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North Korea: Witness to Transformation

Case Studies on Chinese Business in North Korea

by | February 5th, 2014 | 07:00 am
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Last semester, one of my students at SAIS, John Langdon, wrote an interesting term paper consisting of four case studies based on structured interviews of Chinese businesses operating in North Korea. The cases are quite interesting in what they reveal about the roles of sanctions, specialist “fixer” agencies, and political risk in cross-border commerce.

Cement

The first case study involves a Chinese cement producer which invested in a North Korean cement plant, controlled by a North Korean military unit. The firm was introduced to its North Korean partner via another Chinese business. (The prominence of other Chinese businesses in making introductions is consistent with results that Steph Haggard and I obtained in a larger formal survey of Chinese enterprises operating in the DPRK.)  It indicated that it expected significant growth in North Korean cement demand, particularly military demand, and as a consequence expected a 30 percent rate of return on its investment.

The investment was financed via a Chinese shadow bank, in part to avoid any Chinese government scrutiny, and the firm accepted that they were effectively on their own, particularly due to the military involvement on the North Korean side.

The Chinese cement maker provided a generally negative appraisal of the North Korean physical and regulatory infrastructure. Their North Korean partner constantly tried to change the terms of the contract and recourse to bribery was routine. Eventually when it became apparent that the project could not be taken to completion, the two sides got into a dispute over the terms of the dissolution and the project collapsed.

Iron Ore

The Chinese enterprise started out as an importer of North Korean iron ore and later became an investor in partnership with a North Korean state-affiliated trading firm linked to the Ministry of State Security. According to the Chinese enterprise, the investment is highly profitable. The Chinese complain about the inadequacy of North Korea’s physical infrastructure and arbitrary and capricious shifts in regulation which are met with bribes. (This pattern of arbitrary changes in regulation giving rise to opportunities for shakedowns is consistent with results that Steph Haggard and I obtained both in a survey of Chinese businesses operating in the DPRK, as well as surveys of North Korean refugees.) The enterprise has not involved the Chinese government in any problems it has encountered; rather it consults with other Chinese businesses operating in the DPRK for advice. (This is also consistent with the results that Haggard and I obtained.) The Chinese ascribe their relatively positive outcome to experience gained as an importer before becoming an investor.

The firm identified political risk associated with North Korean government policy as their biggest headache. They were occasionally caught up in trade disruptions of one sort of another, but insofar they are dealing in a commodity, the situation would eventually return to normal.

Pressure Vessels

This case study involved a Chinese SOE capital goods producer which exported pressure vessels to a military-affiliated North Korean SOE. The two SOEs had been introduced by a Chinese intermediary.

Given that both counterparties were SOEs, the Chinese reported that they were required to file technical reports with both Chinese and North Korean authorities, but beyond that were not subject to a lot of oversight (apart from strict North Korean monitoring of the Chinese engineers when they were in-country).

The Chinese SOE made similar complaints about the North Korean business environment as did the other enterprises, but in this case bribery was done via a specialist intermediary “fixer” agency.

The trading relationship was terminated as a result of the Chinese move to prohibit the exportation of dual-use technology to North Korea. The government informed the enterprise that they would have to stop selling the pressure vessels to North Korea, and the SOE complied.

Hydroelectric  Generators

The last case study involved a Sichuan-based SOE producer of hydroelectric generators.  The SOE has done business with a variety of North Korean businesses, mostly SOEs, since 1985. The firm was introduced to its North Korean counterparties through an intermediary agency. The agency handled a range of business functions including negotiating contracts and securement of payments.

Nevertheless, the SOE encountered a range of problems in its North Korean operations. These included inadequate infrastructure, a need to bribe, translators “taking sides” with the North Korean counterparty, lack of personal freedom including their engineers being confined to the worksite and their temporary residences, and being transported between the two inside a closed truck from which they could not see. Security personnel were “omnipresent,” the Chinese were restricted in their interactions with North Korean counterparts, and they found listening devices in their residences.

The North Koreans demanded payment for the local workers in Chinese RMB, and the Chinese indicated that they expected that most of these wage payments ended up either going to the North Korean government or into the pockets of North Korean officials. (This pattern of indirect payment in hard currency with the expectation that little reaches the workers is consistent with the results from a survey of South Korean employment practices in North Korea that I will release next month.) The value of money converted into North Korean won for local expenses was wiped out in the November 2009 currency reform.

The enterprise reported little Chinese government oversight or support. However, following the most recent North Korean nuclear test, the government informed the SOE that it should terminate its business in North Korea and report any business inquiries originating from North Korea or Korean-Chinese.

In short, these case studies point to an array of outcomes, some positive, some not. The complaints about the physical and regulatory infrastructure and the resort to bribery are not new. What is intriguing is the endogenous response to this environment, namely the rise of fixer firms who will facilitate cross-border business for a price. That, and the suggestion that despite the rising trade figures, based largely on trade in commodities, Chinese implementation of UN sanctions is having some impact, at least in certain areas.

Comments (3)

Would love to read the full paper. It’s also interesting when viewed through the lens of post-purge Jang. If we view Jang’s purge as a more-or-less authoritative refutation of Chinese style reform, that purge might also be seen as an opening for ROK firms to take up some of the FDI slack.

Roger February 10, 2014 | 4:03 pm

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“This pattern of indirect payment in hard currency with the expectation that little reaches the workers is consistent with the results from a survey of South Korean employment practices in North Korea that I will release next month”

I’m really looking forward to this report.

Andrew February 5, 2014 | 9:50 pm

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You wrote: “In short, these case studies point to an array of outcomes, some positive, some not.”

Really? I rather see the array of outcomes as “one not entirely negative, all others complete disasters”.

Tomas C February 5, 2014 | 5:54 pm

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