progress of the negotiation of the Northeast Asian FTA, because the Japanese interest may be diluted. Continuing political tensions in the region due to the territorial and history textbook disputes are another hindrance to a successful completion of the negotiation. The declaration of the 2012 Trilateral Summit Meeting in support of the official launch of negotiations provided a necessary impetus to the negotiation teams of each country. In addition, the establishment of the Trilateral Cooperation Secretariat (TCS) in Seoul in 2011 provides the negotiation process with welcome logistic and administrative supports.17 However, the talks have not yet made much progress.

Monetary and financial arrangements The idea of an A3 initiative extends not only to the trilateral FTA but also to monetary and financial arrangements.18 From an A3 countries’ perspective, the current model of regional integration based on ASEAN+3 fundamentally lacks an incentive mechanism. It is driven mainly by governments whose interests cannot be secured within the ASEAN+3 framework without a full mandate from

Progress of regional integration 61 their populace: A3 countries are the main donors of capital in regional monetary and financial integration such as CMIM and ABMI, but they are less likely receive the regional benefits. Also, there are striking differences among ASEAN members and it is difficult for A3 to discuss issues of common concern with them. In practice, the ASEAN+3 framework may end up creating an entity that does not fulfill any role to their mutual benefit. Therefore, this is the basic rationale for pursuing the agenda with A3 countries, whose feasibility is better than that of a bigger perimeter including all ASEAN+3 countries.19 As we observed during the global financial crisis, the CMIM under the ASEAN+3 framework was not effective in coping with the crisis and showed serious problems in its governance structure. Thus, if regional monetary and financial cooperation is to be effective in coping with future crises, it is better for three Northeast Asian countries to establish a separate fund, the A3Fund, based on contributions from their foreign reserves. In addition to its role as emergency liquidity facility, the A3Fund can also be used to guarantee local currency-denominated bonds in regional capital market. Such bond issuance with the guarantee of the A3Fund would promote financing for A3 mega projects of regional development and other regional activities that could not have been feasible within national boundaries, allowing for increased supply of public goods for the regional market.

2.2.

Trans-regional initiatives

There are a number of initiatives put forward as concepts for regional integration for the broader East Asian region. Some of them extend to the whole Asia, while others go beyond Asia and cover other continents as well.

Trade arrangements The Regional Comprehensive Economic Partnership (RCEP) is a regional FTA scheme of the ASEAN+3 members and Australia, India, and New Zealand. It was first suggested in November 2011. Those 16 countries supported the RCEP framework and launched their negotiations in November 2012. At that time, the leaders endorsed the “Guiding Principles and Objectives for Negotiating the Regional Comprehensive Economic Partnership” and announced that the RCEP would be “a modern, comprehensive, high-quality and mutually beneficial economic partnership agreement establishing an open trade and investment environment in the region to facilitate the expansion of regional trade and investment and contribute to global economic growth and development”.20 The RCEP will cover trade in goods and services; investment; economic and technical cooperation; intellectual property; competition; dispute settlement; and other issues. It will have broader and deeper engagement, with significant improvements over the existing three ASEAN+1 FTAs. The first round of formal RCEP negotiations was held in May 2012 in Brunei Darussalam, and the negotiations were initially targeted to be concluded by the

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end of 2015 – but they are still ongoing, as of this writing. The RCEP is viewed as an alternative to the TPP, a proposed trade agreement which includes several Asian and American nations but excludes China and India.21 There is a difference between the RCEP, the EAFTA, and the Comprehensive Economic Partnership in East Asia (CEPEA).22 While the membership of the EAFTA and the CEPEA is limited to a specific number of countries, the RCEP does not have a pre-determined membership. Since it is based on open accession, any of the original 16 countries can participate at the outset or later when they are ready to join, and membership is also open to any other external economic partners.23 A number of other trans-regional initiatives are related to the future development concept of Asia-Pacific Economic Cooperation (APEC), which has been suffering from identity and credibility crises.24 For example, the APEC has adopted the concept of the Free Trade Agreement for Asia-Pacific (FTAAP) as its long-term vision, especially to realize its failed attempt to institute the “free trade and investment in the Asia-Pacific region” under the Bogor Goals.25 The FTAAP initiative26 is in fact the first significant departure from the APEC’s long-lasting adherence to its guiding principle of “open regionalism”. As noted by Haesik Park and Yoon-Sok Lee, the two crises facing the APEC process since the outbreak of the Asian crisis in 1997 were the main motivations for the APEC to change its approach.27 In particular, the APEC member economies’ collective failure to meet the Bogor Goals, which gave rise to strong concerns over the APEC’s credibility, has led the APEC to shift from the original principle of open regionalism. Bin Sheng and Robert Scollay argued that the FTAAP initiative had already been proposed before the Asian crisis by the business sector in the Asia-Pacific region.28 But a meaningful shift of the APEC’s stance took place only after the crisis. The TPP initiative involved 12 countries before the US government left in January 2017.29 It had grown from the original four: Brunei, Chile, New Zealand, and Singapore. From its establishment in 2005 until 2009, the TPP operated under the name of “P4” and did not receive much attention from the international community, because all the four original members were small economies that had minimal influence on the APEC process and the world economy as a whole. However, since the US, Canada, and Japan joined the negotiations for an expanded TPP, it emerged as potentially one of most significant and impactful economic integration bodies in the Asia-Pacific.30 The TPP was planning to establish a high-quality FTA, including provisions requiring advanced degree of liberalization and opening on (i) environmental regulations, (ii) labor standards, (iii) regulatory frameworks, (iv) investment liberalization, and (v) state-owned enterprises.31 Once successfully established as originally planned – including the US – the TPP was expected to exert a large impact on the world economy in general and the Asia-Pacific economies in particular.32 However, in January 2017, US President Donald Trump declared US withdrawal from the agreement; in March 2018 the remaining 11 countries

Progress of regional integration 63 signed a revised version of the agreement called the Comprehensive and Progressive Agreement for Trans-Pacific Partnership.

Monetary and financial arrangements While the ASEAN+3 initiated the discussion on the ABMI, the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP) tried a separate initiative to develop regional bond markets by establishing the Asian Bond Fund (ABF). The EMEAP is a cooperative organization of central banks and monetary authorities in the East Asia and Pacific region. Its primary objective is to strengthen the cooperative relationship among its members, which comprise the central banks of 11 economies.33 In June 2003, the EMEAP announced the launching of ABF1. In subsequent developments, the ABF1 revealed a serious limitation as it could invest only in bonds denominated in US dollars, thus failing to resolve the currency mismatch problems in the region. Subsequently, the ABF2, which consists of the Pan-Asian Bond Index Fund (PAIF) and Fund of Band Funds (FoBF) and amounts to US$ 2 billion, was launched, allowing member countries to invest in regional currency-denominated bonds. The PAIF invests in eight EMEAP member countries’ bonds denominated in a regional currency according to a specialized institution’s bond index. The FoBF is a two-layered structure with a parent fund investing in eight Sub-funds, each of which will invest in sovereign and quasi-sovereign domestic currency-denominated bonds issued in the respective markets of the eight EMEAP economies.34 The Manila Framework Group (MFG) was established in November 1997, as deputy finance ministers and central bank governors from 14 countries within and outside the Asia-Pacific region agreed on a new framework for enhanced Asian regional cooperation to promote financial stability (the Manila Framework). The MFG was the first important regional cooperative framework after the Asian crisis, and was formed to cope with possible currency and financial crises. It worked through frequent exchanges of information and regional oversight as well as through a network of repurchase and swap arrangements to reinforce foreign exchange reserve positions. The MFG established a mechanism for regional oversight that was complementary to the IMF’s global oversight. This mechanism provided a basis for a more intensive and high-level process of oversight and dialogue among participating member countries, with support from the IMF, the World Bank, and the ADB. The MFG met twice a year from 1997 to 2001, and once a year thereafter. However, because it had no formal secretariat and included both Asian and non-Asian countries, it was prevented from functioning as an effective forum for peer pressure. The MFG meeting was eventually terminated in 2004. The role of the MFG as a regional forum was replaced by ASEAN+3 meetings, to which the IMF was not invited.35 Figure 5.3 shows the dense web of overlapping and multi-layered arrangements of regional integration initiatives in East Asia.

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TPP Canada, Chile, Mexico, Peru

RCEP

Australia Japan New Zealand Korea

ASEAN+1

ASEAN India

China EAFTA

CEPA

Hong Kong CJK FTA

Macau

Figure 5.3 Multi-layered structure of East Asian regional integration initiatives Source: Modification of Park (2009) Note: The TPP includes only Brunei, Vietnam, and Singapore in the ASEAN.

3. 3.1.

Features and benefits for North Korea of regional economic integration Main features and limits of East Asian regional economic integration

From the observation of existing regional integration arrangements and floating initiatives, we can identify a few features and limits of the regional integration process in East Asia. The evolution of East Asia’s regionalization has been mostly a result of market forces allied with national policies to liberalize and open the region’s markets. Regional integration in East Asia is thus more a spontaneous outcome of national policy initiatives for specific needs than the result of a grand scheme to create a single market for the region, as in Europe.36 Accordingly, the developments of regional arrangements have been somewhat ad hoc and reactive, with most having emerged in response to specific objectives and pressing needs. In general, regional institutions for integration in East Asia are characterized by an intergovernmental structure, consensus decision-making, nonbinding rules and commitments, low delegation, weak compliance, and robust sovereignty norms.37 East Asian integration has also shown some limitations. First, integration has advanced unevenly between the real sector and the financial sector. While the real sector is highly regionalized, the monetary and financial sector is more globalized than regionalized. Economic linkages of East Asian countries with

Progress of regional integration 65 the US and Europe in the real sector have declined. In contrast, as East Asian countries have started to liberalize and globalize the financial sector, their financial markets have become more and more connected to the world financial market.38 Second, uneven integration is observed within the real sector itself: Integration is focused mostly on production stage, while other areas are generally much less integrated. The networks of production facilities established in industries such as electronics, automobiles, and machinery in the region have tied the economies of many East Asian countries together through trade and FDI. But regional integration in final goods and services has lagged behind.39 Third, East Asia’s regional architecture is very complex: It comprises a dense web of overlapping institutional arrangements with overlapping agendas and memberships. Such a complex regional architecture reflects the region’s diverse geography, history, ideology, culture, and politics, as well as the influence of events and the external players. But the tangled web of overlapping bilateral and multilateral arrangements has created a spaghetti-bowl effect, whereby inconsistencies and conflicts between agreements potentially raise the costs of doing business as well as the welfare losses associated with trade diversion.40 Fourth, a serious obstacle to regional economic integration is that, compared to Europe, political leadership in East Asia is weak and fragmented.41 Furthermore, the political geometry of East Asia is more complicated, because of the continuous involvement of the US in East Asian affairs and the power rivalry between Japan and China and between the US and China.42 Another important barrier to the successful progress of East Asian regional integration is that East Asian countries do not have a common regional identity. In fact, unlike in Europe where traditional ideological warfare no longer exists, significant ideological and other barriers to regional integration remain in East Asia. The legacies of colonialism and the Cold War are prevalent and have a strong negative impact on regional identity. For example, there are still significant tensions remaining as a legacy of other aspects of 20th century history, especially in relation to Japan’s record of colonialism and warfare. Thus East Asian countries tend to hold to their national sovereignty and are reluctant to delegate matters to supranational institutions. In this context it is difficult for East Asia to form a regional identity.43

3.2.

Benefits of regional economic integration for North Korea

Despite the problems inherent in East Asia, participation in regional economic integration is probably the best option among various alternative strategies for North Korea to achieve the goal of economic reforms and modernization based on economic openness. In particular, utilization of a regional economic cooperation framework in East Asia will provide a good opportunity for North Korea to overcome the structural problems in its external economic relations and to encourage and sustain its development projects.

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First, if external economic exchanges are to provide meaningful impetus and momentum to economic development, international trade and foreign investment in North Korea need to grow much more than now. East Asia can provide the largest market for North Korea’s exports. According to the gravity model, two key variables that affect international trade are the size of the participating economies and the distance between trading partners: The trade between any two countries increases with the size of their GDPs and diminishes with the distance between them.44 The East Asian market is larger and growing faster than other regional markets. Also the neighboring countries with largest markets in the region, including Korea, China, and Japan, share a border with North Korea. Thus once North Korea is opened and joins regional economic integration, it can easily expand its trade with neighboring countries of large markets and close proximity. The expansion of external economic relations is not confined to trade, but also extended to foreign investment. In the world financial market, the East Asian region as a whole is a net creditor and capital exporter, and a huge amount of capital is readily available for investment in the region. In particular, big regional investor countries including Korea, China, and Japan are actively seeking new investment opportunities, because investments in their domestic markets are somewhat saturated and it is not reasonable to expect high returns. If big potential risks resulting from North Korea’s internal problems and external problems such as international sanctions are removed, North Korea can attract huge foreign investment for its economic development from these neighboring countries. Second, participation in regional economic integration not only expands the size of North Korea’s international transactions but also mitigates the country’s dependency on a specific country and a specific sector. In East Asia, there are many countries with different development levels and with different economic structures. For example, per capita income in Japan and Singapore is more than 30 times higher than in less developed countries in the region. If North Korea begins to trade with countries in the region, its comparative advantage will vary in different industries and its trade structure will be much more diversified than its current structure. Also, in East Asia, the regional/global value chain is expanding. If North Korea participates in the regional/global value chain, its opportunity to increase trade with more diverse regional countries will increase. As a country’s trade structure changes through expansion of external transactions and participation in a regional/global value chain, foreign investments can also be diversified from a specific industry to a variety of dynamic industries. The industrial transformation of a country definitely requires big investments in new industries. As a country’s industrial structure is transformed, its comparative advantage will also change dynamically.45 Therefore foreign investment in North Korea will also be diversified from a very primitive area to more advanced areas. Also the diversification of foreign investment would not be limited to manufacturing sectors but can be spread even to service sectors. According to recent studies of premature deindustrialization,46 many developing countries are

Progress of regional integration 67 becoming service economies without having had a proper experience of industrialization. If North Korea follows this new trend, the service industry may become a main engine of growth earlier than expected, which will attract foreign investment in service sectors. Third, expansion and diversification of trade partners and foreign investments in East Asia is likely to stabilize external economic relations of North Korea. It is expected that the regional market as a whole will continuously grow in the long run, even though individual countries may show some fluctuation in the business cycle. As its industrial and trade structure is upgraded through transactions with regional countries, North Korea will increase exports of high-end products, which are less sensitive than low-end products to price changes and business cycle. Also through participation in regional economic integration, North Korea can more easily contact and talk more casual business issues with neighboring countries, which will lead to a smoother movement towards economic reforms and opening of North Korea. Such a movement towards reform of the economy through regional cooperation would be politically more acceptable. To realize this possibility, it is necessary not only for North Korea to recognize the benefit that regional economic integration would bring, but also for neighboring countries to recognize that there are many positive potential roles for North Korea in the integration process. For example, North Korea can deepen and expand the regional production network, which has been a key factor in East Asian regionalization. The cross border production and trade networks explain the rapid increase of both trade and FDI flows among East Asian countries. This shift of FDI flow in East Asia from Japan, to the new industrialized economies (NIEs), to new emerging markets, and to China is significant for the regional division of labor. There is a change in the flyinggeese pattern of development that had characterized the international division of labor in East Asia with the stagnation of Japan and NIEs and the rise of China. North Korea can act as a “prolonged workbench” in the regional production network as other developing countries have done in the past; i.e. it could take advantage of its comparative advantage of low labor cost and good quality to specialize its production. This would both deepen and expand the regional production network, and further encourage intra-regional trade and investment. Also, North Korea can provide its neighbors with new and increased opportunities in infrastructure construction, resource development, and investment. Currently, there are two bottlenecks in economic growth that neighboring developed countries are confronted with: Lack of new investment opportunities and lack of supply to meet excessive demand for resources and energies. Once North Korea opens up external economic relations with regional countries, it could provide many new investment opportunities for infrastructure development. Also, North Korea is known for rich natural resources; its development could meet the demand for energy and natural resources in the region. Thus North Korea could boost regional economic growth and integration.

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Progress of regional integration

Furthermore, North Korea’s geopolitical features could help it contribute to further intra-regional integration. Geographically, North Korea is located at the center of the Northeast Asian region. Various pilot projects to realize regional integration are possible only with North Korea’s cooperation. North Korea can act as a land bridge for transcontinental projects, such as the connection of the Trans-Siberian Railway and Trans-Korean Railway, and natural gas pipelines running from Russia through North and South Korea. These strategies could greatly boost regional economic integration. They will increase regional investment to develop infrastructure such as railway or pipeline, and encourage intraregional trade by reducing transportation and energy costs for regional industries. North Korea can play an important role as a link between South Korea and Japan on one side and China, Russia, and even the European countries on the other side.

Notes 1 This chapter is borrowed from Rhee (2015), and modified and extended to fit into the framework of this book. 2 Henning (2011), p. 1. 3 ADB (2010), p. xii. 4 Zhang (2011), pp. 5–6. 5 This is discrediting the constructive leadership role of the ASEAN under the ASEAN-centrality concept. For a more detailed discussion, see Park (2010). 6 Eichengreen, Hausmann and Panizza (2002). 7 Moon and Rhee (2012), pp. 111–112. 8 The stigma effect of IMF assistance implies that approaching the IMF is seen as a sign by markets that a country’s problems are worse than thought. 9 This is from ASEAN+3 Macroeconomic Research Office. https://amro-asia.org/ about-amro/amro-and-the-cmim/#overview 10 Jang (2011), pp. 11–12. 11 Choi and Rhee (2013), p. 11. 12 For further information on the APCF, refer to the home page. www.asianprimecollateralforum.org/ 13 ADB (2010), p. 66. 14 Hur and Rhee (2015), pp. 88–89. 15 Moon, Rhee, and Yoon (2006). 16 Choi and Rhee (2013), pp. 12–13. 17 Jo (2012). 18 MoEF (2011). 19 Choi and Rhee (2013), p. 13. 20 ASEAN+3 Joint Leaders’ Statement on the Regional Comprehensive Economic Partnerships. https://asean.org/storage/2018/11/RCEP-Summit-2_JointLeaders-Statement_FINAL2.pdf 21 For a comparison between RCEP and TPP, refer to Dent (2017). 22 The CEPEA is a Japanese-led proposal for trade cooperation among the 16 member countries of the East Asia Summit. The East Asia Summit is a forum held annually by leaders of, initially, 16 countries in the East Asian region. Membership was expanded in 2011 to 18 countries, including the US and Russia. Wikipedia. 23 Wikipedia https://en.wikipedia.org/wiki/Regional_Comprehensive_Economic_ Partnership

Progress of regional integration 69 24 For a more detailed analysis of these two crises facing the APEC, see Park and Lee (2009). 25 APEC Secretariat (2013). https://www.apec.org/About-Us/About-APEC/ Fact-Sheets/Bogor-Goals 26 For a discussion on the desirability of the FTAAP, refer to Kim, Park, and Park (2013). 27 Park and Lee (2009). 28 Sheng (2007); Scollay (2005). 29 The 12 countries that participated in the TPP negotiations were Australia, Brunei, Chile, Canada, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the US, and Vietnam. 30 APEC PSU (2011). 31 According a USTR (United States Trade Representative) report, the US was confident that these provisions entailing a high degree of liberalization and deregulation in its partner economies would generate positive business conditions for US firms (USTR 2013). 32 Lee and Bang (2012). 33 Park (2005). The member states include Australia, China, Hong Kong, Indonesia, Japan, South Korea, Malaysia, New Zealand, the Philippines, Singapore, and Thailand. www.emeap.org. 34 Choi and Rhee (2013), pp. 10–11. 35 Moon and Rhee (2012), pp. 105–106. 36 ADB (2010), p. 3. 37 ADB (2010), p. 156. 38 Chai and Rhee (2006). 39 ADB (2010), pp. 83–84. 40 ADB (2010), p. 64. 41 Eichengreen (1997), p. 35. 42 Rhee (2004). 43 Moon and Rhee (2012), p. 192. 44 Krugman, Obstfeld, and Melitz (2015), pp. 42–47. 45 Lim, Haeran (1998), ch.2. 46 For example, see Rodrik (2015), Dasgupta and Singh (2005), and Grabowski (2017) among others.

6

North Korean trade policy Constraints and options1

Despite its population of 25 million inhabitants, the North Korean economy is tiny. In 2016, its GDP is estimated to be only 2 to 4.5 percent of South Korean GDP.2 This is equivalent to the GDP of one South Korean upper middle-size town such as Suwon or Daegu. As these estimates include very large militarydriven activities,3 North Korean “civil” economy is much smaller. Trade policy will thus be a crucial pillar of the North Korean growth and development strategy. Such a tiny economy deeply needs foreign markets where it can sell its products at better prices than at home, and where it can import goods and services at lower prices than those available at home. That said, the past 60 years deliver a clear warning message to trade policies which seek to open closed economies. Many trade policies have not promoted growth because they have been badly designed, and some of them have even created additional obstacles to growth. This chapter intends to provide the best possible information to North Koreans willing to understand the trade policy options that would be truly pro-growth. North Korea’s economy raises a very unusual challenge. It is so distorted by a chaotic mix of central planning and “private” initiatives (a mix of governmentlicensed operators, street vendors, and black marketeers) that there is no such thing as a “North Korean single market”, that is, a well-integrated set of local markets covering the whole territory. Rather, a multitude of poorly interconnected local markets coexist. In such a context, North Korean trade policy has in fact two goals. First, it needs to eliminate the many North Korean internal barriers that are the first obstacles preventing North Korean firms from producing what they can do best and North Korean consumers – households and enterprises – from consuming what they want and need. Second, it needs to progressively integrate this emerging north Korea Korean single market into the world economy. This chapter begins by presenting the two key principles for an economically sound North Korean trade policy that North Korea should adopt for its own good – hence stick to it at any cost – and the relatively unconventional negotiating tactic it should pursue in the short to medium term. Then, it should look at “reference” countries that have successfully adopted these two principles in order to draw concrete lessons for their implementation in North Korea. Finally, the

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chapter examines the pros and the cons of two departures from the key principles: The creation of FEZs in North Korea and the establishment of closer trade relations with South Korea. Once combined, all these elements show to North Koreans that the transition to an open economy is not the fall into a chaotic world that many fear, but can be a reasoned and manageable path to faster growth and higher development.

1.

Adopting two key principles for its own good

Designing a North Korean trade policy faces three unusual challenges. First and foremost, the chaotic mix of state planning and quasi-private operations makes very hard to get good detailed knowledge of the current North Korean economy and impossible to assess its economic potential once open to the rest of the world. Second, North Korea already faces a lot of international political tensions; hence, it should avoid to amplify them by trade conflicts that a badly designed trade policy will almost inevitably fuel. Last, but not least, North Korea is characterized by a complete lack of the institutions required by international trade operations. These challenges can be handled by adopting two principles that North Korea should follow at any cost because it is for its own good (not for pleasing potential trading partners). Imposing the same barrier on all imported goods – the “uniform tariff ” principle – is the best response to the ignorance of present and future North Korean economic capacities. Not discriminating among trading partners – the “most-favored nation” (MFN) principle – is the best response to the existing high international tensions in the region. Finally, dealing with missing institutions can be achieved by a systematic search of efficient and relatively cost-free substitutes.

1.1.

The uniform tariff: The best response to ignorance of the North Korean economy

There is no trustworthy and detailed information on the North Korean economy that would allow us to forecast or even guess its economic strengths and weaknesses in the world economy, that is, its “comparative advantages” – what North Korea could produce efficiently and export successfully. This profound ignorance flows from the fact that the current transactions inside North Korea and those between North Korea and the rest of the world are distorted by a host of constraints. Focusing on the North Korean economy itself, it could be best described as loosely and randomly related individual transactions – some imposed by central planning, other driven by private initiatives – rather than as continuous flows among well-connected markets. In a nutshell, there is no North Korean “single market” (to use the term coined for the EU). Pyongyang is largely isolated from the rest of the North Korean territory, the regions close to the Chinese border are to some extent connected to the Chinese economy, and the rest of

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the territory suffers from a terrible lack of transport infrastructure. Prices and availability of goods vary enormously depending upon time, location, and, crucially, operators – who are often in the position to grab unjustified and massive economic rents from these dysfunctional situations. Turning to the trade with the rest of the world, North Korean traders are often in a systemically unfavorable negotiating position when making deals with foreigners. Many of these distortions are created by political considerations that pay little – if any – attention to economic factors and can be quickly reversed. Not surprisingly in such circumstances, the basis on which we could forecast the future trade pattern is incredibly narrow. Estimates of North Korean exports and imports in 2016 were very small: They amounted to US$ 2.8 and 3.7 billion, respectively – hence a total (export plus import) trade to GDP ratio of roughly 22 percent of the North Korean GDP (on the basis of Bank of Korea’s estimates). This is only roughly 30 percent of the trade-to-GDP ratio of the poorest countries with comparable population sizes and GDP per capita. The current product composition of North Korean trade is not more useful for estimating North Korea’s strengths and weaknesses. Table 6.1 (see also Chapter 4) suggests that exports are dominated by mineral fuels (coal), ores (rare earth, zinc), apparel, and fish products, while imports are much more diversified (as usual), including mineral fuels (oil), machinery, and food products. However, these data are both incomplete and distorted. They are incomplete because they miss the large flows of smuggled goods generated by the chaotic North Korean economy;4 they are distorted because the traded quantities reflect the prices

Table 6.1 Product composition of North Korean trade, 2016 (unit: US$ million, %) Exports Code

Imports Products

Value

Share Code

Products

HS27 coals and mineral 1,193.2 42.3 HS27 coals and mineral oils oils 614.1 25.8 HS85 electrical/ HS62 apparel and clothing electronics 225.4 8.0 HS84 machinery and HS26 other minerals metals 196.0 HS03 fishery products HS87 6.9 cars and car parts 112.3 HS61 clothing 74.1 2.6 HS39 chemical products HS72 irons 55.3 2.5 HS54 synthetic fibers HS85 electrical/ 2.0 HS61 knitting cloths electronics All above Total exports

90.1 2,820.9

Source: KOTRA, North Korea Statistics

Value

Share

438.8 11.8 330.2

8.9

282.9

7.6

260.6 209.0 187.4 137.6

7.0 5.6 5.0 3.7

All above

49.6 3,710.8

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used by North Korea’s state-owned monopolies and private operators with foreign partners.5 Such prices have often very little to do with those that would exist in a well-functioning North Korean market economy. For instance, it is reported6 that North Korean ores have been sold at discount rates to Chinese intermediaries. Such discount prices inflate mechanically exported quantities, making difficult to estimate what could have been the “undistorted” trade flows for this possibly important export item. The situation in Chile, examined in Section 3.2, gives a sense of how huge such distortions can be. Which is the basic principle that North Korean trade policy should adopt if it seeks to reveal “true” North Korean comparative advantages? The uniform tariff imposes the same level of protection on all importable goods. Imposing the same tariff rate (say 20 percent) on goods A and B makes both products more expensive than the corresponding domestic goods – it protects the domestic production of both goods. However, it does not distort the demand of Good A relative to the demand of Good B: Imports of Good A will be larger than those of Good B if North Koreans desire Good A more than Good B. By contrast, imposing a 50 percent tariff on Good A and a 5 percent tariff on Good B discriminates heavily against the demand for Good A. In other words, the same tariff rate on all the importable goods keeps intact the demand pattern that all the North Korean consumers – households and firms – desire. This feature is a critical condition for healthy and undistorted growth of the North Korean economy in the long run.7 Implementing such an approach requires two concrete decisions: North Korea should use only tariffs for protecting its domestic economy and it should impose the same tariff rate on every product – these two components characterize the so-called uniform tariff principle. Why? First, tariffs are the only trade barriers that are fully transparent, hence easily predictable by every domestic producer or consumer.8 A 10 percent tariff raises the price of the imported good in North Korea by 10 percent, whether the good in question is a car or a T-shirt and whether the quantities imported before the imposition of the tariff are large or small. By contrast, other instruments of protection have an impact that is much less visible, hence easier to be captured by domestic and/or foreign vested interests. For instance, the impact of limiting the quantity of goods to be imported (imposing a quota) is hard to assess. A quota of ten cars or T-shirts generates price increases that will depend, among other factors, on the quantities imported before the imposition of the quota (limiting imports to ten cars is not the same if the previously imported quantity is 20 or 1000 cars) and from the strategies of the firms involved (in particular from their capacity to collude, for instance by sharing the quota among them, hence eliminating competitive pressures). Only well-established operators in the market in question – foreign sellers or North Korean importers – could guess these price increases and draw from their insider knowledge unjustified economic rents to the detriment to the whole North Korean economy. Second, imposing the same tariff rate on all imported products is crucial for attracting investment – the other key source of North Korean growth in

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addition to international trade. It will prevent investors – large and small, foreign, and domestic – from investing in a North Korean sector simply because this sector is more protected than the others. When tariff rates are different, businesspeople tend to invest in the goods protected by the highest tariff rates because these products are seen as the most likely to ensure high rates of profit – whether or not the country has a comparative advantage in producing the goods in question. Under a uniform tariff, businesspeople have no reason to take tariff rates into account in their investment decisions since there is one unique tariff rate for all imported goods. In other words, investment and production decisions by domestic and foreign investors alike will be made only on the basis of North Korean “real” economic factors of success: Production location, skills of the North Korean labor force, existing technologies, etc. For its own good, North Korea should thus adopt an uniform tariff and apply the same tariff rate on all imported goods. Doing so will ensure that only goods that are truly demanded by North Korean consumers – households or firms – are imported while granting some protection for domestic products. It will also contribute to creating a North Korean single market: An unique tariff rate on all imports, and the absence of quotas and economic rent at the borders, will make access to imports possible for all North Korean operators. Prices at the North Korean borders will progressively converge. However, they could diverge again within different North Korea regions or cities for reasons reflecting North Korean poor transport logistics that will be solved by investments in roads and railways. Sections 3 and 4 examine in detail how to implement this principle.

1.2.

MFN: The best response to existing international tensions

The current country composition of North Korean trade is heavily distorted by the trade sanctions related to the nuclear issue – especially since the strengthening of the sanctions in 2016. China’s lax enforcement of trade sanctions until 2016 massively increased its share in North Korean trade (from 20.4 percent in 2000 to 88.2 percent in 2016; see Chapter 4). Whether North Korean imports from China consist only of products of Chinese origin is open to question since there is no information on the magnitude of the trade of non-Chinese products transiting via China. During the last decade, South Korea’s share of the North Korean trade has sharply declined (see Chapter 4), reflecting the net effect of the increasing economic sanctions and the positive impact of South Korea’s support to intra-Korean trade (under the form of special tariff reductions, special financing and insurance schemes, mostly related to the KIC, which was closed in February 2016). As a result, as shown in Chapter 4, Table 4.1, the share of North Korean trade with countries other than China has gone down from 60–70 percent on average (in the early 2000s) to roughly 10 percent (2016), with almost no trade between North Korea and the EU, the US, or Japan. Such a concentrated country composition is clearly not propitious for the long-term growth of the North Korean economy: It does not ensure that imported goods come from

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the most efficient foreign producers, and it massively increases the risks and costs of trade conflicts mutating into political conflicts, and vice versa. By contrast, a well-designed trade policy based on the principle of the MFN enshrined in the General Agreement on Trade and Tariffs (GATT)–WTO Agreements eliminates these two shortcomings. According to the MFN provision, if one country grants to another a better (lower) tariff rate on imports of a product, it should extend this better rate to all the other WTO members, a process undertaken in particular during the GATT–WTO rounds.9 The use of this principle has allowed the GATT–WTO to deeply integrate an economic world that was initially sharply divided among developed, centrally planned, and developing economies. Imposing the same tariff rate on a given product coming from all its trading partners will ensure that North Korean households and producers buy foreign goods on the sole basis of their costs, undistorted by different tariff rates. Moreover, the MFN provision will diffuse political international tensions since North Korea will treat all its trading partners similarly10 – a key benefit for North Korea, which is already immersed in many political international tensions. For its own good, North Korea should thus adopt the MFN principle, i.e. apply the same tariff rate on imports of a given product coming from all its trading partners. Then the goods needed by North Korean consumers – households and firms – will come from the most efficient trading partners, not from countries having the highest political clout. Sections 3 and 5 give some information on how this principle has been implemented.

1.3.

Transitory simple substitutes: The best response to a lack of institutions

The literature on North Korea makes clear that key institutional conditions for a modern trade policy are not present: There is very little trust among foreign and North Korean traders;11 markets are distorted by official monopolies and “private” black or grey markets;12 and, ominously, highly volatile personal relation, generating unjustified economic rents.13 By contrast, a modern trade policy requires a wide range of well-developed institutions: Efficient and transparent customs, trusted agencies enforcing technical norms for food or industrial products, skilled regulators designing legal frameworks for services markets, etc. The problem is that these institutions take a lot of time to create, and even more time to be fully operational. What then should North Korea do in order to buy the time necessary for establishing such well-designed and functioning institutions? It should find substitutes as simple and cost-free as possible that could work as good proxies for these missing institutions in the short to medium term. These substitutes do exist. A first illustration is provided by the two combined principles of uniform tariff and MFN: If the tariff rate enforced by North Korea is the same for all the products that it imports from all its trading partners, then there is no need for a large and sophisticated customs system. A small number of

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customs officers could easily handle the task to levy this tariff. This simple and inexpensive solution provides a huge systemic benefit to the whole North Korean economy. As the uniform tariff is known to all the businesspeople and custom officers, opportunities for corruption are greatly minimized. This result seems trivial, but corruption at the borders is one of the largest sources of corruption in developing countries. In fact, it is considered as the “mother” of the long list of corruptions at every level of the production chain (see the case of Georgia in Appendix 6A). Other substitutes for missing institutions, such as an appropriate use of free-trade zones or a reliance on foreign institutions, are briefly presented in Sections 4 and 5.

2.

Pursuing an unconventional negotiating tactic

This section explores how to combine these principles to address the most pressing problem of today’s North Korean exports: the fact that they face the “statutory” tariff rates of North Korea’s trading partners. These tariff rates were adopted by national laws decades ago and often unchanged since then. As a result, they are extremely high – indeed, multiples of the MFN tariff rates that, after 70 years of GATT–WTO negotiations, most WTO members apply today to each other. North Korean exports face thus an insurmountable handicap compared to their competitors that should be addressed as quickly as possible. North Korea could achieve this goal by negotiating its accession to the WTO or by negotiating bilateral trade treaties. Most studies present WTO accession as the prime solution.14 This view ignores a hard-political constraint: A satisfactory solution to the denuclearization issue. This constraint is much more severe in the case of the WTO membership than in the case of bilateral trade agreements.

2.1.

WTO membership: The denuclearization snag

As long as the denuclearization issue is not resolved in a manner that is satisfactory to all the WTO members, there will always be members ready to oppose North Korea’s accession.15 Some WTO members will be driven by political convictions, others by sheer economic interests – not to let in a new potential competitor that will benefit from WTO advantages, in particular from MFN tariff rates that are several times smaller than statutory tariff rates. One could argue that, legally speaking, North Korea’s accession to the WTO could be put on vote. However, such a procedure is highly unlikely because a deeply entrenched WTO tradition requires a consensus for accepting a new member. This deadlock raises two questions from the North Korean perspective. How much will North Korea lose by not acceding quickly to the WTO? How can it manage the transitory period? These questions have international and domestic dimensions – the domestic dimension being the most important for North Korea’s growth and development. The international dimension is linked to the WTO itself. The WTO is a unique forum that ensures each WTO member gets maximum benefits from

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the MFN principle: Each member gets from all the other members the “best” tariff rate – the rate that the member in question has initially granted to some WTO members and then expanded to the others via GATT–WTO multilateral trade negotiations. In other words, the WTO gives to the MFN principle two dimensions: It ensures that a country does not discriminate against some trading partners when it imports (the “import” dimension); and it ensures that trading partners do not discriminate against the country in question when it exports (the “export” dimension). When North Korea adopts the uniform tariff principle, it meets the “import” dimension: It does not discriminate against trading partners, and it does so because this is the best solution for its own growth, as stressed in Section 1. However, the adoption of a uniform tariff by North Korea does not guarantee that all the other countries would not discriminate against North Korean exports. In the absence of WTO membership, North Korean exports are thus likely to face statutory tariff rates when entering some foreign markets. How big is North Korea’s loss? Not as big as it seems at first glance – at least in the short to medium term – for three reasons. First, WTO law (Articles XXXV-GATT and XIII-WTO) allows the MFN principle to not be applied in some instances, most notably in the case of nonmarket economies – and North Korea is likely to be a non-market economy for some time to come. Second, during the last 15–20 years, the MFN clause has been increasingly eroded by the proliferation of so-called FTAs that eliminate tariffs among FTA members, but keep them between FTA members and nonFTA members.16 Third, the North Korean economy will be so tiny for years to come that the country will not immediately need many foreign economies with whom to trade, hence many countries with whom to negotiate trade agreements – a welcome feature in the tense international context in which North Korea is immerged. Benefiting from the MFN clause by trading with a few partners – such as South Korea or China – would open enough opportunities for most North Korean exports. A few bilateral agreements would thus contain the damage of not being a WTO member in the short to medium term. By contrast, the domestic dimension of not being a WTO member could prove to be costly for North Korea for the following reason. When a WTO member negotiates tariff cuts, it often uses a mechanism called “tariff binding”. Binding a tariff means that a WTO member commits itself not to increase the tariff above a negotiated bound level. If it reneges on its commitment, the member can be requested to pay appropriate compensation to its WTO partners. If the reneging member refuses to pay this compensation WTO law allows its WTO partners to retaliate, which makes reneging costly. The threat of these costs has helped many governments to resist the pressures of domestic lobbies willing to reverse an ongoing liberalization process. Thus, not being a WTO member makes it more difficult for North Korean authorities to resist such internal pressures because there is no systemic and coordinated threat of retaliation from North Korea’s trading partners. As a result, North Korean authorities must have an unflinching determination to keep the domestic

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economy open. History shows that such a political determination tends to erode over time. One of the main reasons for China to join the WTO was that its unilateral market opening policy that boosted so much Chinese growth and development in the 1990s and early 2000s was under increasing attack by Chinese vested interests that were unable to adjust to foreign competition. To sum up, the non-accession of North Korea to the WTO may not be so costly in the short to medium term, when its economic size is still tiny and when initial support for opening the economy is still strong. However, these costs are sure to increase over time: A larger and more diversified North Korean economy will need MFN tariffs from more than a limited number of trading partners, and initial enthusiasm for a more open economy will be increasingly under siege by domestic vested interests unable to cope with foreign competition. In short, WTO membership will become increasingly attractive.

2.2.

Concluding bilateral trade agreements

The transition period for WTO accession could be short or long, depending on how quickly a satisfactory solution to the denuclearization issue is achieved. During this transition period, North Korea will need to negotiate bilateral trade agreements with a few trading partners in order to shift (as much as possible) from exorbitant statutory tariff rates to tariff rates as close as possible to MFN tariffs.17 How to assess North Korea’s situation on this front? The North Korea–US trade agreement is expected to be the most difficult to negotiate. This is due to the key role of the US Congress in US trade policy – a role unmatched by the parliaments of the other democracies. Congress makes things difficult because its members (as any member of a parliament) focus more on the interests of their narrow constituencies when dealing with international trade matters than on the interests of the whole country. Since 2017, the Trump Administration has been adding a new layer of difficulty with its denial of the mutual benefits that partners receive from trade and its antagonistic stance in trade matters. However this chapter assumes that the Trump trade policy will be an “abnormality” in the long run because the American people will increasingly realize that the costs of such a policy are bigger than its benefits for a large majority of them.18 A return to the more balanced approach of previous US presidents can thus be expected, though arguably it could be incomplete and/or slow in coming. This chapter assumes thus that the US Congress will be the main source of difficulties for North Korea. What does that mean exactly for North Korea? In 1974, the US Congress included the so-called Jackson-Vanik amendment to US trade law.19 This amendment deals with “freedom” rights in non-market economies: e.g. the “freedom to emigrate” of Soviet Jews or the absence of “human rights for workers” in China. These rights have no direct link with trade. However, this amendment uses US trade measures against a country as the stick to get these freedom rights enforced. More precisely, it allows the US government to deny the benefit of MFN tariffs to any non-market economy – be a

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WTO member or not – as long as Congress perceives the partner in question is perceived as denying its citizens these essential rights. This is broad and vague enough to give de facto powerful leverage to US negotiators dealing with trade issues with non-market economies. This amendment is almost certain to be invoked in the case of North Korea; the only uncertainty is the “freedom” right that could be invoked by Congress. Hence, it is essential for North Korea to assess the leverage that the amendment gives to US negotiators in the North Korea–US trade negotiations. Denying North Korea the benefit of MFN tariffs means that its exports will continue to face US statutory tariffs as long as the freedom right that Congress defines for North Korea is not met. It is only when Congress decides that this right is met by North Korea that the US will grant the status of “permanent normal trade relations” (PNTR) to North Korea and the MFN tariffs that go with PNTR. The Jackson-Vanik amendment also includes a “carrot”: It allows the US president to ask Congress for an annual waiver of the denial of the PNTR status if the president is convinced that such a waiver would encourage a “positive” evolution of the non-market economy in question. This positive evolution has generally been interpreted by US negotiators as the partner opening its economy more widely to US goods, services, and investment. When the exporters in the non-market economy benefit from such an annual waiver, they realize the massive benefits generated by being subjected to US MFN tariffs as compared to statutory tariffs. Hence, they become strong advocates of the “positive” evolution of their country. The bilateral trade negotiations between the US and Vietnam offer a good illustration of the US negotiating leverage. Table 6.2 shows a clear synchronization between the use of the Jackson-Vanik amendment and trade deals between the US and Vietnam. The March 1988 first annual presidential waiver follows the April 1987 agreement on intellectual property rights in the entertainment sector. The renewable three-year bilateral trade agreement enacted in July 2000 and the July 2004 Agreement on garments and textiles precede the May 2006 US agreement on Vietnam’s WTO accession. The May 2007 bilateral agreement on maritime issues and the June 2007 Trade and Investment Framework closely follow the Congressional action granting PNTR to Vietnam (which was enforced on 29 December 2006) and Vietnam’s accession as the 150th WTO member on 11 January 2007). What could be the effect of the Jackson-Vanik amendment in the case of North Korea? As the amendment’s potential impact depends upon the size of the non-market economy relative to the US, it is a powerful tool in the hands of US negotiators in the North Korea–US bilateral agreement. Not granting PNTR (thus denying MFN tariffs) is a double-edge sword: If the US denies MFN status to a trading partner, this trading partner denies such status to the US. However, the smaller the trading partner’s economy, the more negligible the costs for the US – and the higher the Jackson-Vanik leverage in favor of the US.

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Table 6.2 Milestones in Vietnam–US trade relations, 1989–2007 1989

May

First discussions on normalization of bilateral ties

1991

April

US “roadmap” for phased normalization of Vietnam–US ties

1994

February

US lifts its trade embargo on Vietnam

1995

January

Vietnam’s formal request for WTO accession

1996

May

US presents Vietnam with trade agreement blueprint

1997

April

Vietnam–US agreement on providing legal protection for copyrights owners

1998

March

Presidential waiver of the Jackson-Vanik agreement on Vietnam

1999

July

Principle of a bilateral trade agreement signed

2000

July

Conclusion of the Vietnam–US bilateral trade agreement (to be renewed every three years)

2001

November

Bilateral trade agreement ratification by Vietnam’s National Assembly

2001

December

Bilateral trade agreement entry into force

2002

June

First major US antidumping case against Vietnam (catfish)

2003

July

Vietnam–US Garment and Textile Agreement signed

2004

January

Second major US antidumping case against Vietnam (shrimp)

2004

December

Bilateral trade agreement renewed by the US

2006

May

Vietnam–US agreement on Vietnam’s WTO accession

2006

November

Ratification of Vietnam’s WTO accession protocol by Vietnam’s National Assembly

2006

December

US Congress passes law granting PNTR to Vietnam

2007

January

Vietnam becomes the 150th member of the WTO

2007

March

Vietnam–US maritime agreement signed

2007

June

Vietnam–US Trade and Investment Framework agreement

Source: USTR website

However, today North Korea is in a more favorable situation than, for instance, Vietnam in the 1990s and 2000s, because North Korea has more alternatives to the US market than Vietnam had. North Korean–Chinese relations are better than those between Vietnam and China (which were episodically at war between 1979 and 1991) and the size of the Chinese economy is much larger today than two decades ago. South Korea, with its GDP 30 to 50 times larger than North Korea’s (depending on estimates), offers large-enough opportunities to North Korean exporters that South Korea could not offer to Vietnam 30 years ago. The EU has pivoted substantially to East Asia, and Russia has made a significant comeback. That said, the Vietnam case has one last important lesson for North Korea: The first bilateral trade agreement that North Korea signs should be consistent

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with an overall economic strategy focusing on growth in the long run. North Korean negotiators should concede and stand firm with a clear view of North Korea’s long term economic interests. Vietnam did not have this long-term view. In its trade negotiations with the US, it decided to keep intact its high protections for the inefficient state-owned firms that were operating in sectors that were of little interest for US exporters, and hence under little US pressure to open them. Vietnam’s long-term economic strategy would have been better served by an US–Vietnam trade agreement that progressively opened these inefficient sectors in order to allow their workers and capital to be reallocated to the new and promising sectors. The long-term costs of this choice have been substantial: Over time, Vietnamese state-owned firms have required more subsidies and generating more corruption, endangering the remarkable success achieved by the Vietnamese private sector since the 1990s.20 Keeping early negotiations consistent with a strategy for long-term growth is not an easy task because trading partners will try to get concessions from North Korea that fit their own interests – whether these concessions benefit the North Korean economy in the long run or not. Section 3 discusses how a uniform tariff would help to get this task done.

2.3.

Back to WTO membership

Progress in denuclearization will determine the pace of WTO accession. Initial progress, when it is substantive enough, could open the door to Observer status. That would allow North Korea to learn the complexities – and traps – of the WTO, its rules, and its negotiating processes. At one point in time, progress in denuclearization will be sufficient to open the door to full membership. This membership would not require prior political unification of the Korean Peninsula: North Korea could accede under the status of a “customs territory”, with the same rights and obligations as any other WTO member, as it is today the case of Hong Kong, Macao, and Chinese Taipei. One of the very first important decisions that North Korea should make in the WTO is how to “qualify” its economy. Would it be classified as a “least-developed country” (LDC) or as a “developing economy”? This choice will be a North Korean decision. At first glance, the LDC status looks attractive because it opens widely the markets of the industrial countries to the LDC’s exports without requiring from the LDC in question commitments to open its own markets. However, such a status will be a trap for North Korea’s long-term growth strategy. Both economic analysis and the last 70 years of trade policies show that free access to the markets of other countries is not conducive to growth and development for a country if the country in question does not open its own markets. This is because imports of better and/or cheaper goods and services are a critical ingredient to make the economy of the country in question more efficient, hence to enhance its export capacity and ultimately to grow. The next section shows how the uniform tariff and MFN principles helps to avoid this LDC trap.

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North Korean trade policy

3. Looking for appropriate “reference” countries Are there countries that could be inspiring “references” for North Korea? The uniform tariff and MFN principles are rather abstract. They deserve to be supported by evidence that shows they work well and that also suggests interesting lessons on how to successfully implement them. Countries should meet three conditions to be appropriate references. First, they should share key political and economic similarities with the current North Korean situation: Tense international environment, heavy reliance on raw material exports, low GDP per capita, and transition from a non-market or highly regulated economy. Second, they should have followed a trade policy based on the principles spelled out in the first section: non-discrimination in terms of goods (uniform tariff) and countries (MFN). Third, they should exhibit good performance in terms of economic growth and institutional effectiveness. Looking for reference countries deserves a preliminary caveat. Trade policy is only one of many economic policies (fiscal, budgetary, social, etc.), hence it is not the only source of successful growth. However, countries that have adopted non-discrimination in terms of goods and countries and cared about improving their institutions have often followed “non-discriminatory” policies in the other economic domains, such as adopting a limited number of domestic indirect tax rates (non-discrimination among taxpayers), enforcing well-designed industrial and subsidy policies (no or minimal discrimination among domestic firms), etc. What follows provides some evidence supporting this observation.

3.1.

East Germany and China?

Many studies on North Korea look at East Germany as a reference, in particular those focusing on monetary union (see Chapter 2). However, it is not such a suitable case from a trade point of view for economic and political reasons.21 From an economic point of view, East Germany was one of the best run economies in the Soviet Union’s block. In 1991, its GDP per capita amounted to 43 percent of West German’s GDP per capita, ten times more than the proportion of North Korean to South Korean GDP per capita. The East German economy relied on an infrastructure that was operational, even if it was ageing rapidly due to a lack of investment. If corruption was high – as in any centrally planned economy – it remained within acceptable limits. East Germany is not a good reference from a political point of view either. West Germany and East Germany did not fight a civil war. In the 1990s, the US’s international influence was at its peak while it became rapidly clear that the Soviet Union would not interfere with German reunification because it was absorbed by its own difficult transition problems and had not enough financial resources to intervene. Today, the balance between the US and China is very different. That said, one crucial lesson should be drawn from German reunification: The catching-up process takes decades, and it is painful. Despite a wide consensus on the world trade regime in the 1990s–early 2000s and the improving

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83

economic situation in East Germany, the integration of East and West Germany is even now a work in progress: In 2017, the eastern German GDP per capita still amounts only to 73.2 percent of the western German GDP per capita.22 This gap is big enough to feed nostalgia for the communist era in some parts of eastern Germany and to explain the recent rise of populism in this region. China could be seen as another possible reference country, for obvious reasons. However, its economic size and its leverage in international fora make China unique. Nonetheless, despite the very different context, it is interesting to note that the Chinese unilateral liberalization process in the 1990s and early 2000s has broadly followed the two principles stated in Section 1. First, roughly 80 percent of Chinese quotas on imports were eliminated between 1992 and 1999 in a strong shift to tariffs as the main means of protection.23 Second, the average tariff rates collected in 1997 were very similar across industries, indicating a de facto uniform tariff policy.24 Finally, the MFN principle was seen as key by the Chinese leadership. However, it could be reached only by negotiating WTO accession (which took a long time) since bilateral trade negotiations with the US and the EU were not politically feasible options.

3.2.

Suggesting reference countries

Table 6.3 presents a few countries that are good references for North Korea: the Baltics (Estonia, Latvia, and Lithuania), Georgia, Mongolia, and Chile. It also includes South Korea for comparison sake. Block A shows that all these countries have been exposed to serious international tensions – Russian minorities in the Baltics’ case, and for Mongolia, the fact that it is a landlocked country with only two neighbors. Block B presents the GDP per capita (in constant 2010 US dollars) for the year when one can consider that the main trade liberalization decisions have been made.25 Block C provides information on how deliberate and clear was the adoption of the uniform tariff principle (see Appendix 6A for details) and of the current average tariff rates (the average for all the tariffs and the average for the maximum tariffs only). Block D and E summarize the performances achieved by these countries. Block D shows that the growth rate of these countries has been substantially higher than the world average rate (three times for the Baltics, Mongolia, and Chile; four times for Georgia) and sustained during the 15 years following the introduction of the uniform tariff. Block E presents institutional performances based on the World Bank Doing Business indicators:26 The rankings of the summary indicator (Ease of Doing Business) in 2011 and 2018, and the ranking of Trading Across Borders indicator in 2018.27 These rankings provide two observations. First, adopting a uniform tariff policy tends to be correlated with remarkable rankings (Baltics, Georgia), with Mongolia being the only clear exception. Second, South Korea exhibits excellent institutional performance, despite the fact that it does not implement an uniform tariff. In other words, it seems to have compensated for the complexity of its trade regime by better institutions (for instance, its top-notch customs service). As a result, North

1.3

Population (2017)

2.0

medium/high

medium (27%)

Latvia

2.9

medium/high

low (6%)

Lithuania

1995

largely

yes

0.0

Uniform tariff

Average tariff rates [b]

1995

3.2

largely

2001

5,322

1.4–1.4

almost

2000

1,943

17

Indicator 2 [f ]

26

24–19 19

23–14

5.6

11,984

2010

43

12–6

6.3

4,290

2017

117

73–74

5.4

3,366

2012

71

43–55

4.6

9,101

1999

11.0–11.0

yes

1949 (GATT)

4,618

1984

17.9

low

low

Chile

8

16–5

5.8

17,137

2003

12.7–143

no

1967 (GATT)

7,346

1988

50.8

high

low

South Korea

Notes: [a] For the Baltics, figures in parenthesis give the percentage of Russian population in the total population; for Georgia, see Appendix 6A. [b] The first figure gives the average for all the tariff rates, the second the average only for the maximum tariff rates in 2016. For the Baltics, data are only averages for all tariff rates prior to EU accession, see Appendix 6A. [d] Only 13 years for Georgia. [e] Compound average growth rates. [f] Indicator 1: Ease of doing business ranking for 2011 and 2018, respectively. Indicator 2: Trading across borders ranking for 2018.

Sources: World Bank database for GDP and population. WTO and Table A1 for uniform tariff protection. Doing Business Report (2019) for institutional performances (189 countries).

17–12

Indicator 1 [e]

E. Institutional performances

11,326

14,638

47

GDP per capita

Annual growth rate [d]

5.4

2010

2010

Year [c]

12.7–14.3

largely

1997

1,524

1997

3.0

3.9 2004

land-locked

low

Mongolia

high

high

Georgia

D. Growth performance during the 15 years after liberalization (in constant 2010 US dollars)

10.0

1999

5,140

1999

GATT/WTO Accession

C. Trade policy indicators

1995

7,313

Year of liberalization

GDP per capita

B. GDP per capita for the year of liberalization (in constant 2010 US dollars)

medium (24%)

medium/high

Internal tensions [a]

International tensions

A. Political environment

Estonia

Table 6.3 A brief presentation of countries of interest for North Korea

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85

Korea would be well inspired to use South Korean customs services (see Sections 4 and 5). Chile is a particularly interesting case for North Korea because it was the first country in the world to enforce a MFN uniform tariff, hence to confront two key problems. At which level should its uniform tariff rate be set? And at which pace should it be implemented? The lessons for North Korea are crucial in this respect. In 1973, Chile began a much-needed tariff reform: Its average tariff rate was 105 percent, with many peaks as high as 750 percent, combined with many quotas and a multiple-exchange rate system. However, as shown in Figure 6.1, the average tariff rate in 1975 was still 57 percent. The Chilean government decided to introduce an uniform tariff. The initial plan was to impose a 10 percent tariff (an extremely low level by the standard of the late 1970s) within a very short period (four years). This “big bang” strategy failed. Domestic and foreign investors did not have time needed to realize the main benefit of a uniform tariff, which is to provide a healthy framework for investment decisions (see Section 1). As a result, investors lobbied vigorously against this liberalization. The macroeconomic crisis of 1982–1984 forced the Chilean government to backtrack and to double the tariff rate. Crucially, however, the higher tariff rates – first 20 percent and then 35 percent – were kept uniform during this process of backtracking. The 35 percent tariff was high enough to assuage the fears of domestic and foreign investors and producers, allowing them to realize the uniform tariff’s positive impact on their investment decisions. As a result, and despite a major political change (Chile

(unit: %) 60 50 40 30 20 10

1975.01 1976.03 1978.01 1979.03 1981.01 1982.03 1984.01 1985.03 1987.01 1988.03 1990.01 1991.03 1993.01 1994.03 1996.01 1997.03 1999.01 2000.03 2002.01 2003.03 2005.01 2006.03 2008.01 2009.03 2011.01 2012.03

0

Figure 6.1 History of the uniform tariff in Chile, 1979:1–2011:4 (trimester basis) Source: Corbo (1997) and WTO (2013)

86

North Korean trade policy (unit: US$ thousand)

100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010

Figure 6.2 Chile’s exports of goods and services, 1974–2012 (2005 constant US dollars) Source: World Bank, World Trade Indicators.

shifted from an authoritarian regime to a democratic regime in 1990) there was no reversal of the tariff policy and no opposition to subsequent tariff cuts. Since 2003, the Chilean uniform MFN applied tariff has been 6 percent. As illustrated in Figure 6.2, these changes were driven by booming Chilean exports combined with a fast and strong diversification in Chile’s production and export structure – from overly dominant exports of copper in the late 1970s to the current diverse export pattern, which includes farm and food products and services. This deep structural change illustrates what could happen in North Korea if it uses the same trade policy. Aside from these positive results, the most important lesson from Chile is on how to introduce the uniform tariff policy in a politically acceptable manner. An uniform tariff that is initially “too low” runs the risk of being misunderstood by domestic and foreign businesses who feel endangered to the point that they do not realize the benefit of the uniform tariff – hence resulting in the political failure of the liberalization policy. Announcing a fast implementation schedule compounds these risks. In short, what counts is not hastiness, but progressivity and perseverance. It seems thus politically wise to open the North Korean economy by initially imposing a relatively high uniform tariff rate.

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87

An additional reason for a cautious start is that North Korea is likely to still have a number of powerful state-owned enterprises when it starts its trade liberalization process – as of November 2018, there is no official plan to privatize these enterprises. In such a context, the lower the initial uniform tariff rate, the stronger the pressures from state-owned enterprises for getting exceptions to this tariff. If granted, these exceptions would be very difficult to remove. A distorted economy would then emerge in North Korea, with a highly protected and increasingly inefficient sector of state-owned enterprises endangering the growth of the rest of the economy – as in Vietnam. This cautious scenario raises the question: How high is “high”? Technically, collecting good information on these grey prices and comparing them with world prices could provide a sense of the average tariff protection of the North Korean economy before the trade reform. However, this method is time consuming and sensitive to the quality of the information collected. Non-market economies are notorious for their poor capacity to provide accurate information on their functioning – in fact, most operators have a strong interest to hide the economic rents they extort from the system. As a result, North Korea may have no alternative other than the pragmatic approach followed by Chile: Impose an arbitrary uniform tariff high enough to give domestic and foreign investors in North Korea the time necessary to realize the benefits of a uniform applied tariff on their investment decisions. Then, two forces will progressively exert pressures to reduce this initially high tariff rate. First, the realization that the level of the uniform applied tariff plays no role in relative investment and production decisions will prompt support from domestic and foreign firms, which will allow the government to reduce progressively the applied tariff rate.28 Second, North Korea could use its first bilateral trade agreements as a source of pressure to progressively reduce its initial applied tariff rate. In this case, North Korea’s main concession in these agreements would not be to cut certain tariffs while keeping others unchanged (a damaging move since it would generate distortions in the North Korea economy), but the pace at which the uniform applied tariff will be reduced.

4. Departure from the principles: FEZs Imposing a initially high uniform tariff rate on all the North Korean imports would impose a drag on its growth: It would make expensive the purchase of the goods and machines that North Korean firms need to import massively in order to increase the efficiency of their existing productions or to develop new industrial activities. A first solution to this problem could be a system of drawbacks: Tariffs levied on imported goods and equipment utilized in North Korean production would be given back to the producers importing them. South Korea has used this system widely. However, this requires an efficient and uncorrupted customs service – an institution that South Korea has nowadays, but that will take years to build in North Korea (as indeed it did in South Korea).

88

North Korean trade policy

Another solution is to establish FEZs, that is, well-defined areas in North Korea that are specifically devoted to the production of industrial goods for export (and their related services). Foreign products and equipment needed for this production are imported into the FEZs at a zero or very low uniform tariff – hence avoiding the costs generated by the high uniform tariff imposed on imports into the rest of the North Korean territory. That said, FEZs have additional benefits and costs to explore.

4.1.

Taking full advantage of the benefits from FEZs

First, FEZs offer an efficient solution to North Korea’s severe lack of modern transport infrastructure. It would take time to build all the roads and railways that would be necessary for industrializing the whole of North Korea. FEZs minimize the immediate need for a modern transport infrastructure, especially if they are built on the coasts (as probably they would). In other words, instead of delivering goods and equipment to every part of the North Korean territory, it is much less expensive and faster to allow North Korean workers to move to a few FEZs at the initial stage of economic development. One could argue that building a modern transport infrastructure for the whole of North Korea would not be a big problem for large South Korean or Chinese conglomerates. However, it would inflate the North Korean debt and/or shift North Korean public investment away from other essential activities, such as education or basic health services. Another key benefit of FEZs concerns the North Korean workers hired by the industrial enterprises and the associated services sectors based in FEZs. Concentrating workers in FEZs would help to accelerate the accumulation of technological knowledge. This would favor more efficient investments in technical schools, and it would encourage North Korean workers to improve their skills, because they would be in competition with other skilled workers. In short, FEZs have a key role to play in the accumulation of human capital in North Korea – a key factor in long-term growth. Finally, FEZs could also play a positive role in the bilateral agreements that North Korea would need to negotiate. Including a timetable of the progressive cuts to the uniform applied tariff in these agreements (as suggested in Sections 2 and 3) may be felt as a too rigid constraint by North Korea. By contrast, FEZs represent a fast and deep liberalization of a notable part of the North Korean economy as well as a strong instrument for accelerating and amplifying North Korean industrial growth. This role would be enhanced if FEZs become part of the network of the preferential trade agreements (PTAs) concluded by North Korea’s trading partners. This is not the case today. For instance, goods produced in the KIC were excluded from the coverage of the current FTAs between South Korea and the EU or the US – hence not eligible for the zero tariffs that South Korean goods enjoy in these two large markets. As stressed in Box 6.1, the “internationalization” of the KIC has had the explicit objective of achieving this goal.

North Korean trade policy

89

Box 6.1 “Internationalizing” the KIC: Testing the potential of trade policy to diffuse political tensions The KIC provides a fascinating illustration of this capacity of trade policy to diffuse political tensions. In early 2013, the complex was at the epicenter of the tensions in the Korean Peninsula, and one of the best illustrations of how bilateral trade agreements can be subjected to and magnify international tensions.29 The decision taken jointly a few months later (in August 2013) by the North and South Korean authorities to “internationalize” the KIC was a huge step in using the trade policy to reduce political tensions: Involving other countries in the KIC dramatically changed the status of the KIC by making it implicitly more “WTO-like”. In 14 August 2013, South and North Korea agreed on the normalization of KIC after 133 days of crisis. The joint declaration stated that no further closure of activities at KIC should occur, either by blockage of workers, or their withdrawal, and emphasized the neutrality of the KIC from political tensions. In this joint declaration, the two parties also agreed on concrete measures for internationalizing the KIC that would include (i) active promotion of foreign enterprises in the KIC; (ii) institutional reforms in labor, taxation, and wages, as well as ensuring that insurance policies meet international standards; (iii) the implementation of a special tariff rate for exports to third countries; and (iv) an opening of a South– North joint Foreign Investment Fair.30 On 11 September 2013, the second meeting of the South–North KIC Joint Committee, which had been established by the joint declaration on the normalization of the KIC, agreed to sponsor a common foreign investment fair for foreign enterprises in October 2013. However, a more permanent “internationalization” process would require further elaboration on the side of the South Korean government by addressing institutional issues such as taxes and the possibility of recognizing the goods produced in the KIC as products of South Korean origin in the context of the FTAs that South Korea had signed (e.g. with the EU and the US). The joint committee also agreed on the composition of a “Commercial Arbitration Council” to serve as a dispute settlement body for the in KIC. The Commercial Arbitration Council was initially agreed in 2003 between South and North Korea, but it was never put into practice.31 The KIC was closed in February 2016.

4.2.

Handling the costs generated by FEZs

FEZs generate two main categories of costs. First are those related to their day-to-day management. To be attractive, FEZs require swift and accurate customs controls, hence they need efficient customs systems that North Korea

90

North Korean trade policy

will not have for some time. However, this situation offers another opportunity to find an efficient substitute to missing institutions. Because FEZs are limited areas of North Korea, their managers could request technical support from the very efficient South Korean customs authority. This support would ensure that FEZs would benefit from the most modern customs techniques. This solution has also a broader advantage in the long run: It would prepare the way for a customs unification of the Korean Peninsula. For instance, traded goods are classified according to a list of products called the Harmonized System (HS). The HS is fully normalized at the world level only for its six first digits. It would make sense for North Korea to go further by adopting the South Korean HS classification, which is more detailed, as well as the South Korean customs’ interpretations that such a list requires when dealing with millions of different products. Following the South Korean customs “rule book” would save a lot of time and allow North Korean authorities to avoid many mistakes. It would also simplify the establishment of closer relations with South Korea that are examined in the next section. The second cost is due to the co-existence of a low or zero tariff for the FEZs and a (initially much) higher uniform applied tariff for the rest of North Korea. This situation creates strong incentives to smuggle goods imported in the FEZs into the rest of North Korea. The higher the uniform tariff rate imposed on imports entering the rest of North Korea, and the lower the tariff rate imposed on imports entering into FEZs, the higher the likelihood of smuggling – and the greater its magnitude. This is not only a matter of losing fiscal revenues. Above all, it is a diversion of the resources imported for being efficiently used in FEZs into the much more inefficient rest of the North Korean economy. An efficient customs system in the FEZs could contribute to the solution of this problem in the short to medium term, with its elaborate means of “tracing” goods. However, the true solution in the long run is to make smuggling less and less profitable: This can be done only by progressively reducing the initially high uniform applied tariff adopted for the rest of the North Korean territory. In other words, FEZs would be a useful source of pressures to reduce this tariff rate. By the same token, they contribute to reducing the fragmentation of the North Korean domestic economy and to creating a North Korean single market for goods and services.

4.3.

A key condition for successful FEZs

On balance, creating well-managed FEZs in North Korea seems to be a positive departure from the two basic principles set in Section 1. FEZs do not endanger the uniform tariff principle adopted for the non-FEZ North Korean territory while they exert pressures to reduce this tariff over time. They offer an opportunity to grant valuable concessions to the partners with which North Korea would like to sign bilateral agreements. They support North Korea’s long-term economic strategy because they accelerate industrial growth and the accumulation of modern technical skills by North Korean workers. They contribute to

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91

the progressive creation of a North Korean single market as well as to its integration into the world economy. That said, there is one key condition for a successful FEZ scenario. There should be very few FEZs – probably two to three at most. The North Korean economy is so tiny that more industrial FEZs would mean that each FEZ will not draw the attention of foreign and domestic investors. They will attract small foreign capital (if any) and few North Korean workers – not enough to fuel a successful large-scale North Korean industrialization and “servicification” (the development of the services sectors in North Korea). It is important to stress that this condition is not met, since there are currently more than 25 SEZs (see Chapter 4, Figure 4.9).

5.

Departure from the principles: Closer trade relations with South Korea

Most studies of the North Korean trade policy focus on the establishment of closer trade relations between North Korea and South Korea.32 Such a focus has deep roots in a long political debate in South Korea – from President Kim Dae-Jung’s visit to North Korea to the South–North Joint Declaration on 15 June 2000 to President Roh Moo-Hyun in the South–North Korea Summit in May 2007. This perspective was renewed with President Park Geun-hye stressing Korean unification as a “jackpot” for the whole East Asian region at the 2014 Davos Forum, and with President Moon Jae-In in the April 2018 South–North Korea Summit. This section examines these closer trade relations within the much broader and more complete framework developed in the previous sections. This perspective allows a more detailed assessment of what needs to be done by both parties for a successful trade integration of the Korean Peninsula. That said, what follows has a precise goal: It presents the pros and the cons of a FTA and a customs union – the two main options for establishing closer trade relations between South and North Korea. It does not seek to make recommendations because that would clearly involve political considerations and constitutional issues that are much beyond the scope of this modest study.

5.1.

A FTA between South Korea and North Korea

In an FTA, each partner eliminates its tariffs on goods imported from the other partner, but keeps its own tariffs on products imported from the rest of the world. North Korea will thus eliminate its tariffs on South Korean goods only, and South Korea will do the same on North Korean products. The issue is, how to dismantle the tariffs existing between North and South Korea. A first method would consist in cutting the initial tariff rates of both countries by the same annual percentage over a given period. This was the method used by the six founding members of the EU: The existing tariffs between them were cut by 10 percent on an annual basis over a period of ten years. The

92

North Korean trade policy

second method consists in applying a arithmetical formula that cuts the higher tariff rates by a larger percentage than the smaller tariff rates. This option was used in the GATT–WTO rounds with the so-called Swiss formula. If, as suggested in this chapter, the North Korean tariff is uniform, this second method will be implemented only by South Korea, which has the advantage of accelerating the access of North Korean products to the most protected South Korean markets. How valuable this advantage is remains open to debate: It depends on whether the most protected South Korean products can be efficiently produced in North Korea. The third method consists of an asymmetrical tariff dismantlement whereby South Korea would eliminate all its tariff rates (not only the highest ones) faster than North Korea. That said, today FTAs among modern economies deal with a wide range of other issues: Industrial norms, regulations in services that, for instance, specify which kinds of services can be provided and how they can be supplied, intellectual property rights, public procurement, state-owned enterprises, etc. Addressing these so-called 21st century issues is a much more challenging task than cutting tariffs, especially when the negotiating parties have such different levels of development, such as North Korea and South Korea. The North–South Korean FTA on these issues should thus take into account the constraints imposed by the low level of North Korean development. Interestingly, South Korea should take initiatives that would contribute substantially to alleviating these constraints, but would also be beneficial to the South Korean economy itself.

North Korean constraints The 21st-century trade issues involve in each country many laws and regulations implementing these laws as well as many institutions enforcing these regulations (such as central banks for financial services, agencies in charge of food safety, etc.). These regulations are often costly for consumers: Environmental norms, food safety, the range of authorized services, and quality of services come with a price tag. Framers of a North–South Korean FTA should thus be very careful not to impose high costs on North Korean consumers (who, for some time, will remain too poor to afford to follow the full rule book of a modern economy) nor to overburden embryonic North Korean institutions. The correct balance could be achieved with either of two alternative negotiating approaches. The first negotiating tactic would consist in including in an unique FTA treaty provisions on the whole range of these issues, while recognizing the necessity of a progressive implementation process that would take into account the limited North Korean capacities to enforce the FTA provisions. The EU took this approach in the early years of its existence. The text of the Treaty of Rome covers most of the 21st century topics – it was very advanced for its time – but in general terms. For instance, it has a provision on the “freedom to provide services”, but it does not go into details on how to define and achieve this goal. The concrete implementation of these general provisions of the treaty was left to future and progressive initiatives. For instance, the intra-EU technical barriers

North Korean trade policy

93

(industrial norms) started to be addressed only in the early 1970s, and this is still a work in progress. The same can be said for food safety and services liberalization, which started in the mid or late 1980s. Unfortunately, the EU did not use this progressive approach when poorer Central European countries joined the EU after the Fall of the Berlin Wall in 1989. Rather, it imposed on the new member states the whole rule book that had accumulated between 1959 and 2004 without taking into consideration whether it was manageable for these new members – indeed, putting too much burden on most of them and creating a source of frustrations between Western and Central European member states that are still visible today. The alternative approach would follow a tradition that is followed more frequently in Asia. It would consist of a series of independent treaties negotiated over time that cover more and more domains in an increasingly wide and deep manner. This approach has inspired the 2010 Economic Cooperation Framework Agreement between China Mainland and Chinese Taipei or, more recently, the RCEP among 16 Asia-Pacific countries. Both approaches have pros and cons. The first approach has the merit of building a consistent and global framework; but its lack of progressivity and flexibility in the implementation process can make it very costly, as can be seen in Europe. The second approach is flexible by definition, but it runs the risk of inconsistencies or of running out of steam after a while, leaving an incomplete framework, as can be seen in Asia.

South Korean initiatives It is important to stress that South Korea could take initiatives that would substantially alleviate the problems caused by North Korean constraints. Broadly speaking, these initiatives would consist of internal in-depth evaluations of the intrinsic quality of the current South Korean regulations in order to assess which are good enough to be included in the FTA, which should be revised by South Korea before inclusion in the FTA, and which should be left aside or even eliminated from the South Korean rule book.33 It is important to stress that this exercise would not only be beneficial to North Korea, but also to South Korea because it is an exercise in the indispensable modernization of a rule book. Indeed it is a great pity that such a fully fledged regulatory assessment was not done in the early 1990s by the then 15 EU member states (EU15) before the enlargement process to the Central European countries – leaving the EU15 member states with outdated and/or poorly designed regulations with consequences that are visible today in the EU’s unsatisfactory economic performance.

5.2.

A customs union between North Korea and South Korea

In a customs union, each partner eliminates its tariffs on the goods imported from the other partners (as in a FTA), and all the customs union’s members implement the same tariff rates on the goods imported from the rest of the

94

North Korean trade policy

world. Compared to an FTA, this option raises two additional issues that are challenging for both Koreas. First, a customs union requires that North Korea and South Korea will define for each product the “common” tariff they will impose on the rest of the world. This is not a simple matter. In the EU case, the original six member states adopted the simple average of the initial four tariff rates (Belgium, Luxembourg, and Netherlands had already enforced a common tariff). This simple average method has had the great merit not to give too much weight to the tariff rate of one member state. This will not be the case in a South–North Korean customs union because it has only two members. If, as suggested, the North Korean tariff is uniform, the simple average of the North and South Korean tariff rates will be heavily influenced by the existing South Korean tariff rates, particularly when they are high or low. As illustrated in Table 6.4, South Korea often has higher average and peak applied MFN tariffs than, for instance, the EU.34 It has also a wider range of MFN tariffs (with peaks two to three times larger than EU tariff peaks) and much larger differences between applied and bound tariffs than the EU.35 These differences suggest that goods for which North Korea is unlikely to have comparative advantages would be protected by high South Korean tariff rates, while goods for which North Korea could have comparative advantages would be protected by low South Korean tariff rates. Such a common tariff structure would thus be at odds with North Korean comparative advantages: It would tend to shift North Korean resources into sectors in which the economy is inefficient. In other words, North Korea would largely lose the benefit of its uniform tariff which is so crucial for its first steps of its development. One could argue that the PTAs signed by South Korea with other countries (such as the South Korea–EU or the South Korea–US trade agreements) mean that South Korean applied tariff rates are de facto much lower than those shown in Table 6.4. However, South Korea has no PTAs (or they are not “deep” enough) with countries that could be important export markets for North Korean goods – such as China, Japan or Russia – or with countries that produce the cheap products needed by the relatively poor North Korean consumers – households and enterprises. Once again, a substantial part of the solution can come from a South Korean initiative. More precisely, South Korea should undergo a unilateral reform of its tariff rates before establishing a customs union with North Korea. It should unilaterally reduce sharply its highest tariff rates, preparing by the same token a more uniform common tariff for the North–South Korean customs union. Again, such an initiative would not only help North Korea to better realize where its comparative advantages lie, but it would also benefit South Korea by making its economy more open. The second additional issue created by a customs union has to do with households. The current South Korean tariff structure raises the following question: To which extent does it protect “cheap” goods more than “luxury” goods? If it taxes cheap goods more heavily, the common tariff schedule of the customs union (if it is based on the simple average of the existing North and South Korean tariff

Table 6.4 Tariff structures of South Korea and the EU (unit: %) South Korea

EU

Final bound duties

Animal products

avg

max

26

89

bound 100

MFN applied

Final bound duties

MFN applied

avg

max

avg

max

bound

avg

max

22

89

24

140

100

23

140

Dairy products

70

176

100

68

176

58

226

100

55

205

Fruits, vegetables

64

887

100

58

887

10

170

100

12

170

Coffe, tea

74

514

100

54

514

0

25

100

6

25

161

800

100

134

800

20

167

100

16

167

Cereals and prepa. Oilseeds

44

630

100

37

630

7

171

100

7

171

Sugar

32

243

100

17

243

28

131

100

29

131

Beverages

43

270

100

32

270

22

175

100

19

162

2

2

100

0

0

0

0

100

0

0

Other ag. products

Cotton

21

754

100

16

754

4

131

100

5

131

Fish

15

32

54

16

47

11

26

100

10

26

Minerals, metals

8

35

96

5

8

2

12

100

2

12

Petroleum

9

13

80

5

8

2

5

100

3

5

Chemicals

6

373

98

6

317

5

17

100

5

17

Wood, paper Textiles

3

13

89

2

10

1

10

100

1

10

17

30

99

9

13

7

12

100

7

12

Clothing

28

35

100

13

13

12

12

100

12

12

Leather, footwear

12

16

98

8

16

4

17

100

4

17

Non-elec. machinery

10

20

97

6

13

2

10

100

2

10

Elec. machinery

9

20

74

6

13

3

14

100

3

14

Transport equip.

8

20

81

6

10

4

22

100

4

22

10

16

95

7

13

3

14

100

3

14

Manufactures, NES

Source: WTO website, tariff profiles Note: For simplicity sake, figures have been rounded.

96

North Korean trade policy

rates) would have the same structure. It would be more favorable for the goods consumed by the North Korean upper class at the detriment of the products consumed by the rest of the North Koreans. If this distortion is significant enough, it would have obvious political consequences: It would make reunification more costly for the relatively poor North Koreans than for the richer ones – indirectly amplifying the differences among North Koreans in terms of real income. This would be the opposite of the South Korean “Han River miracle”, which was characterized by low income differences among the various layers of the South Korean population during the first decades of South Korea’s growth. The last consequence of the South–North Korean custom union is that North Korea would automatically join the WTO with the same concessions and obligations than South Korea. This would be similar to what happened to East Germany in 1990: By becoming part of the Federal Republic of Germany, East Germany was immediately subjected to all the WTO concessions and obligations of the EU – from tariffs to industrial norms to sanitary and photo-sanitary measures to intellectual property rights, to public procurement, etc. As argued earlier, this huge package of regulatory obligations has been a burden for the former East Germany that the massive subsidies granted by the former West German have only partially compensated.

5.3.

North Korea and ongoing negotiations of FTAs in Asia

As already mentioned, there are many ongoing negotiations on FTAs in Asia: ECFA, RCEP, the Progressive and Comprehensive Agreement for Trans-Pacific Partnership to name a few. If North Korea is interested in these agreements, it has two main options. First, it could try to become a full participant to (some of) these negotiations. The main problem faced by this approach is that most of these negotiations are advanced enough to make difficult to include a newcomer – and this is all the more if this newcomer has thin experience in such complex negotiations and would have great difficulties providing the information on its own economy that would be needed by North Korean negotiators. The second option for North Korea would be to include an “association” provision in its PTA with South Korea. This provision would define the appropriate procedures for North Korea’s participation in South Korean negotiations on a FTA. This provision could also offer the opportunity to review South Korea’s existing FTAs, in particular those with the EU and the US – hence helping to solve pending problems, such as applying the rules of origin to the goods produced in the couple of North Korean FEZs.

Appendix 6A. The Baltic and Georgian experiences As underlined in Section 3, the Baltic countries (Estonia, Latvia, and Lithuania) have had interesting experiences. They have little idea about their comparative advantages: In the Soviet Union, productions were allocated among the various Soviet Republics by central planners who were much more concerned with

North Korean trade policy

97

creating artificial economic inter-dependency among the Soviet Republics than with promoting economic efficiency. They have faced fragile domestic and international situations: The proportion of Russian nationals in their populations ranged from being limited to substantial; in addition, Russia was not ready for a hands-off policy with respect to former members of the Soviet Union, as best illustrated by the situation in Ukraine. Georgia faced these same constraints even more severely (Russia has been persistently unfriendly to Georgia to the point of going to war with it and fueling the secession of two provinces), with huge economic distortions (dating from Stalin era) and corruption (Georgia was said to be the most corrupt of the Soviet Republics). The Baltics have favored relatively radical choices in trade policy as well as in other economic policies – Estonia being the most extreme and clear in this matter – and beginning in 2006 Georgia has followed their example. Table 6.A1 summarizes these policies, which consist of the following measures. •

• • •

The elimination of almost all the tariffs and tariff equivalents (licenses, quotas, etc.) on both imports and exports (in the centrally controlled European economies, barriers to exports were often as constraining as barriers to imports).36 A very short list of exceptions (5 percent of the products in Latvia) largely concentrated on agricultural products and on the export side.37 The abolition of state-owned enterprises in external trade activities. The currency regime, that is, how easy it will be for traders to acquire foreign currencies at a good rate.38

It is interesting to note that all these measures were very frugal in terms of institutional requirements. There was no or very little need of administrations to grant licenses and quotas since most of them were eliminated. The relatively rapid abolition of state-owned enterprises in external trade activities was not only justified by the absence of market power of any of these countries in the world markets – this would be the case for North Korean stated-owned enterprises – but it also eliminated the need to create a competition authority for monitoring the (likely) costly monopolistic behavior of these enterprises (as sole importers or exporters). The most dramatic changes occurred in the customs systems. The degree of freedom of the customs authorities was quite limited since the vast majority of goods were subjected to a uniform or quasi-uniform low tariff rate, leaving no possibility for customs officers to play with various tariff rates in exchange for bribes. Georgia offers a good illustration of the fast impact of a (relatively) uniform and MFN tariff policy in this domain: In less than four years, Georgia shifted from the 133th most corrupt country (in 2004) to the 55th (in 2013) and then to the 44th (in 2016) – achieving a better rank than some EU member states.39 This factor is crucial for making North Korea an attractive place for investors. It is also crucial since tariff revenues will be the main source of domestic fiscal resources in North Korea for its first – decisive – years of transition. Table 6.A2 shows the GDP growth of all the Central European countries having joined the EU – hence having benefited from the same support from

Table 6.A1 Key components of trade policy reforms: the Baltics and Georgia Restructions Instruments Estonia

Latvia

Lithuania

Georgia [a]

Import Tariffs restrictions

0.5% for statistical purpose.

Average tariff of 10%, low rates on inputs

Average tariff of 3.2%; maximum tariff rate is 30%; 70% of tariff lines have a zero tariff rate; inputs have low rates.

Average tariff of 1.5%; 85% tariff lines are duty free; the rest has a 12% tariff max.

None.

About 10 No licence; products. however specific duties on 150 products (defined at HS-6 digit).

Taxes for cultural items only.

383 tariff lines (defined at HS-6 digit); maximum export tax is 100%; 90 percent of export taxes are below 10%; mostly agricultural products metals, raw materials (sand, wood, leather)

Licences and quotas

Export Taxes restrictions

Licences and quotas

State trading

None.

15 products None. (defined at HS-4 to HS-5 digits); maximum export tax is 50%, with half of them below 10%.

None. Tobacco, alcohol, some agricultural and forest products, metals, broadcast equipment, oil shale, petroleum and mineral oil.

None, except for temporary bans on red clover seed, untreated oak and ash timber.

Minimal restrictions for reasons related to health, environment and culture.

None.

None.

None.

None.

Restructions Instruments Estonia

Latvia

Lithuania

Foreign exchange

Convertible with wide access to foreign exchange through commercial bureaus; no surrender requirement.

Convertible Floating since 1992; exchange rate. currency board since April 1994; no surrender requirement.

Convertible current account with a currency board mechanism since 1992; no surrender requirement since early 1994; virtual capital account convertibility.

Georgia [a]

Source: For the Baltics, Michalopoulos and Tarr (1996). For George, WTO Trade Policy Review (2010)

Table 6.A2 GDP per capital of the Central European member states, 1995–2013 Growth rates (%)

GDP per capita

GDP per capita

GNI per capita

current US$

Slovenia=100

current US$

PPP [a]

current US$

PPP [a]

1995

1995

12.2

8.1

n.a

7.8

2012

2012

Baltic countries Estonia

2,629 16,316

25.0

73.9

Latvia

12.3

8.2

11.9

8.2

2,107 14,009

20.0

63.4

Lithuania

12.6

8.3

12.0

8.0

2,178 14,150

20.7

64.1

6.6

1,555

6,986

14.8

31.6

Other Central European EU Member States Bulgaria

11.9

6.6

10.4

Croatia

9.3

5.8

6.6

5.6

4,722 13,227

44.9

59.9

Czech Republic

9.0

4.4

11.5

3.9

5,596 18,608

53.2

84.2

Hungary

7.1

5.3

6.9

5.0

4,411 12,622

41.9

57.1

9.4

6.7

9.1

6.5

3,603 12,708

34.2

57.5

Romania

Poland

11.7

7.2

11.7

7.1

1,564

7,943

14.9

36.0

Slovak Republic

9.4

6.8

10.1

6.7

4,710 16,934

44.8

76.7

Slovenia

7.2

4.7

6.9

4.5

10,524 22,092 100.0

100.0

Source: World Bank Note: [a] PPP: purchasing power parity.

100

North Korean trade policy

the EU. (Georgia is not included in Table 6.A2 because it did not enjoy this situation but has faced a very different international environment, including war.) It shows clearly that, over 18 years, the growth performance of the Baltics has been better than the growth performance associated to the more complicated trade policies implemented by other Central European countries.

Notes 1 This chapter relies on working papers by Messerlin and Hong (2013, 2014). Patrick Messerlin would like to express his gratitude to Hong Song-Pyo for his great help. 2 The first estimate is provided by the UN (based on North Korean data) and the second estimate by the Bank of Korea (from South Korea). A third estimate (close to 7 percent) is provided by the US CIA. 3 Brown (2018). 4 Smuggling is additional trade, but at prices which have very little to do with market prices because of the premium for covering the risks in a society characterized by harsh punishment in such circumstances. 5 Lankov (2013). 6 Bruce (2012). 7 As economic analysis shows (Tarr 2000), arguments against an uniform tariff require specific circumstances: terms of trade effects, “strategic,” infant or restructuring industry considerations, revenue or balance of payments purposes, and tariffs as a WTO negotiating tool. None of these arguments are important for North Korea at the beginning of its transition. Terms of trade effects and strategic industries assume that North Korea would enjoy market power in some world markets, which is very unlikely. Infant or restructuring considerations are precisely those that should be avoided because of the deep level of ignorance about North Korean comparative advantages. Revenue or balance of payments problems are better handled by macroeconomic policies. The case of the WTO is addressed in section 2. 8 This chapter focuses on ad valorem tariffs, that is, tariff rates expressed in a percentage of world prices. It ignore other forms of tariffs (such as specific tariffs), which have undesirable features. 9 Generally, the country grants this new concession in exchange for a new concession from its partner. As a result, all the other WTO members could benefit from both concessions under the MFN principle. 10 Ahnlid (2012). 11 Haggard, Lee, and Noland (2011). 12 Lankov (2013). 13 Haggard and Noland (2012a, 2012b). 14 For instance, see Cronin and Silberstein (2018). 15 This issue could be coupled with others, such as terrorism or weapons of mass destruction. 16 A better term would be “preferential trade agreements” since such agreements discriminate between the trading partners of a country. 17 These bilateral agreements would also serve as the basis for North Korea’s WTO membership since the WTO protocol of accession relies on the bilateral negotiations between the candidate country and its major trading partners. 18 Hamilton (2018) and Krugman (2018). 19 Cooper (2012). 20 Pincus et al. (2012), p. 25. 21 Frank (2015a, 2015b). 22 Deutscher Bundestag (2018).

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23 Lardy (2002). 24 The only exception in manufacturing was the automobile sector. The main reason for this situation was that the share of tariff-paying imports was very small due to the FEZs. Hertel, Zhai and Wang (2004). 25 The North Korean GDP per capita is estimated to US$ 1,000–1,200 and its population is 24.9 million. 26 Doing Business Report (2019). 27 Discontinuities in the methodology require caution, hence the choice of 2011 as the first year of observation. 28 North Korea should also decide on the level of the “bound” uniform tariff – which initial level and how quickly to reducing it. Such decisions are driven much more by judgments on political opportunities and feasibility than by economic considerations. As a result, this topic is not discussed in this chapter. 29 Messerlin (2013). 30 See the integral text of the “Agreement on Normalization of Inter-Korean Kaesong Industrial Complex”, Yonhapnews. 2013, August 14. “http://www. yonhapnews.co.kr/bulletin/2013/08/14/0200000000AKR20130814 209200043.HTML” www.yonhapnews.co.kr/bulletin/2013/08/14/0200000 000AKR20130814209200043.html 31 Hong, Jeeseong, 2013. Improvement of ‘three-way’, including introduction of electronic access system. Yonhapnews, 2013, September 11. “http://www. yonhapnews.co.kr/politics/2013/09/11/0505000000AKR20130911069153043. HTML” www.yonhapnews.co.kr/politics/2013/09/11/0505000000AKR2013 0911069153043.html 32 See, for instance, Chun and Rhee (2012). 33 Such a process would enormously benefit from the creation in Seoul of an institution such as the Australian Productivity Commission that would be asked to review the South Korean regulations. 34 Table 6.4 shows the EU as an useful example, since the EU has integrated East Germany. 35 That said, South Korea has the KOREU and KORUS PTAs – that is, counterforces that protectionist incentives to increase South Korean applied tariffs up to the bound level in order to solve transition problems in North Korea. 36 The export constraints that were maintained were limited to few politically sensitive products. This is important because barriers on exports are equivalent to barriers on imports, hence they could have re-introduced a substantial dose of protection if there were many. 37 There are roughly 6,000–7,000 products in a trade tariff structure defined at the HS-6 digit. 38 The foreign exchange measures are crucial, but they are not discussed in this chapter because they are much more tightly related to the broad monetary and budgetary policies than to the trade policy per se. 39 Transparency International (2017).

7

Regional financial cooperation and North Korean development

Excluding political factors such as international sanctions, a key reason behind the failures of various development projects of North Korea lies in its lack of funds for infrastructure construction and foreigners’ lack of interest in investing in North Korea. Foreign investment is essential for full-fledged development of the North Korean economy. Attraction of foreign capital to North Korea requires not only internal enhancement of investment conditions but also externally its joining regional and international financial institutions.

1.

Foreign investment policy as an economic development strategy

North Korea has been regarded by some as one of the worst countries for foreign investors. There are many reasons behind this failure in attracting foreign capital to North Korea: Its poor infrastructure, frequent policy reversals, big potential risks, totalitarian regime, etc. But the most important reason is that North Korea does not consider an open policy toward trade and financial transactions with foreign countries as a part of development strategy but only as an instrument for collecting hard currency.

1.1.

Economic opening policy

Regarding the link between economic opening and economic development, still the debate is going on. This debate was much more intense during the 1960s through the 1980s when East Asian countries strongly promoted the opening policy while other developing countries promoted an inward-oriented policy. Most popular arguments for economic opening include the improvement of efficiency, the effect of scale economies, and the reduction of economic volatility. Economic opening provides firms with an incentive to seek new ways to survive in the world market where the government cannot protect competition with foreigners. Competition in the world market also offers more opportunities for learning and innovation to improve efficiency than are provided by protectionism. This efficiency-improving effect can be achieved through international

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103

financial transactions as well. Financial opening moves flows of capital from capital-rich economies to capital-poor countries since, in the latter, the returns to capital tend to be higher. These flows complement limited domestic savings in capital-poor economies and, by reducing the cost of capital, allow for increased investment. Certain types of financial flows such as foreign direct investment can also generate technology spillovers and serve as conduits for acquiring managerial and other forms of organizational expertise from more advanced economies, which will further enhance the efficiency of resources and the country’s social welfare. Economic opening also encourages economic development through expansion of the market. Usually the domestic market size of developing countries is not large enough to take advantage of economies of scale. Thus even though the companies in these countries can produce some goods with better technology than others in the market, it does not guarantee that they can benefit from the better technology unless their production size is big enough to enjoy the effect of economies of scale. The only way for developing countries to ensure a large market and economies of scale is to go to the world market. Export allows firms or industries to sell goods in a larger market so as to take advantage of economies of scale, and eventually gives developing countries a dynamic comparative advantage. There are also a number of indirect channels through which financial opening could enhance growth. It can help promote specialization by allowing for sharing of income risk, which in turn increases productivity and growth as well. In addition, economic opening could have stability effect, which is an essential requirement to boost economic growth in developing and transition economies. Trade and financial opening to the international market simultaneously allow for enhanced specialization based on comparative advantage considerations. Although it may make countries more vulnerable to industry-specific shocks, the industrial transformation from the low-end sectors to the high-end ones much reduces the economy’s sensitivity to business cycle.1 In principle, financial opening allows capital-poor countries to diversify away from their narrow production bases, which are often dependent on agriculture or natural resource, and this should reduce macroeconomic volatility. Also one of main arguments for engaging in international transactions is that production and market diversification reduces risk without sacrificing expected return. Unless economies in different countries move together very closely, international diversification leads shocks in those different economies to cancel out each other and the overall volatility and risk can be reduced. In contrast to these arguments for economic opening, there are strong arguments for protections, including protection of infant industries, economic security, and reduction of exposure to external shocks. The infant industry argument starts with the notion that developing countries have a potential comparative advantage in some industries in the long run, but cannot compete with those in advanced countries at the moment. If developing countries protect these industries from foreign competition until they can stand on

104

Financial cooperation and North Korea

their own feet through learning by doing or through economies of scale, the long-term welfare of developing countries could be increased. Thus to overcome the pre-emption effect or the advantage of first mover,2 these industries need to be protected so that they can achieve reduction in unit cost and be transformed from importers to exporters in their industries. The infant industry argument is also used to support the strategy of import-substituting industrialization, that is, the replacement of imported manufactures by domestic products. Another argument for implementing protections is to strengthen economic security. This argument says that national security may be threatened by dependence on external sources of technology, raw materials, food, and fuel.3 Thus domestic-production is necessary for national security, and import barriers would help a country accumulate more capacity to produce goods that would be important in a future national security. Japan bashing in the 1980s and China bashing in the 2000s are related to economic security argument. This concern is well expressed by the following quote. In the event of war or other national emergency, it is highly unlikely that the domestic footwear industry could provide sufficient footwear for the military and civilian population. . . . We won’t be able to wait for ships to deliver shoes from Taiwan or Korea or Brazil or Eastern Europe. . . . Improper footwear can lead to needless casualties and turn sure victory into possible defeat.4 Reduction of vulnerability to external shocks is also strongly suggested for protections. As a country expands its international transactions, it is more likely to be exposed to external shocks and its economy can become more unstable – due not to internal but to external problems. For example, if economic opening causes export instability and export earnings fluctuate to a greater extent, this fluctuation of the export sector will lead to fluctuation of the internal sector. Thus the boom–bust cycle will be further amplified through international transactions. Financial opening can further amplify the cycle. When the economy is booming, increases in private capital inflows provide the additional liquidity that allows banks and non-bank financial intermediaries to increase lending. But the lending boom following macroeconomic expansion tends to lead to a deterioration of portfolio quality and an increase in financial vulnerability. As the lending boom proceeds, the riskiness of the investments will rise and loans to borrowers with poor credit ratings are likely to increase. Also, when credit is plentiful, borrowers can easily pass creditworthiness tests because they can find another lender who is willing to provide them with credit. Hence credit booms will be excessively rapid and associated with deteriorating loan portfolios, further amplifying the boom–bust cycle, enlarging bubbles, and sometimes causing crises. To lessen the influence of external shocks and to enhance economic security, it would be desirable to expand domestic demand and to reduce external exposure.

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105

There has been a long debate on two competing strategies – outward-looking strategy vs. inward-looking – and it would be an endless task to attempt to determine the appropriate strategy of developing countries. The World Bank compared different strategies and concluded that “the economic performance of the outward-oriented economies has been broadly superior to that of the inward-oriented economies in almost all respects”.5 In particular, the average annual growth rate in per-capita income in strongly outward-oriented economies was 6.9 percent during the period of 1963–1973, which is more than four times the 1.6 percent in strongly inward-oriented economies. Even after the oil shocks, the same trend continued during the period of 1973–1985: Per-capita income grew by 5.9 percent per year in strongly outward-oriented economies, while it did not grow but fell by 0.1 percent per year in strongly inward-oriented economies. These results show that the merits of outward-oriented policies such as efficiency improvement through competition, innovation, and economies of scale play more role in economic development than its potential problems such as exposure to external shocks. In contrast, it appears that the infant industry argument was not as valid as some had initially believed. Trade restrictions that protect new infant industries did not enhance but worsened their competitiveness. Also import substitution industrialization involved costs and promoted wasteful use of resources because of complex, time-consuming regulations. It set high tariff rates not only for consumers but also for firms that needed to buy imported materials for their final products, and caused inefficiency in the whole economy. Now the outward-oriented policy has become a dominant strategy for economic development in late-developing countries and in transition countries. North Korea seems to have adopted a closed economy policy based on the arguments for protectionism. In particular, North Korea has emphasized selfreliance for national security. However, the experiences of many developing and transition countries clearly suggest that economic opening should be adopted and maintained for a long time as a primary policy with full commitment if North Korea is to attain economic reforms and sustainable development.

Table 7.1 Annual growth rate of per-capita income (unit: %) Trade regime

1963–1973

1973–1983

Strongly outward oriented Moderately outward oriented Moderately inward oriented Strongly inward oriented

7.4 3.7 2.5 1.7

6.1 1.8 0.7 −0.1

Source: World Bank, World Development Report (1987), p. 84

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Financial cooperation and North Korea

1.2.

SEZ policy

When North Korean strategies for attracting foreign capital are compared with those of China, we can easily find a clear difference. In China, the strategy of foreign capital inflow and establishment of SEZs have been pushed as instruments of reform and tools with which to open the economy, which is a key part of the grand development strategy. In North Korea, strategies such as establishing SEZs to promote economic openness and to attract foreign capital are sometimes announced as very important objectives. But it is hard to see such a policy as an instrument for promoting reforms and as a key part of the development strategy. In appearance, North Korea’s foreign investment policy to attract foreign capital through establishing SEZs seems similar to the efforts of the Chinese government. North Korea has also issued extensive laws and regulations designed to attract foreign investment.6 But its real intention is quite different from that of China. In China, the reform and opening policies have been key to develop the Chinese economy since the end of the 1970s. Thus the Chinese government considered SEZs as a gateway to link China to the world market, and it set them up so as to make the contact between domestic residents and foreigners easier. SEZs in China have been provided special treatment of more flexible and market-oriented measures to attract foreign companies so that “foreign and domestic trade and investment are conducted without the authorization of the Chinese central government in Beijing”.7 Also, to attract foreign capital the Chinese government has offered special tax and business incentives for foreign investment. The World Bank identified five factors contributing to the successful and effective operation of SEZs in China. • • • • •

SEZs need to be linked to economic opening and capitalize on innovation. A bottom-up, problem solving approach has to be combined with top-down governmental support. SEZs can promote industrial expansion by cultivating market leaders, supporting research and development, and building brands. They can incubate local ideas by integrating learning, innovation, and production. They can bring together resources and expertise from government, industry, and research institutions to move into more advanced value chains.8

In contrast, the North Korean government does not like domestic residents to easily make contact with foreigners through SEZs but instead want to maintain SEZs as separate from the rest of the economy. This suggests that the first factor of China’s success, i.e., linkage of SEZs to economic opening, is not considered important in North Korea’s SEZ policy. If it were to promote SEZs as a trigger for economic development, North Korea should operate SEZs so

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that its residents can more easily contact foreigners to attract foreign investment and to acquire advanced technology from foreign companies. Contrary to the successful case in China, SEZs in North Korea have not been created as places dedicated to the influx of trade and investment but instead are nothing more than the means to collect hard currency. Since an economic opening policy is not a part of North Korea’s grand development strategy, it is not long-term based. Thus it is not surprising that the initial reform moves have often been followed by setbacks, resulting in a continuous sequence of cooperation and conflict, escalation and deescalation. This is quite different from how South Korea and China have operated SEZs for economic development: In these countries, SEZs have never been shut down. Their experiences suggest that to overcome the problems of North Korea’s SEZ policy, it is most important for North Korea to fully commit to keeping SEZs open, no matter what happens, by including the policy of economic opening as a key part in its long-term grand development strategy. This is directly related to what foreign investors would consider before investing in North Korea. The extant literature focuses on what factors should be taken into account when making investment decisions in foreign countries. Key economic factors regarded as important in these decisions include the size and maturity of the host country market, infrastructure, labor cost, tax rate, natural resource endowment, and the nature of investing firms.9 Since FDI requires a longer time horizon and involves higher risk, political and institutional factors, in addition to economic factors, should be considered important as well. In the case of North Korea, non-economic factors such as the host country’s commitment to investment policies and the political capacity for implementing them10 are more critical to attract foreign capital than economic factors at the initial stage. In our opinion, North Korea has a reputation as a corporate graveyard for foreign investors. A notable example is the case of Orascom Telecom Media and Technology Holding, an Egyptian company that helped build North Korea’s communication networks after entering the country in 2009. But Orascom faltered in the business and has struggled to exercise control over its North Korean unit since the North Korean government backed the launch of its own cellular network.11 A Swedish automobile company, Volvo, has not yet been paid the money owed for 1,000 cars exported to North Korea in the 1970s.12 Even companies from China, which has been North Korea’s only long-term ally, have often been burnt. Xiyang, a Chinese mining company, signed a contract in 2007 to build a mine producing iron ore. In 2012 North Korea suddenly terminated the deal and canceled the joint venture company, costing the company tens of millions of dollars.13 All of this explains that in North Korea, securing credibility with foreign investors is sine qua non to attract foreign capital, as a businessman comments: “Much of the country’s infrastructure is dilapidated. The risk of instability, too, looms large. . . . But a major deterrent to foreign investment is the chronic breakdown in the rule of law [in North Korea]”.14

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Financial cooperation and North Korea

Table 7.2 Comparison of SEZs

Objective

South Korea

North Korea

China

Inducing foreign investment by allowing free operation of foreign companies

Inducing foreign capital and technology by allowing marketoriented operation

Inducing foreign investment in limited areas

Infrastructure

Good

Poor

Good

Employment

Flexible compared to domestic market

Need discussion with the government

Provided much autonomy

Foreign exchange

Free use under US$ 10,000

Limited

Free use

Domestic sale

Allowed

Not allowed

Allowed

Inducing system

Local governments

Not well equipped

Institutions inside SEZs

Financing

Foreign investors, international organizations

Foreign investors

Foreign investors, international public funds, Chinese merchants

Operation

Never shut down

On and off

Never shut down

Source: Lee (2018), p. 11

2.

North Korea’s participation in global and regional financial institutions

Infrastructure redevelopment is the quickest avenue to enhancing productivity and economic growth. Hundreds of billions of dollars are required to rebuild North Korea’s infrastructure, which is in total decay, to a level adequate for promoting economic modernization. This would require massive investment by South Korea and other foreign investors. Ensuring sufficient foreign investment is a precondition for full-fledged development of the North Korean economy. To encourage inflow of foreign capital to North Korea, the country’s accession to international financial institutions is definitely required. It is extremely difficult to find an example of a country that has reached its full development potential without joining international financial institutions. In addition to direct loans from those institutions, the involvement of international financial institutions can further encourage private investors to bring capital to North Korea, a country with high risk and uncertainty. This kind of encouragement is often observed during financial crises. When East Asian countries were hit by the crisis in 1997, foreign investors hesitated to invest in the region. It was after the IMF provided rescue financing to the countries that private companies began to invest in those countries. The IMF’s

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involvement gave a clear signal that a huge part of potential risk would be protected by the IMF during the turbulent period of the crisis. Likewise, if international financial institutions provide financial support to North Korea, private investors could be reassured and more willing to invest in North Korea. Thus, to attract foreign capital in earnest, North Korea needs to become a member of international financial institutions.

2.1.

Financing sources for development from international financial institutions

Key international financial institutions from which North Korea can receive financing support for development are the IMF and the World Bank at the global level and the ADB and the AIIB at the regional level. The IMF is an international organization, “working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world”.15 It was originally created in 1944 as a part of the Bretton Woods agreements, with 29 members, and now includes 189 countries. The IMF’s three core functions are economic oversight, loan provision, and capacity development. The IMF used to provide short-term loans to aid member countries with the balance of payments difficulties to prevent the spread of international economic crises. But the IMF also provides concessional financial support with a zero interest rate to low-income countries through the Poverty Reduction and Growth Trust. This trust has three concessional lending windows: Extended Credit Facility, Standby Credit Facility, and Rapid Credit Facility. Among them, the Extended Credit Facility, which provides sustained program engagement and financing for countries facing protracted problems with balance of payments, is probably the most relevant as a financing source for the development of North Korea.16 With 189 members, the World Bank Group (WBG) is the world’s largest development institution, comprising five international organizations, as shown in Table 7.3: The International Bank for Reconstruction and Development (IBRD), the International Development Association (IDA), the International Finance Corporation (IFC), the Multilateral Investment Guarantee Agency (MIGA), and the International Center for Settlement of Investment Disputes (ICSID). The IBRD17 was originally founded with the Bretton Woods agreements in 1944, and now includes a closely associated group of five development institutions. The WBG shares a commitment to reducing poverty, increasing shared prosperity, and promoting sustainable development, but its five institutions differ in their main functions. The IBRD and the IDA are usually referred to collectively as the World Bank. At its foundation, the WBG provided loans mainly to help reconstruction of countries devastated by World War II, but the focus has shifted from reconstruction to development. Among its five institutions, financing sources for the development of North Korea would be available from the IBRD and the IDA. The IBRD provides loans and advice to middle-income and credit-worthy poor

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Table 7.3 World Bank Group IBRD

IDA

IFC

MIGA

ICSID

provides debt financing on the basis of sovereign guarantees

provides concessional financing (interest-free loans or grants), usually with sovereign guarantees

provides various forms of financing without sovereign guarantees, primarily to the private sector

provides insurance against certain types of risk, including political risk, primarily to the private sector

provides international facilities for conciliation and arbitration of investment disputes

Source: www.worldbank.org/en/about

countries, while the IDA provides loans and grants to the world’s poorest countries. At the beginning, North Korea is likely to use the services of the IDA. The loans provided by the IDA are charged a zero or very low interest rate, and the repayment periods are very long (over 30 to 38 years) with a five- to ten-year grace period. The IDA also has debt relief programs through the Heavily Indebted Poor Countries Initiative and the Multilateral Debt Relief Initiative.18 The ADB is a multilateral regional development bank that fosters economic growth and cooperation in the Asia-Pacific region.19 It assists its members and partners by providing loans, technical assistance, grants, and equity investments to promote social and economic development. From 31 members at its establishment in 1966, the ADB has grown to encompass 67 members – of which 48 are from within Asia and the Pacific.20 South Korea has been a member since its foundation, and North Korea is not yet a member. The ADB was modeled closely on the World Bank, and has a similar weighted voting system where votes are distributed in proportion with members’ capital subscriptions. As of now, Japan and the US hold the largest proportion of voting powers at 12.840 percent and 12.752 percent respectively, followed by China 5.477 percent, India 5.386 percent, and Australia 4.948 percent. South Korea holds 4.347 percent of voting powers, eighth overall. The ADB established the Asian Development Fund (ADF) in 1973 to provide concessional loans to lower-income developing member countries.21 The ADF initially provided loans on concessional terms. But ADB’s concessional lending has been financed from Ordinary Capital Resources (OCR) since 2017, and the ADF has become a grant-only operation. This is similar to the IBRD’s function of development financing. Member states can adjust the repayment period and the criteria for currency and interest rate determination. The repayment period for OCR loans is typically 3 to 30 years. Activities supported by the ADF promote poverty reduction and improvements in the quality of life in the poorer countries of the Asia-Pacific region. ADF resources come mainly from contributions of ADB’s member countries, which are mobilized under periodic replenishments, and net income transfers from the OCR. Currently, 18 developing

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countries of the ADB’s 67 member states are classified as concessional assistance only and are eligible for ADF grants. The AIIB is a multilateral development bank that aims to support the building of infrastructure in Asia and beyond.22 The bank was proposed by China in 2013 and the initiative was launched in October 2014. The Articles of Agreement entered into force in December 2015, and the AIIB commenced its operations in January 2016. Initially the bank started with 57 founding members, including South Korea; as of 2018, the AIIB has a total of 86 approved members from around the world (42 regional members, 22 non-regional members, and 22 prospective members).23 The capital of the Bank is equal to US$ 100 billion, equivalent to two-thirds of the capital of the ADB and about half that of the World Bank. China has 26.6491 percent of voting powers and can exercise a veto on the bank’s key decisions, including amendments to the Articles of Agreement that require a vote of 75 percent or more from the Board of Governors, changes in authorized capital, and the size and composition of the Board of Directors. This is comparable to the ADB, in which Japan and the US have more than 25 percent of voting powers and joint veto rights. In the AIIB, India has the second largest voting power of 7.6605 percent, followed by Russia 6.0368 percent, Indonesia 3.2208 percent, Germany 4.2171 percent, and South Korea 3.5560 percent. Regional members hold 75.172 percent of voting powers and the other 24.828 percent goes to non-regional members.24 Broadly, the AIIB provides three types of financial support to member states’ governments and public institutions, as well as to the private sector, through loans, investments, and guarantees: Sovereign-backed financing, non-sovereignbacked financing, and equity investment. It is not yet clear which form of funding will be the most important, but it is noteworthy that China has linked the establishment of the AIIB to the One Belt and One Road Initiative. Also, according to the founding purposes of the AIIB, financial support will mainly be concentrated on investment in infrastructure and other productive sectors. The countries that border with China and are of relevance to the Initiative are mostly low-income developing countries. Thus a large proportion of AIIB projects is expected to support infrastructure development through concessional funding. The AIIB is likely to maintain a complementary relationship with the ADB by focusing on supporting infrastructure development, unlike the ADB, which emphasizes poverty reduction.

2.2.

Prospects of North Korea’s entry into international financial institutions

The IMF Articles of Agreement do not explicitly state conditions for membership, and joining the IMF is open to all. A country that did not join the IMF before 31 December 1945 must apply and then be accepted by the existing members. The IMF Board of Governors makes the decision, by applying the principles applied to the existing member states’ subscriptions to the new member

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candidate. Approval for membership requires the majority of votes by the member states, who together hold more than two-thirds of the total voting rights. Membership shall be open to other countries at such times and in accordance with such terms as may be prescribed by the Board of Governors. These terms, including the terms for subscriptions, shall be based on principles consistent with those applied to other countries that are already members.25 (a) Any country may apply for membership in the Fund by filing with the Fund an application, which shall set forth all relevant facts. (b) The Executive Board shall report on all applications to the Board of Governors. When an application is submitted to the Board of Governors with a recommendation that the applicant country be admitted to membership, the Executive Board after consultation with the applicant country shall recommend to the Board of Governors the amount of the quota, the form of payment of the subscription, and such other conditions as, in the opinion of the Executive Board, the Board of Governors may wish to prescribe.26 In order for a country to join the IBRD, it must first join the IMF. The IBRD Board of Governors makes the final approval of the country’s entry. At the Board of Governors, a majority of the votes from member countries that hold two-thirds or more of the total voting power must be in favor of the country’s membership. Once a country becomes an IBRD member, and only then, can it apply for membership in other WBG institutions. (a) The original members of the Bank shall be those members of the International Monetary Fund which accept membership in the Bank before the date specified in Article XI, Section 2 (e). (b) Membership shall be open to other members of the Fund, at such times and in accordance with such terms as may be prescribed by the Bank.27 The procedure for joining the ADB is similar to that of joining the IBRD. According to the ADB charter, UN member countries in the Asian region can become members of the ADB. In the case of a country outside the region, it must be a developed country as well as a UN member state. Membership in the Bank shall be open to: (i) members and associate members of the United Nations Economic Commission for Asia and the Far East; and (ii) other regional countries and non-regional developed countries which are members of the United Nations or of any of its specialized agencies.28 The Executive Board, in consultation with the applicant country, determines the number of shares of capital stock to be subscribed and other matters to be finalized by the Board of Governors. However, the ADB Executive Board is not

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required to report the application of a country whose membership it does not recommend. Membership requires the affirmative vote of two-thirds of the total number of Governors, representing no less than three-fourths of the total voting power of the members.29 This condition is more difficult to fulfill than what is required to join the IMF or the IBRD, where a majority of the votes from member countries that hold two-thirds or more of the total voting power must be in favor of the country’s membership. Any country opposed by Japan and the US, which hold more than 25 percent of ADB’s voting rights, cannot join the ADB. Only members of the IBRD or the ADB may join the AIIB. A country that was not a founding member of the AIIB by December 2016 must have membership in the IBRD or the ADB before applying to the AIIB. Membership in the Bank shall be open to members of the International Bank for Reconstruction and Development or the Asian Development Bank.30 Members of the International Bank for Reconstruction and Development or the Asian Development Bank which do not become members in accordance with Article 58 may be admitted, under such terms and conditions as the Bank shall determine, to membership in the Bank by a Special Majority vote of the Board of Governors as provided in Article 28.31 The procedure for joining the AIIB is similar to that for joining the IBRD and the ADB. The Board of Directors, in consultation with the applicant country whose membership it recommends, determines the number of shares of capital stock to be subscribed and other matters to be finalized by the Board of Governors. Membership requires no less than a majority of the votes by the member states and no less than a majority of the total voting rights. While the ADB does not impose specific conditions for its membership, except UN membership, the AIIB requires membership in either the IBRD or the ADB as a precondition. This suggests that North Korea’s participation in the AIIB will be blocked from the beginning; unless North Korea joins the IBRD or the ADB, it would not be possible to join the AIIB. Then, what should be the first step for North Korea to join global and regional financial institutions? According to the Articles of Agreement of the IBRD, the ADB, and the AIIB, membership in the IMF is a prerequisite for joining other international financial institutions. Although the ADB is formally separate from the IMF and the IBRD, it is almost impossible for a country that is not an IMF member to join the ADB. In the case of North Korea, opposition from the US and Japan alone is enough to block its membership in the ADB even before the proposal reaches the Board of Governors. It is well known that North Korea has already applied for membership in the ADB twice, but the proposal could not reach the Board of Governors due to opposition from Japan and the US. The AIIB specifically requires membership in the IBRD, which requires membership in the IMF; i.e. a country can join the AIIB once it receives membership in the IBRD and only after joining the IMF. Once North Korea joins

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the IMF, the IBRD, and the ADB, its accession to the AIIB will be a matter of time. This is because requirements for membership in the AIIB (no less than a majority of the votes by member states and no less than a majority of the total votes) are relatively loose compared to those for membership in the ADB (no less than two-thirds of the votes by members states and no less than threefourths of the total votes). Ironically, this suggests that only if North Korea joins the US-led IMF, would it be able to join the China-led AIIB. In sum, a key precondition for North Korea to acquire membership in global and regional financial institutions is membership in the IMF. As of 2017, only a few nations – including North Korea, Cuba, Andorra, Liechtenstein, and Monaco – among the UN member countries have not joined the IMF. Cuba was originally a member of the IMF before its withdrawal following the Cuban Revolution in 1959. Andorra, Liechtenstein, and Monaco are too small to be considered serious applicants to IMF membership. North Korea has shown considerable interest in joining the IMF and the IBRD. Although North Korea has not officially applied for membership in the IMF and the IBRD, it is well aware that joining them would be the first step in joining other global and regional financial institutions. The compiled share of voting rights of pro-US countries such as Japan, western European states, Canada, Australia, Mexico, and Saudi Arabia are well above 50 percent both in the IMF and in the IBRD. Joining the IMF and the IBRD requires a majority of votes from the member states. In the current situation, North Korea’s membership in the IMF and the IBRD will be blocked if the pro-US countries are against the proposal of North Korea’s membership. Once the North Korean nuclear issue enters a resolution phase, there is a possibility that its membership in the IMF would be put on the agenda. When settlement of the North Korean nuclear problems becomes a serious possibility, it would be in the national interests of South Korea to formulate a strategy to facilitate its entry into the IMF by persuading the pro-US group into accepting its application.

3. Links with regional development projects Once North Korea joins international financial institutions, it can benefit from the financing programs of those institutions. But the financing needs for the development of North Korea will be too large to be fully met by financing from existing institutions only. There have been many plans for establishing a cooperative development financing mechanism in Northeast Asia. Some of these mechanisms can be used as additional financing sources for the development of North Korea. Northeast Asia – comprising South Korea, North Korea, China’s northeastern provinces, Japan, Mongolia, and the Russia’s Far East – is believed to be key to Asia’s prosperity and is called “the last major economic frontier of the Asian continent”.32 The potential for infrastructure investment development and cooperation in Northeast Asia is huge as shown in Table 7.4. According to Masahiro Kawai, the total financing needs for the development of Northeast Asia (excluding Japan and South Korea) is estimated to be US$ 62.9 billion per year over

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Table 7.4 Estimation of infrastructure demand in Northeast Asia (unit: US$ billion) Choo (2004)

Kawai (2013)

63.6

48.8

Russian Far East

1.3

4.9

Mongolia

0.1

1.7

North Korea

1.2

Northeastern China

Cross-border Annual demand

5.3 2.2

66.7

62.9

Source: Modified Table 1 from Kim (2014), p. 2

the next ten years.33 Northeast Asian governments will have to mobilize external funding of US$ 13 billion a year in addition to obtaining financing from other sources such as international financial institutions. Won-Suh Choo provided a similar estimate (US$ 66.7 billion per year over ten years) for infrastructure development in Northeast Asia.34 To meet North Korea’s financing needs, various ideas have been floating around. Among them, three are worth our special attention: Northeast Asian Development Bank (NEADB), Northeast Asian Infrastructure Fund (NEAIF), and Northeast Asian Development Corporation (NEADC). The ideas of the NEADB was first proposed by Duck-Woo Nam,35 former prime minister of South Korea, at the international conference, titled “In Search of New Economic Order in East Asia”, in 1990, and has been developed further by LeeJay Cho and Stanley Katz, among others.36 There were at least two motives behind the proposal of NEADB. First, the region of Northeast Asia is neglected and underdeveloped compared to Southeast Asia in terms of cooperation for economic development. A main reason for its underdevelopment is that the infrastructure is very poor and falls far short of satisfying private investors’ demands. The poor and inadequate infrastructure discourages the attraction of foreign investment, which further worsens development in the region. To turn the economy of Northeast Asia onto a path of self-sustainable growth, it is necessary to improve the infrastructure to a level that is on par with international standards – and this would require substantial amounts of long-term investment. Usually bilateral governmental assistance and the loans from multilateral development banks (MDBs) such as the World Bank and the ADB have been the main sources of these long-term investments. But the amounts from these MDBs considerably fall short of the estimated financing needs in the region, and new sources are needed to fill the gap. “[T]he most viable and effective institutional arrangement for meeting Northeast Asia’s projected infrastructure financing gap would be a new sub-regional development bank – the Northeast Asian Development Bank (NEADB)”.37 Northeast Asian countries have been transformed from capital importers to capital exporters in the international financial markets, in particular since the

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40 30 20 10

investment

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

1990

0

savings

Figure 7.1 Investment and savings rates in East Asia Source: World Bank Development Indicator Note: “East Asia” refers to the +3 Northeast Asian countries, five advanced ASEAN countries, and Hong Kong.

Asian crisis. As shown in Figure 7.1, East Asia – in which Korea, China, and Japan account for more than 80 percent of the whole GDP – has accumulated a huge amount of long-term savings and is seeking new investment opportunities. However, the net savings of Northeast Asian countries are invested in advanced financial markets, not in the region as needed to meet the needs for infrastructure development. A main reason is that infrastructure investment in Northeast Asia is too risky – and this is even more the case for the investment in North Korea. Thus to encourage investment in Northeast Asia, an international effort in the region is needed to provide protection against potential risk involved in long-term infrastructure investment. The NEADB is conceived as a multilateral, quasi-commercial bank with ownership shared by national governments in the region and other approved international organizations. Six Northeast Asian countries will be main shareholders and other Asian countries and non-Asian countries can participate as shareholders in the NEADB. The NEADB would function like other MDBs and access the international financial markets to borrow long-term funds by issuing bonds in its own name, which would be secured by capital shares linked to member countries’ foreign reserves. Thus, the bank would not simply be a conduit for governments’ largesse . . . but would represent a new proactive investment channel that could secure and transfer multiple amounts of private sector resources from overseas capital markets to Northeast Asia for financing infrastructure projects.38

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The ideas of the NEADB has continuously attracted the attention of scholars and governments in the region; in South Korea, it was once promoted even at the government level.39 Despite much attention, the NEADB has shown little progress. One reason for this is that it is very difficult for all parties to agree on the specifics of the proposal. For example, the proposed size of capital varies from US$ 6 billion to US$ 50 billion, and the composition of shareholders is very different among various versions of the proposal.40 Another reason is that the US and Japan oppose the establishment of a new regional bank. They seem to be worried about the reduction of financial hegemony in the region: If a new bank is launched, the status of the ADB might be weakened. Also there have been objections to establishing a new development bank for Northeast Asia because its functions would overlap with existing banks. The World Bank and the ADB can provide financing for infrastructure projects in the Northeast Asian region, or a special fund could be set up in the existing MDBs that would serve the same purpose as the NEADB. To overcome these problems, Kawai proposed the establishment of the NEAIF.41 He compared three financing options for infrastructure development in Northeast Asia: Creating special and trust funds in the existing MDBs, the NEAIF, and the NEADB. The first strategy is to set up special and trust funds42 designated for infrastructure investment in Northeast Asia. These funds are provided to developing countries in the region on concessional terms. The second strategy is to establish a well-structured infrastructure investment fund – the NEAIF – designated for Northeast Asia, similar to the ASEAN Infrastructure Fund.43 Northeast Asian governments will be the primary contributors of core equity as well as beneficiaries in the NEAIF, and other countries and international organizations could also join as equity capital contributors. The third strategy is to form the NEADB, which would help meet Northeast Asia’s longterm infrastructure financing needs and thereby accelerate the region’s economic development and integration. After examining the three financing options (Table 7.5), Kawai suggested a two-step approach: First, Northeast Asian governments set up special and trust funds in MDBs such as the ADB, the EBRD, and the World Bank; second, if those special and trust funds cannot fully meet their financing needs, Northeast Asian governments would create the NEAIF. Establishing the NEADB is not recommended because the existing MDBs can provide financial support for infrastructure development in Northeast Asia, and the NEAIF would be able to address additional financing needs by working with all development stakeholders. Focusing on the development of North Korea, the NEAIF concept may look attractive in that its membership, operations, and governance structure are determined in a flexible manner so that North Korea’s unique situation can be taken into account in the decision making. Also a considerable portion of its external financing can be mobilized for most of North Korea’s national infrastructure projects if the country fulfills the conditions for joining the IMF and other international financial institutions as described earlier.

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Table 7.5 Pros and cons of three financing options Options

Pros

Cons

Special and trust funds in existing MDBs

Easy to set up with voluntary contributions Availability of additional, concessional resources for recipient governments Able to rely on knowledge and expertise of the MDBs Transparent governance in place

Need to replenish fund (often with difficulty) once every several years Unable to leverage funds in international capital markets due to the lack of capital and other collateral Possible need for a change in the MDBs’ articles, or for a recipient country to join the supporting MDB

Infrastructure investment fund (NEAIF)

No need for international treaty or domestic national assembly’s approval for creation More transparent in governance with legal personality and better structure than special and trust funds Able to generate additional resources, including MDB co-financing Able to utilize expertise of the MDB

Need for greater diplomatic negotiations among potential member countries than special and trust funds Limited ability to leverage capital subscription at least initially Need for a recipient country to join the supporting MDB

MDB(NEADB)

Able to secure solid institutional structure and governance and manage lending to recipient countries and related risks Able to leverage capital subscription and generate a substantial multiplier effect in terms of fund mobilization

Difficult to establish due to fiscal constraints (from Japan, the US, and the EU) and cumbersome procedures of international treaty ratification Need for high credit rating and, thus, strong shareholder backing Risk of overlap and duplication with businesses of the existing MDBs

Source: Kawai (2013), p. 30 Note: EU = European Union, MDB = multilateral development bank, NEADB = Northeast Asian Development Bank, NEAIF = Northeast Asian Infrastructure Fund, US = United States.

However, the NEAIF has a few disadvantages regarding the development of North Korea. First, with the structure of the NEAIF, North Korea will not be eligible to join the fund until it becomes a member of international financial institutions such as the IMF. North Korea currently has no access to any financing from the international financial institutions, and a regional financing

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mechanism is needed to fill the financing gap for its development even before it joins those international financial institutions. Second, even though the NEAIF sets a country exposure limit to its lending, China may absorb a substantial amount of financial resources for its own infrastructure development in lagging areas. Therefore, a regional financing mechanism more focused on national projects in countries with severe financing constraints such as North Korea and Mongolia would be more desirable in Northeast Asia. Third, the NEAIF and NEADB proposals require the participation of member countries at central government levels. Political differences and historical animosity have long hindered cooperation among the countries in Northeast Asia, and the regional cooperation for economic development lags far behind that in Southeast Asia. Efforts to realize the economic potential of Northeast Asia have been under way for several decades, but without much result. Thus preparations at the national government level to create the fund or the bank may still take long time. A strategy that is more easily undertaken and realized is more desirable and needed at this point. Fourth, the potential for infrastructure development in Northeast Asia is huge, and large economic benefits can be created for the countries involved through development cooperation. If high returns are expected in many cases of infrastructure investment, private investors may also want to participate in the project. Leaving room for these private investors to join as equity capital contributors would further accelerate the momentum of the project. To overcome these problems, the NEADC could be established as a financing mechanism for Northeast Asian countries.44 The NEADC is a plan for South Korea, China, and Japan to found a joint investment company or an affiliated firm by each contributing some amounts of capital mainly through their government-run banks (such as an export–import bank or a development bank) rather than through the governments themselves. The establishment of a joint investment company is intended to raise funds to develop the Northeast Asian region by issuing bonds in intra-regional markets and to specialize in investing in regional projects, including infrastructure construction taking place within the region. The NEADC could avoid the aforementioned problems of other financing mechanisms such as the NEAIF and the NEADB (Table 7.6). It does not require a recipient to join the corporation, even though North Korea is still strongly demanded to fully return to the international community as a cooperative and responsible country. A large portion of the NEADC’s investment will be directed to national projects in countries with very severe financing constraints, including North Korea, and most national infrastructure projects in countries such as China with less financing constraints will be encouraged to seek financing from their own domestic resources. Also, national development banks or Exim banks instead of national governments are involved in the establishment of this organization. The Chinese government may have interest in the development of its northeastern provinces as a part of its one-belt-one-road initiative, and it may not show much interest in the NEADC. If that is the case, local development

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Table 7.6 Comparison of strategies for development financing in Northeast Asia NEADB

NEAIF

NEADC

Main actors

Government-led

Governmentled

Private–public cooperation

Agreement

Among central governments Need international treaty or domestic diet approval

Among central governments No need for international treaty or domestic diet approval

Agreement of local governments is possible No need for international treaty or domestic diet approval

Capital contributor

Ministry of finance

Ministry of finance

Development bank and/or Exim bank

Capital size

Large

Large

Small to medium

Other financing

International borrowings, bond issuance, co-financing with ADB

International borrowings, bond issuance, co-financing with other MDBs

Bond issuance, pension trust

Rigid

Relatively flexible

Relatively flexible

Financing

Governance

Source: Modification of Park and Rhee (2018)

banks in China’s northeastern provinces – which will show much more interest in their own local development than the central government – could be invited to participate instead. Moreover, private banks from non-Asian countries could also participate as shareholders in the corporation. Therefore, if the NEADC is used effectively, it will become possible to provide funds for the development of underdeveloped areas in Northeast Asia, including the Tumen River and the Dandong-Sinuiju areas, and for infrastructure projects such as connection of railroads and the construction of power-generating facilities, ports, and roads. Accordingly, North Korea could reap huge benefits through its cooperation with the NEADC. Project opportunities such as the development of local areas in North Korea and the Northeast Asian region could considerably raise the value of the NEADC. With the increase of its value, the NEADC could raise funds more easily and further expand its business. This would facilitate regional economic collaboration efforts not only on the monetary and financial front but also on the political front. Therefore, when North Korea’s nuclear issue is resolved and it returns to the international community, it would be worthwhile to consider pushing for the creation of this regional financial institution.

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Notes 1 Appleyard, Field, and Cobb also point out that export instability of the LDCs is associated with the fact that “many developing countries are relatively more engaged in the export of primary products that of manufactured goods” (2008, p. 427). 2 When a good is subject to external economies of scale, a position of an exporting country often persists even though another country can produce the same good more efficiently than the original country, and there is no guarantee that the right country will produce such a good in the world market of free trade. This is called the pre-emption effect or the advantage of the first mover. For a more detailed explanation and some examples, refer to Krugman, Obstfeld, and Melitz (2015). 3 Cable (1995), pp. 305–324. 4 President of the Footwear Industry of America, Hearing at the Senate Armed Services Committee (1984). 5 World Bank (1987), World Development Report 1987, p. 85. 6 North Korea has issued extensive laws and regulations that are designed to foster foreign investment, including the Foreign Investment Law, the Free Economic and Trade Zone Law, the Foreign Enterprises Law, the Equity Joint Venture Law, and the Contractual Joint Venture Law. For details of those laws, refer to “Foreign Investment Laws of North Korea” at FindLaw’s home page. https:// corporate.findlaw.com/law-library/the-foreign-investment-laws-of-north-korea. html 7 Wikipedia, “Special Economic Zones of China.” https://en.wikipedia.org/wiki/ Special_economic_zones_of_China 8 World Bank (2015), “China’s Special Economic Zones,” p. 2. www.worldbank. org/content/dam/Worldbank/Event/Africa/Investing%20in%20Africa%20 Forum/2015/investing-in-africa-forum-chinas-special-economic-zone.pdf 9 de Mello (1997), p. 134. 10 Coan and Kugler (2008), Henisz (2000), and Jensen (2006). 11 Nicolas (2010), p. 24. 12 Hajek (2017). 13 Sharp (2018). 14 Sharp, Kim and Lepido (2018). 15 IMF home page. www.imf.org/en/About. Article I of the IMF Articles of Agreement elaborate six specific purposes of the IMF. For a more detailed description, refer to www.imf.org/external/pubs/ft/aa/pdf/aa.pdf 16 www.imf.org/en/About/Factsheets/Sheets/2016/08/02/21/04/ExtendedCredit-Facility 17 For the original purpose of the IBRD, refer to Article 1 of the IBRD Articles of Agreement. http://siteresources.worldbank.org/EXTABOUTUS/Resources/ ibrd-articlesofagreement.pdf 18 http://ida.worldbank.org/about/what-is-ida 19 “The purpose of the Bank shall be to foster economic growth and co-operation in the region of Asia and the Far East (hereinafter referred to as the ‘region’) and to contribute to the acceleration of the process of economic development of the developing member countries in the region, collectively and individually.” (ADB Article 1). 20 Home page of the ADB. www.adb.org/ 21 Home page of the ADF. www.adb.org/site/funds/adf 22 “The purpose of the Bank shall be to: (i) foster sustainable economic development, create wealth and improve infrastructure connectivity in Asia by investing in infrastructure and other productive sectors; and (ii) promote regional

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23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39

40 41 42 43 44

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cooperation and partnership in addressing development challenges by working in close collaboration with other multilateral and bilateral development institutions.” (AIIB Article 1). Home page of the AIIB. www.aiib.org/en/index.html Regarding the organizational structure of AIIB, refer to www.aiib.org/en/ about-aiib/index.html IMF Article II-2. Application for Membership: Section 21 of By-Laws Rules and Regulations of the IMF. www.imf.org/external/pubs/ft/bl/pdf/by-laws.pdf IBRD Articles of Agreement, Article II, Section 1. http://siteresources. worldbank.org/EXTABOUTUS/Resources/ibrd-articlesofagreement.pdf ADB Charter: Article 3–1. ADB Charter: Article 3–2. AIIB Article 3–1. AIIB Article 3–2. Rowley (2018). Kawai (2013). Choo (2004). “Why is a Northeast Asian Development Bank needed?” www.dwnam.pe.kr/ jiam3_1.html (Accessed August 16, 2018). For more details on this idea, refer to Campbell (1993), Katz (1999, 2004), Cho and Chang (2011), and Cho and Katz (2011). Katz (2004), p. 298. Katz (2004), p. 299. The former president, Park Geun-Hye, said “If North Korea gives up its nuclear ambitions, we will push ahead with the establishment of a Northeast Asian development bank in cooperation with the international community.” Korea.net (2015), “President pushes for Northeast Asian Development Bank,” September 10th. www.korea.net/NewsFocus/policies/view?articleId=129825 Kim (2014) introduced various versions of the proposal. pp. 25–46. Kawai (2013). Special funds are part of MDB resources and accounted for as such, while trust funds are off the MDBs’ balance sheets, owned by the contributing donors, and administered by a trustee organization such as an MDB. For details on the ASEAN Infrastructure Fund, refer to its website. www.adb. org/site/funds/funds/asean-infrastructure-fund. For more details on these ideas, refer to Moon, Oh, and Rhee (2005).

8

Conclusion

In recent years, North Korea has received increasing attention for what some see as a shift in the economic stance from an entirely self-reliant system (based on the Juche) to one that is opened to international society. However, it is still difficult to ascertain whether Pyongyang has genuinely changed its views on the world economy, and what this means for the hermit kingdom’s complex relationship with the international community. On the one hand, North Korea seems to be signaling that it is ready to economically engage with other nations and the world, but on the other hand, it does not appear to be making any meaningful economic reforms. In this respect, it can be said that North Korea seems to have a two-faced approach to external economic relations. This book examined external economic strategies that North Korea may show interest in and how they are related with regional economic integration process for the reforms and development of the North Korean economy. In particular, the book was intended to contribute to the debates on concrete proposals to open the economy of North Korea, focusing on its trade policy and foreign investment policy. We emphasized the word “concrete” with the belief that discussion of concrete options plays a very important role in inducing North Korea to join the international community. First, discussion on concrete proposals can increase trust among all the parties, while debate on broad generalities cannot be conducive to such a trust because it leaves too much room to interpretation and conflict. Also the more we discuss specific and concrete issues, the more North Koreans are exposed to information on ideas about their future and realize that the transition would not necessarily be a fall into a chaotic and hellish world. In addition, discussion of concrete action plans can create more opportunities for North Korea to contact South Korea and other countries, because these meetings on concrete issues can be made less political, less unusual, less confrontational, and more focused on practical business. To provide concrete proposals on external economic strategies of North Korea, we set up two principles. The first principle is that economic opening and integration should have a high priority, anteceding or at least being parallel to economic reforms and transformation, both on theoretical and empirical grounds. Whenever a country in transition has tried to change its economic system, there has been intense debate on the order in which economic

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transformation and economic integration should occur. The main factors that affect the sequencing of transformation and integration are as follows: Macroeconomic imbalance, economic centralization, resource abundance, country size, and industrial structure. Considering these factors and the conditions of the North Korean economy, we suggest that North Korea should give high priority to economic opening and integration. Not only theoretical grounds but also real experiences of transition in developing countries lead to the same conclusion. Even China, which has adopted a gradual approach to economic reforms and opening, emphasized economic opening over economic reforms at the beginning stage. The second principle is that proposals to encourage North Korea to undertake economic reforms and integration should mitigate the regime’s perception of economic opening as a potential threat to its existence and increase its perception of the benefits of economic opening and integration. North Korea is believed to consider international transactions to be “needed, but not liked and actually feared”. Thus regarding external economic relations and regional economic integration, North Korea has still mixed feelings and so far adopted a cautious stance towards it. North Korea’s record of limited economic interactions with foreign countries also reflects its mixed feelings towards the international community. Consequently, North Korea’s external economic relations show the following structural problems: The volume of North Korea’s economic transactions with the world, including trade and FDI flows, is still minuscule; its international economic transactions are too heavily concentrated geographically on China and sectorally on primitive underground resources; and its external economic transactions are very much volatile and vulnerable even to small shocks. To overcome these structural problems, expand external transactions, and boost the economy, what is most needed is to remove North Korea’s negative perception of external economic relations and its fear of regime collapse. Among various alternative strategies to achieve the goal of economic reforms and economic development based on economic opening, utilization of a regional economic cooperation framework would be the best option for North Korea. East Asia can provide a large export market for North Korea and can become the largest source of foreign investment. Since many East Asian countries are at different levels of development, with different industrial structures, North Korea can find comparative advantages in various sectors and mitigate its heavy dependency on a specific country and on a specific sector through international transactions with neighboring regional countries. Also when international transactions are expanded and diversified, the volatility and vulnerability of North Korea’s external transactions can be reduced. In addition to the benefits of overcoming the structural problems of its external economic relations, participation in regional economic integration can provide an opportunity to overcome some political problems, leading to a smoother movement towards economic reforms and opening of North Korea to the international community. It is worthy of note that North Korea’s participation in regional economic

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integration would bring benefits not only for that country but also for the regional integration process itself in East Asia. This book proposed and discussed concrete strategies related to external economic policies, i.e trade policy and foreign investment policy, which are believed to be vital in promoting economic reforms and sustainable development for North Korea. First, trade policy and foreign investment policy should be adopted as a part of grand economic development scheme. North Korea has considered its opening policy though international transactions with foreign countries as an instrument to collect hard currency rather than as a key development strategy. If a trade policy is designed as a part of economic development policy, North Korea can tell what would be the most economically sound options in the long run when it conducts trade negotiations with foreign countries. Thus in negotiating with foreign countries, it can make decisions with a clear idea of what could be conceded and what should not be conceded for its long-term economic growth. If North Korea realizes that foreign investment is essential to develop its infrastructure and sustain economic development, it will use its foreign investment policy as a key strategy to attract foreign capital through full commitment to opening policies so that its reputation as a corporate graveyard for foreign investors can be improved and eventually disappear. Second, if North Korea’s trade and foreign investment policies are to be successful, it should join international trade and financial organizations such as the WTO and the IMF. Without joining the WTO, North Korea can still open the economy either unilaterally or bilaterally in the context of regional trade negotiations. But the binding mechanism of WTO accession makes North Korea’s commitment to the opening policy more credible. Unless North Korea joins the WTO, then the binding mechanism is not applied and domestic interests may influence and reverse the trade opening policy. Thus without accession to the WTO, it will be very hard for North Korea to maintain and fulfill the commitment to opening policy in the long run. Also it is very hard to find an example of a country that has attained full-fledged economic development without accession to international financial institutions such as the IMF. To ensure sufficient foreign investment, North Korea must join them, because international financial institutions provide loans for development and can further encourage private investors to invest in North Korea. If North Korea wants to join international financial institutions, the first step is to join the IMF, whose membership is a prerequisite for accession to other regional and global financial institutions including the ADB, the AIIB, and the World Bank. Third, there are some ideas that North Korea should be involved in regional economic integration process. For closer trade relations between the two Koreas, North Korea can establish an FTA or a customs union with South Korea. There are various pros and cons to these ideas, and a careful assessment of them and North Korean economic situations is needed to select a best option. Also, North Korea can participate in ongoing negotiations on PTAs in East Asia. It could try either to become a full participant to these negotiations or to include an association provision in its PTA with South Korea. For financing sources,

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accession to regional financial institutions may provide some money for its development. But the financing needs for the development of North Korea will be too large to be met by existing sources and additional development financing mechanisms are needed. There are three notable ideas for meeting these financing needs, including creation of the NEADB, the NEAIF, and the NEADC. But the first two proposals still have a few disadvantages in meeting the financing needs for developing North Korea, and we propose the establishment of the NEADC to overcome those problems. The book deserves a final remark. As underlined in several instances, opening North Korea through trade and financial transactions is only one component of the new policies needed for boosting the country’s growth and sustaining its economic development. Exchange rate policy, macroeconomic policies, labor market policies, structural policies, and social policies, establishing progressively competitive markets for goods, services, labor, and capital and stabilizing the economy and the society in North Korea, will all be crucial for achieving economic success. The major economically sound available options in all these crucial policies should also be examined in studies like this one in order to provide North Koreans with the best information possible – illustrating once again that the transition period is not doomed to be a free fall into a chaotic world.

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Index

Note: Page numbers in italics indicate figures and in bold indicate tables on the corresponding pages. acquis communautaire 20n3 ASEAN+3 Macroeconomic Research Office (AMRO) 56, 57 Asian Bond Market Initiative (ABMI) 54–56, 57 Asian Currency Unit (ACU) 56, 58, 58 Asian Development Bank (ADB) 110–113 Asian Development Fund (ADF) 110–111 Asian Infrastructure Investment Bank (AIIB) 109, 111–114 Asian Prime Collateral Forum (APCF) 55 Asia-Pacific Economic Cooperation (APEC) 62 Association of Southeast Asian Nations (ASEAN) 31–32, 50–53; Asian Bond Market Initiative (ABMI) and 54–56; Chiang Mai Initiative (CMI) and 53–54, 54 Baltic countries 96–100, 98–99 bilateral trade agreements 78–81, 80 Bin Sheng 62 CEE (Central and Eastern Europe) countries 19–20; economic integration and transformation experience of 8–12, 10, 11 Chiang Mai Initiative (CMI) 53–54, 54, 61 Chile 85, 85–86, 85–87 China 29, 34–35; foreign direct investment in North Korea by 42; foreign trade agreements (FTAs)

between North Korea and 59–60; One Belt and One Road Initiative 111; as reference country 82–83; SEZs in 105–107, 108; trade with North Korea 36–40, 37, 37–40 Cho, Lee-Jay 115 Chung Ju-young 47 comparative advantages 71 Comprehensive Economic Partnership in East Asia (CEPEA) 62 Copenhagen criteria 10–11 currency unions 14, 16, 20n9 customs union 93–96, 95 democratization 17 Duterte, R. 31 East Asian regional integration: benefits for North Korea of 65–68; main features and limits of 64–65; monetary and financial cooperation in 53–58, 54, 57, 58, 60–61, 63, 64; regional trade agreements in 50–53, 52; sub-regional and trans-regional initiatives in 58–63, 64 East Germany 12–15, 13, 16, 82–83 economic integration and transformation: in East Asia (see East Asian regional integration); experience of CEE countries with 8–12, 10, 11; experience of German unification and 12–15, 13, 16; North Korea’s motives for 27–29; North Korea’s strategies for 30, 30–32; sequencing of 16–20 economic opening policy 102–105, 105

138

Index

Economic Review and Policy Dialogue (ERPD) 56 economic size of countries 18–19 European Union (EU) 9–12, 10, 20; Baltics and Georgia and 96–100, 98–99 Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP) 63 Fisher, S. 17 foreign direct investment in North Korea 40–42, 41, 42, 47–48, 67 foreign economic zones (FEZs) 87–91 foreign trade, North Korean: geographical and sectoral distribution 36–40, 37, 37–40; overall trends in 34–35, 35–36 foreign trade agreements (FTAs) 59–60; North Korea and ongoing negotiations of Asian 96; between South Korea and North Korea 91–93 Free Trade Agreement for Asia-Pacific (FTAAP) 62 Gelb, A. 17 General Agreement on Trade and Tariffs (GATT)-WTO Agreements 75 geographical and sectoral distribution of North Korean foreign trade 36–40, 37, 37–40 Georgia 96–100, 98–99 German unification 12–15, 13, 16, 82–83 globalization 16 gradual approach 20n8 Greater Tumen Initiative (GTI) 44 Harmonized System (HS) 90 Henning, R. 50 historical institutionalism 18 Hyundai Group 45, 47 imbalances, extent of macroeconomic 18 industrialization, level of 19 institutionalism, historical 18 International Bank for Reconstruction and Development (IBRD) 109, 110, 112–114 International Center for Settlement of Investment Disputes (ICSID) 109, 110 International Development Association (IDA) 109–110, 110

International Finance Corporation (IFC) 109, 110 International Monetary Fund (IMF) 108–109 Jackson-Vanik amendment 78–79 Japan 29; foreign direct investment in North Korea by 41; foreign trade agreements (FTAs) between North Korea and 59–60; trade with North Korea 36–40, 37, 37–40 Juche 29, 30–31 Kaesung Industrial Complex (KIC) 35, 40, 41, 45–46, 45–47 Katz, S. 115 Kim Il-sung 29, 47 Kim Jong Nam 1 Lim, Haeran 16 macroeconomic imbalances, extent of 18 “make now move now” view on North Korea 1–2 monetary and financial cooperation in East Asia 53–58, 54, 57, 58, 60–61, 63, 64 most-favored nation (MFN) principle 71, 74–75, 78–79; appropriate reference countries for 82–87, 84, 85–86 Mount Kumkang International Tourist Park 45, 47 motives of international transactions 27–28 Multilateral Investment Guarantee Agency (MIGA) 109, 110 Nam, Duck-Woo 115 National Unification Advisory Council 23 nomenklatura 1–3 nongovernmental organizations (NGOs) 23 Northeast Asian Development Bank (NEADB) 115–120, 118, 120 Northeast Asian Development Corporation (NEADC) 115–120, 118, 120 Northeast Asian Infrastructure Fund (NEAIF) 115–119, 118, 120 North Korea: background and purpose of understanding 1–4; customs union between South Korea and 93–96, 95;

Index economic opening policy of 102–105, 105; fear of market-based future entrenched in 2; features and benefits of regional economic integration for 64–68; foreign direct investment in 40–42, 41, 42, 47–48, 67; foreign trade by 34–40, 35–40, 37; main features of external economic relations of 47–49; “make no move now” view on 1–2; motives for external economic relations in 27–29; participation in global and regional financial institutions by 108–114, 110; perceptions of 22–26, 24; special economic zones (SEZs) in 35, 40–41, 42–47, 43, 45–46; strategies for regional economic integration by 30, 30–32, 123–126 North Korean trade policy 70–71; closer trade relations with South Korea via 91–96, 95; concluding bilateral trade agreements and 78–81, 80; foreign economic zones (FEZs) and 87–91; looking for appropriate reference countries for 82–87, 84, 85–86; mostfavored nation (MFN) principle and 71, 74–75, 78–79; possibility of WTO membership and 76–78, 81; pursuing an unconventional negotiating tactic and 76–81, 80; transitory simple substitutes and 75–76; uniform tariff and 71–74, 72 Orascom Telecom Media and Technology Holding 107 Park Geun-hye 91 perceptions of North Korea 22–26, 24 preferential trade agreements (PTAs) 88 Rajin-Sunbong SEZ 42–44 Regional Comprehensive Economic Partnership (RCEP) 61–62 regional development project 114–120, 115, 116, 118, 120 regional financial cooperation: foreign investment policy as economic development strategy in 102–107, 105, 108; links with regional development projects 114–120, 115, 116, 118, 120; North Korea’s participation in global and regional financial institutions and 108–114, 110

139

regional integration see East Asian regional integration regional trade agreements 50–53, 52 resources, availability of 18 Rhee, Yeongseop 16 Roh Moo-Hyun 91 Scobell, Andrew 25 Scollay, R. 62 sequencing of economic integration and transformation 16–20 shock of regime collapse 17 South Korea: aid to North Korea from 26; closer trade relations between North Korea and 91–96, 95; customs union between North Korea and 93–96, 95; foreign economic zones (FEZs) and 87–91; foreign trade agreements (FTAs) between North Korea and 59–60; perceptions of North Korea in 23–24, 24; SEZs in 105–107, 108; trade with North Korea 36–40, 37, 37–40 Soviet Union 29; foreign direct investment in North Korea by 41 special economic zones (SEZs) 35, 40–41, 42–47, 43, 45–46; North Korea’s foreign investment policy on 106–107, 108 sub-regional and trans-regional initiatives in East Asia 58–63, 64 Trading Across Borders indicator 83 Trans-Pacific Partnership (TPP) 62–63, 64 Trump, D. 62, 78 Tumen River Area Development Program (TRADP) 42–44 UN Conference on Trade and Development (UNCTAD) 41 uniform tariff 71–74, 72 Vietnam 34–35, 80, 80, 80–81, 87 Volvo 107 West Germany 12–15, 13, 16, 82–83 World Bank 105; on SEZs in China 106 World Bank Doing Business indicators 83 World Bank Group (WBG) 109, 110 World Trade Organization (WTO) 76–78, 81, 100n7 Xiyang company 107