DPRK ECONOMY: CHINESE EXPERTS FORESEE ECONOMIC

C O N F I D E N T I A L SEOUL 000423

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E.O. 12958: DECL: 02/07/2026
TAGS: ECON EAID PREL PGOV KN KS CH JA
SUBJECT: DPRK ECONOMY: CHINESE EXPERTS FORESEE ECONOMIC

REFORMS, BUT DOUBT ANY CHANGE IN ROLE OF MILITARY

Classified By: EconMinCouns Kurt Tong, for Reasons 1.4 (b,d)

SUMMARY
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1. (SBU) A January 18-19 academic conference in Beijing
explored the potential for North Korea to change its
"military first" security policy in order to realize more
meaningful economic reform, faster economic growth and an
increase in international aid. The American organizers of
the event worked hard to highlight the likely improvements in
North Korean economic performance resulting from a "bold
switchover" in North Korea's security stance, while also
emphasizing the potential for increased inflows of
development assistance from overseas in such a situation.
Chinese and South Korean experts participating in the event,
however, tended to discount the incentives for change in
North Korea's security stance. At the same time, they also
doubted the potency of the disincentives to the DPRK
maintaining its current hostile stance to the outside world.


2. (C) While there was significant diversity of opinion among
the Chinese think-tank experts assembled at the conference,
the majority seemed to believe that it was most likely for
North Korea to pursue a certain pace and degree of economic
reform, while continuing to avoid risky changes in internal
political alignment. All the Chinese experts, however,
agreed that North Korea would continue to try to strengthen
its economic relationship with China, and many believed that
North Korea will attempt to mimic China's economic reform
path -- although the DPRK might not necessarily succeed. End
summary.

NBR CONFERENCE TACKLES "BIG PICTURE" REFORM POSSIBILITIES
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2. (C) Embassy Seoul EconMinCouns was recently invited to
participate in a closed-door, off-the-record academic
conference in Beijing focused on identifying the economic
benefits to North Korea and the region of a "bold switchover"
in North Korea's security stance. The "bold switchover," as
defined by conference organizer Nick Eberstadt of the
American Enterprise Institute, refers to a curtailing of the
DPRK's "military first" policy and substantial downsizing of
the North Korean military -- including, by definition,
de-nuclearization. The event, which was convened and funded
by the Seattle-based National Bureau of Asian Research (NBR)
with assistance from China's State Council Development
Research Center (DRC) and the PLA-affiliated Chinese
Foundation for International and Strategic Studies (CFISS),
was somewhat unique (as Track II events go) for the variety
of opinion presented by the Chinese experts in attendance, as
well as the frankness of their commentary. This message was
coordinated with Embassy Beijing.

DPRK CAUGHT IN A TRAP OF ITS OWN DESIGN
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3. (C) Keynote speaker Zhao Huji of the Central Party School
kicked the proceedings off on a pessimistic note by
explaining the chicken-and-egg dilemma of North Korea's three
"structural crises:" in economics; political legitimacy; and
military affairs. Zhao persuasively argued that the DPRK's
economic reforms had reached an impasse; without broader
opening to the outside, accelerated economic progress could
not be anticipated. However, Zhao asserted that the North's
chronic food shortage and limited economic reforms that have
taken place to date have already established a "second
economy" throughout the country, which constitutes a
potential political challenge to North Korea's leadership.
Meanwhile, on the military and security front, the DPRK is
trapped in a "military first" policy that exaggerates
external threats to the country in order to compensate for
the absence of a strong philosophical underpinning for the
government.


4. (C) Thus, Zhao concluded, a "bold switchover" is
difficult, given that North Korea is also loathe to rely

entirely upon China or Russia for its security. Zhao
believes the July 2002 economic reforms have already had a
large impact on the North Korean economy, but he forecast
ultimate failure for the reforms given the inability of the
North Korean regime to contain the macroeconomic
instabilities generated by the reforms. In short, Zhao said,
North Korea needs a "bold switchover" to succeed in economic
reform, but the leadership cannot risk such a fundamental
realignment due to its own lack of political legitimacy.

ECONOMIC BENEFITS FROM A CHANGE IN DPRK SECURITY STANCE
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5. (SBU) Nick Eberstadt followed with a more positive spin on
the potential for change in the North. Like Zhao, Eberstadt
concurred that the "military first" policy, the DPRK's chosen
approach to state survival, actually precludes long-term
success in state survival. Taking a positive tack, however,
he presented an econometric analysis based on data from other
transition economies to loosely quantify the potential for
economic growth if North Korea were to relinquish its current
security policy stance. Such a change, Eberstadt said, would
free significant capital and labor resources for use in more
productive ways. Eberstadt also noted that considerable
Western aid would be made available to the North if it were
to undertake a "bold switchover," even absent any fundamental
realignment of North Korea's centrally-planned economic
system.


6. (C) In commentary on Eberstadt's paper, Zang Hyoungsoo of
South Korea's Hanyang University questioned how much
incremental foreign aid would really be forthcoming for North
Korea after a change in its security stance. He also noted
that the labor contribution benefits of a "bold switchover"
might be exaggerated, given that the North Korean military is
already an important participant in the economy; Zang foresaw
greater benefits from reallocation of capital resources.
Piao Jianyi of the Chinese Academy of Social Sciences chimed
in with doubts about the earnestness of North Korea's
economic reform efforts, or any real interest in changing the
"military first" policy. Piao explained that that he is
convinced the DPRK's over-riding goal is to re-establish aid
relationships so that it can return to the relative stability
it enjoyed in the 1980's, under the umbrella of Soviet
assistance.


7. (C) Hu Angang of Tsinghua University countered that North
Korea is very interested in learning from China, as well as
simply garnering Chinese economic aid and deepening trade and
investment relations with China. This, Hu said, is why Kim
Jong-il had chosen to visit China just as the Chinese
government was in the midst of writing its next Five-Year
Plan (China's primary instrument for medium-term fiscal
policy planning). Hu then proceeded to outline the reasons
for the success of China's transition development model: 1)
macroeconomic stability; 2) political stability based around
Deng Xiaoping's determination to catch up with the outside
world; 3) gradualism, starting with agricultural sector
reform; and 4) external opening and a stable relationship
with the United States. Hu suggested that the United States
should invite Kim Jong-il to the United States, as it did
Deng Xiaoping in the 1970's. China, meanwhile, should open
its markets wider to North Korea, and accelerate investment
in North Korean infrastructure, human resources and
agricultural reform programs, Hu said.


8. (SBU) Yoon Deok-ryong of the Korean Institute for
International Economic Policy (KIEP) followed with a
presentation outlining the details of South Korean economic
cooperation with North Korea, concluding that "peace" between
North and South will result in substantial economic benefits
for both sides. In the North, economic reform and opening
will accelerate growth, while in the South, "peace" will
improve the ROK's credit rating and provide new opportunities
for profitable investment and trade with North Korea and
Northeast China. Yoon asserted that ROK government
investments in economic cooperation with North Korea in the
current timeframe will not only help hasten the arrival of

this economic "peace dividend," but also lower ultimate
reunification costs in the long-term.


9. (C) Commenting on Yoon's presentation, Marcus Noland of
the Institute for International Economics downplayed the
significance of North Korea's July 2002 economic reforms,
describing them as nothing more than a coping strategy to
ratify, legalize and thereby control ongoing marketization.
Noland also explained his view that official assistance to
North Korea in the current situation could actually inhibit
further economic reform, rather than accelerate it. Cheng
Yujie of the China Institute of Contemporary International
Relations (CICIR) chimed in with a somewhat superficial
presentation about the need for caution and gradualism in
approaches to North Korea, due to the unlikelihood that the
DPRK leadership would buy into sudden change. Given that the
military is already integrated into the DPRK economy, rapid
marketization could destabilize the government through both
challenges to ideology as well as confusion among political
and economic stakeholders.


10. (SBU) Masahiro Kawai of the Asian Development Bank and
former World Bank official Bruce Babson wrapped up the first
day's proceedings with presentations on the potential for
post-"bold switchover" economic assistance from Japan and the
international financial institutions (IFI's). Kawai noted
that de-nuclearization and resolution of the abductions issue
were mandatory preconditions for extensive Japanese
assistance. However, in the context of such changes, and
normalization of Japan-DPRK ties, Kawai foresaw that a
consequent Japanese aid package to North Korea could be on
roughly the same scale (plus inflation) as that provided to
the Republic of Korea at the time of Japan-ROK normalization
in 1965.


11. (SBU) In outlining the process for new members to join
the International Monetary Fund and World Bank, Babson
perhaps unintentionally ended up highlighting the
difficulties that North Korea would face in accessing aid
from the IFI's. The DPRK would need to first accept the
IMF's transparency and accounting norms, Babson said.
Following that, the first stages of IFI assistance would
likely center on technical assistance, and establishment of
international donor coordination systems, rather than large
immediate infrastructure investments. Chinese participants
in the conference reacted with some dismay to Babson's
presentation, noting that the North Koreans would perceive
all this as a threat to their sovereignty, without
accompanying benefits. Kawai of the Asian Development Bank
tried to soften the blow by suggesting that the ADB would
likely be more generous than the World Bank, and not require
IMF membership first -- points which Babson in turn found
distressing.

BENEFITS FOR NORTHEAST CHINA?
--------------


12. (C) For the concluding session on Day Two, Li Dunqiu of
the State Council Development Research Center began the
proceedings with a well-researched illustration of the
rapidly deepening economic ties between North Korea and
Northeast China. Li foresaw large benefits for Northeast
China stemming from economic reform and opening in North
Korea, with the best case scenario being open borders between
North and South Korea, which "would forcefully propel the
economic development of China's northeast." Foreign
investors would find the Northeast China region much more
attractive if military tensions in the region were eased, Li
concluded.


13. (C) Commenting on Li's presentation, contrarian Piao
Jianyi of CASS asserted that a "bold switchover" in North
Korea could also end up hurting Northeast China, via
resulting political instability and refugee flows. David
Dollar of the World Bank's Beijing Office concurred with Li
in identifying the benefits for Northeast China of changes in
North Korea, although he cautioned that it would not be a
panacea, since Northeast China also has its own

internally-generated problems of lagging economic reform,
bankrupt state-owned enterprises and widespread corruption.


14. (C) Gao Jingzhu of Yanbian University noted that, as a
factual matter, Chinese investment in North Korea to date
remains quite small. While there is some investment in
minerals extraction, larger state-owned firms seem
disinterested in investing in the DPRK. The Chinese
government has also done little to encourage such
investments, Gao said. He explained that although official
export credits are available for trade with North Korea, both
official and unofficial Chinese bankers are skeptical of
lending to North Korea ventures, given the poor track record
of past failures. Ga added that the Tumen River Basin
Development Project, despite its recent nominal extension,
remains basically dead-on-arrival.

WHY DID KIM JONG-IL VISIT CHINA?
--------------


15. (C) In a parallel presentation, Li Dunqiu also relayed
his conclusions about Kim Jong-il's nine-day, January 2006
visit to China. First, Li said, the visit reflected strong
desire to improve relations with China, as evidenced by the
fact that Kim brought along such a large cohort of DPRK
officialdom. Second, Kim's visit signaled a clear desire to
learn about the "China model" for transition and development.
Li saw signs of hope that -- unlike Kim's January 2001 visit
when he looked only at China's largest cities and companies,
perhaps without much comprehension of what he was looking at
and how it was achieved -- on this visit Kim toured smaller
cities and research institutes focused on more appropriate
(less sophisticated) technologies, including agricultural
industries.


16. (C) Ren Xiao of the Shanghai Institute for International
Studies concurred with Li, saying that analysts should not
underestimate the importance of the Kim visit. Several
Chinese participants were in fact visibly excited by the
possibilities generated by Kim Jong-il's China tour, which
took place at the same time as the NBR conference. Marcus
Noland cast doubt on the impact of the visit, however, noting
that it is impossible to tell what Kim Jong-il actually sees
when he looks at China. The January 2001 visit to Shanghai
seemed to only generate a desire to have similar tall
buildings in Pyongyang, Noland said.

CONVERSELY, HOW BAD IS A NEGATIVE SCENARIO?
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17. (SBU) Noland followed with a paper outlining the likely
negative economic costs for Japan, South Korea and China of a
North Korean "nuclear breakout," defined as testing a nuclear
weapon or transferring nuclear materials or technology to
another country or non-state entity. Noland concluded that
while the trade impact of such an event would be small, given
the small size of the North Korean economy, the impact on
regional financial markets could be considerable. In the
worst case, South Korea could experience capital flight and
significantly higher overseas borrowing costs, while China
could see a worsening of U.S.-China economic relations. The
impact on Japan would likely be more temporary, although also
tangible.


18. (C) In response, Chinese and ROK participants in the
meeting generally found fault with Noland's conclusions,
calling them exaggerated. The South Koreans questioned how
lasting an impact a "nuclear breakout" would have on Seoul
financial markets, while Ding Yifan of the State Council
Development Research Center opined that U.S.-China and
Japan-China ties could certainly weather the storm as well.
The top Chinese concern seemed to be the possibility of Japan
"going nuclear" in response to a North Korean "nuclear
breakout." Noland retorted that these conclusions only
underscored his pessimism about the prospects for a North
Korean "bold switchover" -- not only are the incentives to
change smaller than portrayed (witness the discussion of
World Bank aid),but the disincentives for "bad behavior" on

the part of North Korea are also not perceived to be all that
large.

WRAPPING UP
--------------


19. (SBU) Alexandre Mansourov of the Asia Pacific Center for
Security Studies gave the final presentation of the
conference. Mansourov concluded that many of the building
blocks for an economic resurgence are being established in
North Korea, including investment in livestock and other
agri-businesses, growing trade with China and the ROK
(including all-important fertilizer inputs from South Korea),
and investment in "sweatshops" and other light industry
infrastructure. Mansourov did not perceive the "military
first" policy as a fatal impediment to economic reforms in
the DPRK, at least on the scale currently envisioned by
planners in the North. He also saw purely economic reforms
as less risky for the North Korean regime than either
tinkering with the "military first" policy or pursuing
de-nuclearization via the Six Party Talks.


20. (C) In short, calling into question the premise that a
"bold switchover" would be needed for North Korea to pursue
meaningful and effective economic reform, Mansourov presented
changes in North Korea's security stance and economic reform
as occurring along independent axes. He predicted that the
North will gravitate toward a quadrant that maximizes
economic policy change and minimizes changes in the DPRK's
security stance. The North will do this, he said, in full
knowledge that it will preclude economic cooperation and aid
from the United States, Japan or the IFI's, because it is
confident that it will still be able to enjoy the benefits of
deepening economic relations with China and South Korea.
Chinese participants in the conference did not find fault
with Mansourov's analysis.


21. (SBU) Finally, turning to the role of Russia, Mansourov
was dismissive. He called the trans-Korea gas pipeline,
trans-Korea railroad and Russian investment in North Korean
small enterprises the "three myths" of Russian economic
engagement with North Korea. In each case, Mansourov said,
the cost is too high and potential benefits too low to
attract concerted Russian interest. Mansourov did note,
however, that the Kremlin has historically been flexible
about using debt forgiveness as a form of assistance, in the
right circumstances. For example, Russia has forgiven large
debts owed by Iraq, Afghanistan, Syria and Mongolia, for
mainly political reasons. North Korea has considerable
unpaid official debt incurred with the former Soviet Union.
VERSHBOW