North Korea 'surrenders' economic sovereignty to encourage Chinese investment

In an economic plan reminiscent of China in the 1970s, North Korea is looking to develop two special economic zones (SEZs) in the coastal region of Rason and the island of Hwanggumpyong. The SEZs will offer tax breaks to investors and will officially permit the use of Chinese renminbi (RMB)in a bid to attract investors and much-needed cash flow into the investment-starved economy.

With rudimentary physical and financial infrastructure, and the uncertainties surrounding the country, North Korea has repeatedly failed to attract substantial foreign investment from countries other than China. As a result, “Chinese investment is crucial to North Korea – for its development but also as a gateway to attract other foreign investors”, says Jennifer Lee, Korea analyst at Eurasia Group. The only way this project will go anywhere is “with the support of the Chinese”, says Andrew Gilholm, head of Asia analysis at Control Risks. He adds: “There needs to be genuine commercial interest from Chinese companies, which remains extremely limited, especially when Chinese companies have been burned over and over again when they have tried to invest in North Korea.”

It has been the norm, not the exception, for Chinese firms to have their money expropriated when investing in North Korea, which has discouraged Chinese investors from entering the North Korean market. Despite this, the government is more keen than corporates to take advantage of North Korea’s SEZs, with the result of creating mixed messages. Lee says: “The Chinese government is pushing to make the conditions in these SEZs optimal for Chinese firms, but at the same time [the Chinese government has] told North Korea that entry decisions would be made by the firms themselves.”

The creation of SEZs has to be viewed in a geo-political context. 

“This is a stunning surrender of economic sovereignty by North Korea, even if a partial one,” says Allan Dwyer, assistant professor of finance at the Bissett School of Business, Mount Royal University, Calgary. “[North Korea is] admitting that their own currency is worthless and they will do anything to smooth the operations of the new SEZs.”

Indeed, it is in Beijing’s best interest to maintain a close relationship with North Korea. “My suspicion is that the Chinese are doing it not in expectation of great economic gain but rather as a way to keep stability within their zone of influence,” explains Dwyer. “A North-Korean Spring is something that could easily bleed into China, which has already seen hundreds of acts of civil disobedience and public disorder in the last 24 months. The SEZs with North Korea are a pre-emptive strategic move by China and should be viewed as a Chinese, not a North Korean, initiative.”

On the surface, it would appear that North Korea is implementing meaningful change to economic policy, but we should not read too much into this, says Gilholm. “We shouldn’t exaggerate the changes we’ve seen,” he says. “This might seem like a big deal by Korean standards, but in reality this reform is timid and very much in the early stages. Any reform could be completely stripped away, similar to what Kim Jong-ildid, because there has been no real political shift to make investments more credible.”

It is believed that initial investor interest will lie in exploring North Korea’s natural resources, which have remained untapped because of a lack of infrastructure, equipment and technology. Chinese hunger for natural resources could drive Chinese corporates to the country, but, this is only speculation. As Dwyer points out: “There is some evidence that mining could be lucrative, but no one really knows.”