We know that economies function more smoothly when they have working institutions to support economic exchange: law and regulation, courts and other means of settling disputes, and protection of property rights. Trade and investment between China and North Korea thus presents an interesting puzzle. In recent years there has been a substantial increase in cross-border exchange despite apparent absence of conventional institutions or economic reforms. Even such basics as a published tariff schedule are missing.
How exactly does the China-DPRK trade work? The answer to this question is important not only for economic reasons; we would like to see a reformed and more market-oriented North Korea. But it also has implications for the debate about engagement. Will increasing trade and investment have wider transformative effects or will only buttress the power of the regime?
We conducted an unprecedented survey of more than 300 Chinese enterprises that are doing or have done business in North Korea. Despite holding generally negative views about the North Korean business environment—particularly with regard to infrastructure and regulation, most—but not all–of the Chinese firms report that they are able to make money.
But to do so, they tread carefully and sharply limit their risks. Fearing expropriation, they prefer to trade rather than invest; most of the firms that we surveyed were small companies conducting cash-and-carry business. Fearing predation and corruption, Chinese enterprises keep their activities small scale to “fly below the radar” and discourage unwanted attention from rapacious North Korean officials. When they trade they demand cash—in US dollars or Chinese Yuan. Very few extend credit to their North Korean counterparties and most are even reluctant to delay settlement; they prefer payment at the time of order or delivery.
The firms that do extend credit or relaxed settlement terms—the ones that cut their North Korean counterparts some slack—are virtually all Chinese state-owned enterprises (SOEs) dealing with North Korean SOEs. In short, it is a business environment characterized by low levels of trust.
Disputes are pervasive, but there are few formal avenues for dispute resolution. Most of the Chinese enterprises believe that they are effectively on their own. The Chinese government can’t or won’t support them and the North Korean government is clearly untrustworthy. No one trusts the North Korean courts or believes that the court system could resolve a commercial dispute, despite whatever laws and procedures may be on the books. Other strategies, such as appeals to other Chinese firms or business associations appear largely ineffective.
The lucky firms are politically connected, or at least they think they are. When making personal appeals to North Korean officials, the Chinese indicate that local officials are the best bet; this could be a positive sign that lower level officials are more willing to support a more open business environment. Provincial officials are a second choice. Central government officials in Pyongyang are the least likely to help resolve a problem.
As a consequence, the Chinese enterprises pay bribes. Lots of them. We found that the firms that were most likely to pay bribes were investors. These firms are more vulnerable than traders to asset seizures and other forms of interference, as the ongoing conflicts over Mt. Geumgang show.
Our survey provides ample evidence of how the weakness of the business environment deters cross-border integration, despite the rapid growth of trade during the 2000s. Weak rules deter investment relative to trade and inhibit normal trade finance; investment and credit are key to robust cross-border exchange. Given the weakness of formal institutions and the corresponding limits on the risks Chinese firms are willing to take, the rapid growth in exchange that we have seen in recent years may prove self-limiting unless formal institutions are strengthened. Such institutional improvement would contribute to a greater volume of exchange, more investment relative to trade, and better financial terms for the North Korean participants.
But North Korean officials may benefit from this kind of partially reformed, corrupt environment. It may not be in their self-interest for the system to be regularized, even if the country overall would benefit. If anything, the North Korean government appears to be headed in the opposite direction. Over the past year it has attempted to quash the decentralized, market-conforming cross-border exchange that has grown up over the past 20 years and promote relations via entities that are more tightly controlled by the central authorities. Such moves may benefit Pyongyang elites, but are unlikely to constitute a solution to the country’s chronic economic problems.
Nor is the cross-border trade that we examine in our surveys likely to moderate North Korea’s provocative foreign policy behavior, a major hope of the engagement school. Rather, to the extent that the state is able to successfully channel exchange through entities under its direct control, the expansion of trade and investment could simply strengthen the state sector.
We have argued in the past that engagement can have positive effects, but our surveys show that such engagement strategies are hard to design when the state is strong and opposed to reform. We need to think of new ways to support low-level cross-border trade that sidesteps the authorities and strengthens markets and more independent traders in North Korea. But in the absence of reforms, it is overly optimistic to believe that these strategies will have wide-ranging effects.
