South Korean Lemons Withering in North Korea

September 24, 2012 7:00 AM

A few weeks ago I stumbled across an article by Steven Borowiec titled “South Korean Businesses in the North Going Broke.”  The thrust of the piece, which paralleled other articles that appeared during the spring, is that the policies of President Lee Myung-bak have inflicted more damage on South Korean firms than the North. Borowiec reports that according to the Ministry of Unification, “319 of the registered South Korean companies have gone out of business since Lee came to power. The remaining 800 or so may not be far behind.” The South Korean government just announced a program to supply 7.5 billion won in subsidies to South Korean firms adversely affected by the fallout from sanctions imposed following the sinking of the Cheonan.

Yet on a deeper level, it is not clear which way the causality runs.  As we have argued in some sense the North-South trade is a market for lemons: financially strapped South Korean SMEs head north, avail themselves of South Korean public subsidies, and gamble for resurrection.  In paper now available online in the International Economic Journal we demonstrate how entry, profitability, and sustainability are disturbingly contingent on South Korean public support.

While there is a tendency to blame it on LMB, Borowiec’s interviewees don’t necessarily see it that way. One South Korean textile producer put it this way:

“North Korea’s basic problem is its system. They have had the same system for so long and have made no changes to the leadership. If anyone thinks they can leave the regime as it is and have the economy improve, they are wrong.” When asked whether North Korea could become a reliable host for foreign investment, Borowiec reports that the response was “Not as it is currently constituted…for commerce to flourish in the North it would require a western concept that Pyongyang is not likely to adopt: the rule of law and the sanctity of contract. There are cases of Chinese and South Korean firms signing contracts with North Korean partners, only to have them fail to execute the deal and be left with no product or method of recourse.” (cf. Xiyang).  The textile entrepreneur continued, “There is no trust at all. There is no way to trust a contract. If they really want to change the system, they need to change that.”

We couldn’t have said it better ourselves.

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Marcus Noland Senior Research Staff

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