April 1, 2017 1:00 pm JST
Timothy S. Rich

Prospects dim for Chinese investment push in North Korea

Willingness to accommodate foreign companies may be nearing limit

North Korea has in recent years quietly taken a number of steps to accommodate Chinese investors. While both private and state-owned Chinese companies have taken advantage of this gradual opening, prospects for further development of this relationship are dimming.

This comes as a result of surging bilateral tensions over North Korea's defiance of U.N. resolutions regarding its weapons programs, long-standing concerns in Pyongyang about undue Chinese influence, and worries that further reforms sought by prospective investors, such as stronger protection against expropriation, could undermine controls valued by the regime.

Despite increased international concern about North Korean behavior, Chinese foreign direct investment has increased since the mid-2000s, with investors viewing minor market reforms as following a similar path to China's initial 1980s experiments. Although Beijing stands to benefit from encouraging the development of a more economically stable and globally integrated neighbor, a focus on China's ideological or strategic interests overlooks the more important role of private investors.

In a previous study, Heon Joo Jung of Yonsei University and I found that private companies and individual investors account for most of the investments in North Korea, although initial successes involving state-owned enterprises sparked private interest.

Investors have been motivated to consider North Korea for a variety of reasons. Growing competition for opportunities elsewhere, even in comparatively closed countries such as Cuba and Myanmar, can entice investors to overlooked North Korea. A growing tourism industry seems ripe for foreign investment. North Korea also possesses considerable natural resources, including coal, but lacks mining and extraction capabilities which international investors might bring.

However, if potential investors cannot expect to realize profits, few will take the risk. Similarly, if investors believe that there is no protection of property rights, and that their investment can simply be seized when the host country desires, few will invest. Expropriation remains the most common concern about North Korea among Chinese investors.

Language and cultural barriers further limit access to North Korea. Yet those with language skills, especially among Korean-Chinese living near the border, frequently overcome this hurdle. They appear to comprise a high proportion of Chinese investors in North Korea and to have the largest-scale investments.

Desire for FDI

North Korea opened the door for FDI with a 1984 joint venture law, followed by the establishment in 1991 of a Chinese-style special economic zone along the Chinese border at Rason. There was further expansion in 2002 with the establishment of the Sinuijiu Special Administrative Region, also on the border with China, and of the Kaesong Industrial Complex, near the border with South Korea.

Kaesong has now closed, a victim of international tensions sparked by North Korean weapons tests. But SEZs have proliferated under current North Korean leader Kim Jong Un, with relevant laws often crafted in consultation with Chinese investors. Compared to earlier efforts, the zones have expanded geographically and in a range of sizes, allowing for greater regional experimentation. Reforms have also opened up the possibility of international arbitration within the zones, further assuaging investor concern. A 2013 reform allows foreigners to take 50-year transferable land leases within selected SEZs.

Kim's administration has also shown a willingness to grant monopoly production or sales rights, for example with bicycle manufacturing, as well as set competitive tax rates. It remains unclear to what extent these incentives have worked, although anecdotal evidence suggests that the SEZs are more active than during the 1990s experiment.

There is evidence of shifts in the types of investment coming over time, suggesting that investors have come to feel more confident about profitability and property rights. Early investors largely focused on areas requiring limited capital, such as retail or fish farms, reducing the risk of significant loss in case of expropriation. While most investments remain small, larger investments in capital-intensive industries have followed, including moves into North Korean iron ore by Xiyang Group and into automotive parts manufacturing by Wanxiang Group, both private Chinese companies.

Despite these efforts, room for further development of investment opportunities appears limited. Shortages of fuel and electricity are widespread, and the special economic zones have land but little infrastructure, which investors are expected to construct themselves. Some investors seem willing to do this, especially if can they expect long-term profits.

International sanctions

Outside the SEZs, China Railways Investments Group announced in 2015 that it planned to invest in high-speed trains and telecommunications in North Korea. But investors face significant difficulties in complying with a myriad of international sanctions and domestic laws, in the U.S. and elsewhere, that limit imports and exports from North Korea.

Pyongyang also undermines investors' ability to realize profits. For example, Orascom, the Egyptian telecommunications company that set up North Korea's first 3G mobile network, encountered demands in 2015 that an estimated $600 million in profits remain in Pyongyang rather than be repatriated.

North Korean officials can also hold investments hostage, as Xiyang Group discovered in 2012. After investing $35-$50 million in an iron ore mine, its electricity and telephone service were cut after it refused to renegotiate investment terms. Xiyang Group claimed it had been cheated, but North Korea denied its claims, saying the Chinese company had delivered on only half its investment obligations.

More broadly, North Koreans often appear to misunderstand the goal of FDI, equating it with political goals rather than profit maximization. They thus see little need for efficiency.

Despite the need for foreign investment, Pyongyang appears reluctant to commit to further reforms that could challenge the regime's control, and officials are particularly concerned about Chinese influence, a worry dating back to the Korean War.

Chinese investors, arguably the best suited to take advantage of opportunities in North Korea, are unlikely on their own to provide the catalyst necessary for sustainable economic growth. Furthermore, as China becomes more willing to enforce sanctions against North Korea, Pyongyang's willingness to accept even Chinese investor demands becomes less certain.

Investors must also consider the potential public relations cost of associating with North Korea, whether through direct investment or by relying inadvertently on Chinese suppliers outsourcing to North Korea. Australian sportswear group Rip Curl faced a storm of negative publicity in 2016 after one of its Chinese contractors was caught using a North Korean subcontractor.

As the Rip Curl case demonstrates, Chinese investors may be willing to separate the political and economic implications of investing in North Korea, undeterred by their neighbor's military posturing, but investors elsewhere may not.

Timothy S. Rich is an assistant professor of political science at Western Kentucky University.

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