WHAT IS GOING ON WITH NORTH KOREAN ECONOMIC

C O N F I D E N T I A L SEOUL 000425

SIPDIS

SIPDIS

STATE FOR D, EB AND EAP
NSC FOR WILDER AND CHA
MOSCOW HOLD FOR VLADIVOSTOK

E.O. 12958: DECL: 02/07/2016
TAGS: EAID EAGR EFIN PREL KN KS
SUBJECT: WHAT IS GOING ON WITH NORTH KOREAN ECONOMIC
POLICY? -- SOUTH KOREA'S EVOLVING CONVENTIONAL WISDOM


Classified By: Amb. Alexander Vershbow, for Reasons 1.4 (b,d)

SUMMARY
--------------


1. (SBU) In the three years following North Korea's July 2002
economic reform program, most South Korean experts on the
North Korean economy came to share certain assumptions about
the state of transformation of economic policy in the North.
Some of the key elements of that shared "conventional wisdom"
were:

-- The July 2002 economic reforms originated in response to
unplanned changes already taking place in the North Korean
economy -- including increased use of market-type mechanisms
-- and ratified and institutionalized selected portions of
those changes.

-- However, the July 2002 reforms also accelerated and gave
added impetus to certain trends in the North Korean economy,
including widening inter-regional economic gaps and a shift
from planned production of heavy industrial goods to
less-planned investment in tradable consumer items.

-- The reforms were supported by pro-reform elements in the
North, although disliked by the North Korean military and
ideological conservatives.

-- Nevertheless, the policy changes themselves were
significant, and "irreversible" in the sense of not being
easily undone, because the reforms were already succeeding in
establishing new modes of commerce, and associated North
Korean stakeholders.

-- Finally, in the context of the above changes, North
Koreans would eagerly seek to learn from their South Korean
brothers about international modes of capitalism and
international development. Thus, North-South economic
cooperation activities, however they were designed, would
inevitably convey important educational content and have a
real impact on the design of additional economic policy
changes in the North.


2. (SBU) This conventional wisdom, however, has been shaken
by four factors emerging over the past year:

-- First, disappointment with the educational content and
impact of North-South collaborations;

-- Second, North Korea's shutdown of economic cooperation
channels with international organizations and NGOs, and by
extension with European governments;

-- Third, the reversal of some economic reforms, including
the termination of cell phone service and the
re-establishment of the Public Distribution System as the
primary channel for food rationing; and

-- Fourth, increasingly obvious evidence of rapidly deepening
economic relations between North Korea and China.


3. (C) In the face of these challenges to their conventional
wisdom, some South Korean experts are coming to the
uncomfortable conclusion that the Republic of Korea, which
viewed itself as a driver of change through its "Sunshine
Policy," is in fact playing a passive role as a facilitator
of a North Korean survival strategy whose ultimate winners
may be North Korea and China.


4. (C) Nevertheless, the large majority of South Koreans
remain committed to South-North economic engagement, due to
their desire for peaceful and stable relations with the
North, their continuing hope that North Korea will reform in
the long run, and their desire not to lose to China in the
two nations' implicit competition to influence economic
policy directions and ultimately to control economic assets
in the North. End Summary.

DPRK STRUCTURAL ECONOMIC CHANGES: THE VIEW FROM SEOUL

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5. (SBU) Post has taken advantage of recent opportunities to
expand dialogue with several of our best contacts in the
South Korean academic and policy community who specialize in
observing and interpreting economic performance and economic
policy trends in North Korea.


6. (SBU) The consensus view among our ROK interlocutors is
that DPRK economic conditions have improved in the past
several years, following very difficult times in the late
1990s. Their perspective on the North Korean economy
encompasses the following empirical observations:

-- The DPRK's agricultural economy has stabilized, but is
highly dependent on foreign inputs: North Korea will never
be capable of feeding itself.

-- North Korea's industrial economy has also stabilized, but
at a very low level of activity: Heavy industry is seen by
ROK experts as the weakest part of the DPRK economy, but they
do not see it as "near collapse." In fact, South Koreans
believe it has already collapsed, and that much of the
productive capacity of North Korea's "old" economy is now
obsolete and unlikely to be used again. As a result, there
is widespread cannibalization of depreciated assets.

-- The DPRK service and trading economy is growing smartly,
powered by external trade with China: South Korean experts
believe that the July 2002 reforms assisted in the expansion
of consumer goods sales, particularly imports. They believe
that Chinese statistics undercount cross-border trade, and
that "non-productive" consumer imports will continue to
expand. (On the negative end, many ROK experts see North
Korea as positioned in a classic low-value-added development
trap, trading raw materials and primary goods for more
valuable manufactures. In this sense, they see little
prospect for North Korea's chronic trade deficit to be
resolved over the medium term. Rather, absent increased
foreign investment and better technology, North Korea will
continue to experience worsening terms of trade, inflation
and downward pressure on its currency.)

-- Finally, in a structural sense, North Korea is undergoing
significant income redistributions: South Korean experts
believe that the winners are Pyongyang's relatively
well-connected urban cadres and the newly-rich farmers in
southern and western North Korea, who are able to leverage
their better land and growing conditions to sell into urban
markets. The losers are salary-dependent urban workers and
the increasingly poor farmers working marginal lands in the
central and northeastern regions of the DPRK.


7. (SBU) Behind these empirical changes, almost all ROK
experts agree that North Korea's July 2002 economic reforms
accelerated and gave added impetus to the above trends.
Although many note that the economic reforms originated at
least in part in response to unplanned changes already taking
place in the North Korean economy, the South Korean consensus
view has been that, nevertheless, the economic reform process
in North Korea has begun in earnest, is significant, and is
not likely to be easily reversed.


8. (C) South Korean experts also share the view that even
though the July 2002 economic reforms were disliked by the
North Korean military and ideological conservatives, they
were supported by Chairman Kim Jong-il and pro-reform
technocratic elements in the North. Therefore, North Korean
economic policy reform has already achieved sufficient
momentum that South Korea can hope to participate in and
benefit from additional reforms in the future. As noted by
Yoon Deok-ryong, a leading expert at the Korea Institute for
International Economic Policy (KIEP),"Until recently at
least, Seoul economists working on the DPRK were expecting a
flood of invitations from the North, seeking technical advice
on how to push forward with a second round of reforms to
complement the July 2002 initiative."

EMPIRICAL CHALLENGES TO ROK CONVENTIONAL WISDOM

-------------- --


9. (C) The Year 2005, however, saw many challenges to the
South Korean conventional wisdom about economic policy reform
in North. Previously, most ROK experts told us that they saw
the July 2002 economic reforms as "irreversible" because the
reforms had already succeeded in establishing new modes of
commerce, and associated North Korean stakeholders. Their
confidence in the momentum of economic reform in North Korea,
however, was challenged in early 2005 by the decision of DPRK
authorities effectively to terminate cell phone service in
the North, except for continued access by high-level
government officials. Subsequently, and more significantly,
the North Korean government reestablished the Public
Distribution System (PDS) as the sole legal channel for grain
distribution in North Korea. This measure was followed by a
ban on internal monetized trade in grain and government
seizures of grain held outside the PDS. These DPRK steps may
have been partially motivated as inflation control measures,
but they were perceived in Seoul as a reassertion of central
control over the North Korean economy. Soon thereafter, the
DPRK government commenced an initiative to shut down
cooperation channels with a large sub-set of NGOs and
international organizations -- including the World Food
Program -- which the DPRK found more troublesome than
valuable to the maintenance of the North Korean economy.


10. (C) In the area of bilateral North-South activities as
well, South Koreans in 2005 started to see signs that their
hopes for a substantive impact on North Korean economic
policy through bilateral engagement were not working to the
extent they originally hoped. The North, for example, cut
back on study tours to Pyongyang by South Koreans after the
Ryongchon train explosion and channeled most ROK visits to
the capital district in the form of safe "Arirang Festival"
tourism. The year 2005 also saw an increasingly cynical DPRK
approach to inter-Korean economic cooperation talks, for
example demanding millions of pairs of shoes in return for
"allowing" South Korea to complete the rebuilding of a
functioning railway from the DMZ to Kaesong City. Several
initiatives, including the railways and tourism to Mount
Baekdu, Kaesong City and Pyongyang ran up against
unreasonable demands from DRPK partners.


11. (C) Meanwhile, more South Koreans experts have found
themselves disappointed with the educational content of
North-South collaborations. In particular, it has become
clear that the Kaesong Industrial Complex (KIC) -- intended
by the South to be a potent "Trojan Horse" of capitalist
economics -- is intended by the North to be an arms-length
transaction with minimal direct interaction between
responsible officials on each side. Companies operating in
the KIC have reported that they often must communicate to
their workers through "safe" foreman intermediaries, and do
not pay wages directly to North Korean workers (in fact, they
have no idea how much the workers are really receiving of the
USD 57.00 per month paid to Pyongyang).


12. (C) These empirical challenges to the effectiveness of
the "Peace and Prosperity Policy" are causing some
readjustment in the reasoning and expectations behind
North-South economic cooperation, as expressed to us by ROK
experts. For example, Kim Byung-yeon, an economics professor
at Sogang University specializing in North Korea, told the
Ambassador at a recent Embassy gathering of DPRK economy
experts that he had come to the reluctant conclusion that the
ROK's engagement policy is having little or no impact on the
internal economic policies of North Korea. Professor Kim
also does not think additional near-term increases in ROK aid
would have any greater impact under the current circumstances
and modes of inter-Korean interaction. Despite his
skepticism, however, Kim said he continues to support
North-South economic cooperation for its long-term effects,
and in order to maintain peaceful and stable relations with
the North. "As with a small child," Kim said, "we must be
patient with North Korea as it learns the facts of the real
world."

CHINA MAY BE THE WINNER


--------------


13. (C) The other increasingly common justification for
North-South economic engagement heard among ROK experts is
the need to counter-balance rapidly deepening economic
relations between North Korea and China. The new
conventional wisdom among ROK academics and many government
officials is that the North Koreans find interaction with
Chinese less demanding and less risky than working with South
Koreans. For example, Professor Nam Sung-wook of Korea
University, the ROK's leading authority on DPRK agriculture,
told the Ambassador that North Koreans still do not trust
South Koreans, since they know that South Korea would like to
see the Kim Jong-il regime come to an end. Therefore, they
will accept South Korean investments only in small quantities
and under tightly-controlled conditions, whereas Nam believes
that North Korea is much more accepting of Chinese
investment. Chinese employers, Nam said, are permitted to
pay their North Korean employees directly, unlike ROK
employers in the Kaesong Industrial Complex.


14. (C) Kim Jong-il's January visit to multiple cities in
southern China has only deepened the conviction in Seoul that
Chinese businesses enjoy better access to the DPRK than South
Koreans, and there is increased talk here of the ROK
competing with China for control of North Korea's economic
assets. For example, Deputy Prime Minister Han Duck-soo, who
is a strong supporter of South-North economic engagement,
recently told the Ambassador that "South Koreans worry that
when it comes time for reunification, we'll find that Chinese
have already seized all the best assets in the North."
Former President Kim Dae-jung made a similar point to the
Ambassador this week.

CONCLUSION: SHIFTING RATIONALES FOR ENGAGEMENT
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15. (C) The South Korean expert community is home to both
optimists and "Doubting Thomases" about the future course of
DPRK economic reform. The optimists still see North Korea as
sincerely interested in pursuing a China-style or
Vietnam-style course toward broad economic reform and opening
to the outside world. The DPRK, they reason, is only held
back by worries about social stability. The Doubting
Thomases now see North Korea's goals as more modest -- the
North just aims to capture easily-available productivity
increases by inserting market prices into some elements of
the economy, at the same time benefiting the DPRK elites and
keeping them happy.


16. (C) The year 2005 saw some experts in Seoul shifting from
the optimistic to the doubtful camp, as mounting empirical
evidence pointed to a lack of sincerity about economic reform
in the North. It is important to note, however, that both
camps in the ROK remain supportive of South-North engagement.
In doing so, they reflect the consensus desire of the South
Korean citizenry for peaceful and stable relations with the
North. In addition, South Koreans are also now united in
their concern about the possibility of South Korea losing to
China in an implicit competition to maintain influence over
the North Korean economy. Even opponents of the Roh
Administration tend to view engagement with the DPRK as the
ROK's least-bad option, and even skeptics in the Seoul
academic community maintain some hope that North Korea will
become more earnest about economic reform and opening in the
long run.


17. (C) One final observation: Frustration in Seoul over the
apparent powerlessness of South-North economic cooperation to
motivate more earnest economic reform in the North could
inspire new approaches on the part of the South Korean
government. Therefore, it is possible that in the coming
year, even as South-North contacts continue to expand, we
will see an increased emphasis on aiding the North in ways
that are more likely to result in real improvements in North
Korean infrastructure and more focused investments in the
development of human, environmental and agricultural capital.


18. (C) On the other hand, we do not think any significant

change in direction is likely. The ROKG will be reluctant,
in the first instance, to initiate many changes in direction
during the run-up to the impending 2007 national elections,
where South-North ties will certainly be a matter of debate.
Moreover, at political levels in the Roh Administration, we
have seen scant evidence that anyone shared the academics'
doubts about the efficacy of the ROKG's engagement policy.
On the contrary, citing the large number of ROK visitors to
the North, incoming Minister of Unification Lee Jong-seok has
called 2005 the "breakout year" for North-South contacts.
Presidential candidates from both the ruling and opposition
parties are expected to debate the tactics of the
government's engagement policy, but not the wisdom of the
policy itself.
VERSHBOW