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Jun142010

Sanctions Busting, North Korea Style

by Felix Imonti


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In March of this year, North Korea’s finance chief was executed for his role in disastrous currency reforms that led to even worse conditions for the struggling population and brought rare signs of popular unrest. Hopes that this episode might prompt the government towards a newfound interest in the welfare of the people have been quickly dashed. Amid tightening sanctions and increased global attention, crime is not paying as well for Kim Jong-Il as it once did. His desperate search for foreign currency may be masked in the language of building a modern, prosperous economy, but the real priority is an attempt to maintain the lavish lifestyles of the elite, paid for with the continued oppression of the people through unsustainable policies.


Kim Jong-Il has said his father advised him to focus on the military and the Workers Party and to leave the economy and other mundane matters to party functionaries. He followed that advice in November 2009 when he left Director of Finance Pak Nam-Ki responsible for designing and overseeing the currency conversion. Pak’s mismanagement of the conversion – which involved simply removing zeroes and capping the amount of money people could trade in for the new currency – was to bring a society suffering from chronic shortages of nearly everything to the edge of economic disaster. One typical family, who fled to China and were interviewed by the New York Times, described how they saw their life savings go from US$1,560 to US$30 in the blink of an eye.


 


CRUSHING THE BLACK MARKET


The late Pak Nam-Ki was appointed to the directorship in 2005. He arrived with a mission to crush the free market that had grown over the previous decade. The underground economy had become an essential means for the distribution of food during the famine in the mid 1990s. At first, basic items were smuggled across the border from China. Since those early days, the growth of the Chinese economy has made available a broader variety of goods, some of them forbidden to the Korean consumer, such as cell phones and televisions that can receive signals from across the border.


However important the free market was to maintaining a degree of social stability by providing scarce products, it was also weakening the centrally managed economy by opening the population to foreign sources of information and by an increasing number of workers leaving their state jobs to work exclusively in the underground markets. During the currency conversion in early December 2009, workers were offered a cash bonus in the name of Kim Jong-Un to return to their jobs within the state sector. It was necessary to reassert control over the labour force in order to break the growing influence of wealthier members of the underground commercial class and to carry out an economic development programme that would be revealed in a New Year’s editorial: “Bring about a radical turn in the people’s standard of living by accelerating the development of light industry and agriculture.”


Suppression of the underground economy had been ongoing for several years. The drive was intensified in February 2008 with the public execution of 15 blackmarketeers in Onsung. That was followed in June 2009 by the closure of the national wholesale distribution center in Pyongsung. Despite his efforts, the markets continued to function. But the currency conversion on 30 November 2009 finally brought the black market to a halt. He added to the hardship later in December by prohibiting the ownership of foreign currencies. Without Chinese yuan, South Korean won or US dollars, all vital trade with China stopped.


Through his draconian acts, Pak Nam-Ki created a severe food shortage and aroused public opposition. Although the economy was floundering, he was still basking in the approval of the Dear Leader on 4 January when they appeared together during an inspection tour. By the end of the month, he was under arrest and in early March he was executed for “sabotaging” the currency programme. Premier Kim Yong-Il told an assembly of party officials at the People’s Palace of Culture on 5 February: “I sincerely apologise for having caused great pain to the people by recklessly enforcing the latest currency reform without making sufficient preparations or considering the circumstances.”


 


BALKING INVESTORS


There are wider ramifications from this setback, however, since Kim Jong-Il has pledged to raise North Korea to the standing of a technologically advanced society in time for the 100th anniversary of his father’s birth in 2012. This will require a massive infusion of foreign capital. The social disorders at the end of 2009 might make potential investors balk at putting their money into an unstable country.


As the news leaked out of the Hermit Kingdom of public demonstrations and people dying from starvation, Pyongyang turned to a programme of damage control. According to an Associated Press report in March, the North Korean diplomatic service has been trying to convince foreign investors that the economic problems at the end of the year were minor and short-lived.


Calming foreign concerns is vital, especially in China which is seen in Pyongyang as the likely source for 60 per cent of foreign investment. Kim Jong-Il’s open defiance of international opposition to North Korean development of missiles and nuclear weapons has cut off the country from other sources of investment capital and made him increasingly dependent on Chinese largesse. A North Korean delegation sent to the European Union in 2009 found European investors unwilling to challenge UN sanctions and they returned empty-handed. Since the election of President Lee Myung-bak’s government in Seoul in 2008, even once-compliant South Korea has hardened its position, a situation that has only worsened for North Korea in the wake of the ROKS Cheonan sinking on 26 March.


 


SUPERFICIAL REFORMS


Seeking foreign capital and technology to boost the economy is a reversion to an earlier failed strategy. In 1984, Kim Il-Sung introduced regulations modeled on those adopted by the Chinese at the beginning of their transition towards a market economy. North Korean state corporations formed joined ventures with state corporations in China and the Soviet Union, but the shift in direction went scarcely beyond those arrangements.


The collapse of the Soviet Union in 1991 prompted a more ambitious policy change to replace the lost trade and aid. A free economic zone was created in the northeastern city of Rason, a crucial port city where North Korea shares borders with Russia and China. Even South Koreans were invited to invest, until Kim Jong-Il ended the agreement in 1999. The plan was to attract US$7 billion in new investments, but only US$140 million was ever received. Four hundred small enterprises were formed with most of the investments coming from China and from North Koreans living in Japan.


Separated from the rest of society in a cocoon of luxuries, Kim Jong-Il and the small circle of elites around him know little about the deprivation that has left nine million people malnourished. The regime has relied heavily on the criminal activities of Office 39, a type of state-sponsored global mafia, which is believed to be directed by Chang Song-Taek, Kim Jong-Il’s brother in law. Some 40 per cent of North Korean foreign earnings have come from counterfeit currencies, of name-brand products, insurance fraud, and the sale of weapons.


What is different this time is that tightening sanctions are threatening cash flow from the usual sources and worsening the persistent annual trade deficit. Faced with the loss of funds to keep his supporters satisfied, the regime is seeking new methods of acquiring foreign currencies.


 


CENTRALISING CONTROL


The answer adopted is a renewed search for outside investment, a policy heralded by state news agency KNCA on 20 January, when it announced that the National Defense Commission (NDC) had ordered the creation of a national development bank “in order to carry out investment affairs for projects important to national policy and to conduct business with international commercial banks and international financial institutions.”


The involvement of the NDC, the most significant centre of authority of which Kim Jong-Il is chairman, signaled that the Dear Leader had taken direct command over the project.


A meeting at the Pyongyang Yanggakdo International Hotel established the seven directors of the ruling committee. They represent various branches of the government: the NDC, the Cabinet, the Ministry of Public Finance, the Korean Asia-Pacific Peace Committee, and the Korea Taepung International Investment Group. Among the directors is the same Chang Song-Taek, who had recently been appointed a member of the NDC and director of the Administrative Department of the Workers’ Party. The committee’s chairman is Pak Chol-su, a Korean-Chinese with business contacts in China and the means to lure investments into the Hermit Kingdom.


The Taepung International Investment Group (TIIG) is vital to North Korea’s plans, and its elevated importance has been demonstrated by the transfer of its headquarters to Pyongyang. First established in September 2006, with offices in Hong Kong and China, it proved its worth during 2007 by arranging to have the Chinese Tangshan Iron and Steel Group and Datang Power form a joint venture to build a 1.5 million-ton processing plant and a 600,000 kW coal-burning power plant in the Kimchaek Industrial District.


Under the guidance of Pak Chol-su, the TIIG has been designated to find foreign capital to provide to the national development bank. The directors of the reorganized TIIG received an order from Kim Jong-Il entitled: “On Ensuring the Operations of the Korean Daepung International Financial Group”, which made clear his personal interest in the programme’s success.


A key component in the programme is the resuscitation of plans for the development of Rason. The all-year port will give nearby regions access to the Pacific Ocean. Coal mines in landlocked Jilin Province get an outlet to the steel mills and the coal-fired power plants along the southern coast of China. Russian development of the oil and gas fields in Siberia will be made easier with ready access to distant markets. Already, the Chinese have a lease until 2028 and the Russians to 2060 on port facilities.


The importance of the port city was revealed by a visit in December by Kim Jong-Il when he described it as “one of the important centres for foreign trade.” Soon after, Pyongyang announced on 22 January that administration of Rason had been transferred to national control in order to remove the bureaucratic barriers faced by investors. An upgrade of the rail and highway links to the Chinese border has been promised and new tax provisions have been proposed to investors. The government is offering North Korean labour to investors at a bargain price of US$40 per month, compared to the Kaeson Industrial Park where 110 South Korean companies employ 42,000 workers at the rate of US$57 per month. How much the workers actually receive is unknown, since the money is routed through the government.


Across the country, eight special economic zones are planned. Investors will be able to lease property for 50 years, import essential materials without taxes, receive preferable tax rates and employ bargain priced labor. Pak Chol-su told the Kyodo New Service in April that US$120 billion would be invested over the next five years to develop utilities, transportation and energy supplies.


 


JUST ENOUGH TO SURVIVE


How realistic are these plans? According to the US State Department, North Korea had a GDP in 2008 of just US$26.2 billion. The idea that it could achieve investment of US$24 billion per annum is beyond improbable - it is downright delusional.


Nonetheless, the regime could succeed in achieving just enough foreign currency to keep the elite placated, even if few advantages trickle down to the masses. Wang Jiarui, chief of the Chinese Communist Party's international department, during a February visit to Pyongyang offered to invest US$10 billion through the Taepung International Investment Group to develop the infrastructure. China remains interested in North Korea for a variety of reasons that over-ride international pressure to disengage: the abundance of natural resources, plentiful cheap labour to replace the shrinking supply at home, and the need to maintain a stable buffer zone on the border. At the same time, North Korea depends upon China for oil supplies, food aid, and 50 per cent of its international trade. Last year, official trade figures that exclude military materials and exchanges between Communist parties totaled US$2.68 billion, a sum certain to increase as more Chinese companies accept Kim Jong-Il’s invitation to invest.


Kim Jong-Il’s principal lure for getting manufacturers into his kingdom is its abundant, low-cost and docile labour force, as well as a loophole in trade regulations that allows cross-border production as long as outgoing items are left unfinished. This enables Chinese textile companies to ship fabrics into North Korea to be turned into jeans or whatever else they require, and to reship the nearly completed products to shops in Hong Kong for finishing. The products are labeled “Made in Hong Kong” and sold throughout the world with  consumers none the wiser.


A massive shortfall remains in the planned levels of investment, with few alternative sources to fill the deficit. So far, the most important non-Chinese investment has come from the Egyptian corporation, Orascom Telecom. The telecommunications company has been providing limited mobile telephone services since December 2008 to 100,000 subscribers, exclusively in Pyongyang and the nearby port city of Nampo through its subsidiary, Koryolink. In spite of assurances by Pyongyang that investments conducted through Taepung International Investment Group are not in violation of UN sanctions and a newly introduced advertisement campaigned to attract investors, few investors other than the Chinese are likely to follow Orascom Telecom into the Hermit Kingdom.


This may not matter. The move towards rapid industrialisation does not mean that policies in North Korea have changed. If anything, Kim Jong-Il is strengthening the system of dual economies, under which the elite live comfortably at the expense of great hardship for the masses. The NDC does not publish any statistics about the Kim Family income, while levels of investment and revenue will be classified information. The leadership remains primarily interested in bolstering exports in order to ensure the continued flow of luxuries for the ruling class, with supplies to the domestic market only a secondary concern. Any domestic sales by the manufacturers will have to be made through state trading companies that will set the prices and have sole distribution rights.


Kim Jong-Il is offering different policies with no substantive change. It is increasingly clear that Pak Nam-Ki was executed not because the leadership disapproved of his attempts to consolidate central control, but simply because his methods to that end failed in practice. Ri Ki Song, a professor at the Institute of Economy at North Korea's Academy of Social Sciences, confirmed that private markets would no longer be tolerated in an interview with APTN in April, saying: "Markets will be removed in the future, by reducing their numbers step-by-step, while continuously expanding the planned supply through state-run commercial networks."


Far from adopting a Chinese model of economic development, using foreign manufacturers to produce goods in North Korea for export is designed to thwart the sanctions that have begun to make life difficult for the members of the elite - and satisfying his supporters' luxury cravings is a bigger challenge for Kim than the discontent of a public that lacks the means to mount a significant challenge to the ruling class. If he succeeds in attracting sufficient investment to keep the cash flowing, there will be little reason for him or his heir to change.


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Felix Imonti is a Canadian based near Tokyo. He writes about economics and international politics, with a particular focus on the Middle East and Asia.

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