[Korea’s 60th Anniversary Special Contributions]Inter-Korean economic relations at 60

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[Korea’s 60th Anniversary Special Contributions]Inter-Korean economic relations at 60

In 1950, North Korea attacked South Korea in a bid to forcibly unify the peninsula, drawing the United States and China into the conflict. Most of the capital stock was destroyed as armies from both sides twice traversed nearly the entire length of the peninsula. There was considerable population movement as well, mostly from the North to the South, and it is impossible to ascertain with any precision the capacities of the two countries when hostilities ended in 1953.

The two Korean states subsequently not only pursued divergent development strategies but also pushed those strategies to extremes. South Korea not only adopted a capitalist system but also went on to pioneer an outward-oriented development strategy, emphasizing international trade as a catalyst. North Korea, in contrast, not only chose central planning but also intentionally time-phased its plans to frustrate linkages with those of other fraternally allied socialist states and in doing so created the world’s most autarkic economy, notable in the degree to which markets were repressed.

Despite the historic economic integration of the two parts of the peninsula, for the first half century following partition, economic interaction between North and South Korea was tightly circumscribed. However, over the past decade, driven by developments in both the North and the South, there has been a substantial expansion in inter-Korean exchange.

In 1998, following the inauguration of President Kim Dae-jung, South Korea launched the Sunshine Policy of engagement with the North. Since then there has been a tremendous expansion of inter-Korean exchange. Two-way trade has expanded from $222 million in 1998 to $1.8 billion in 2007. Officially, aid has risen from $47 million to $306 million; the figure is even larger if other forms of transfer are counted. The number of South Koreans visiting the North has grown from less than 3,000 to roughly a quarter-million, though sadly, the number of North Koreans visiting the South is far, far fewer.

A consensus has emerged in South Korea about the desirability of economic engagement with the North. At issue are the terms of that engagement.

Given the decades of enmity and distrust, it is not surprising, indeed appropriate, that the initial cooperation projects, most prominently the Mount Kumgang tourism project and the Kaesong Industrial Complex, were in effect “loss leaders” extended by the larger, wealthier partner to signal benign intentions toward the smaller, poorer, less secure state.

Both projects are enclaves near the border, fenced off, literally and figuratively, from the rest of North Korea, operating on a mix of public and private financing. It appears that North Korea is sufficiently comfortable with these arrangements to replicate them elsewhere, for example in the form of a Mt. Paektu tourism venture (on the Chinese border) and Kaesong-like industrial enclaves in Haeju and elsewhere.

The industrial parks are justifiable insofar as the most natural South Korean investors in the North are small- and medium-sized industrial enterprises which are increasingly uncompetitive in South Korea, but could remain viable given access to lower-wage North Korean labor.

Extending the provision of physical infrastructure and effective political guarantees for these small enterprises makes a certain sense, particularly if the alternative is for these firms to move their operations to China or Vietnam. Kaesong has expanded rapidly, now housing enterprises employing roughly 30,000 workers, and is beginning to open to foreign as well as South Korean investors.

Yet even these enclave projects have encountered their share of setbacks; operation of the Mt. Kumgang project has been at least temporarily disrupted by the July 2008 shooting there of a South Korean tourist. In the long run, it would be desirable to broaden the modalities of engagement beyond publicly subsidized enclaves.

The Sunshine Policy derived its name from Aesop’s fable of the North Wind and the Sun in which the Sun and Wind compete to see which can strip the coat off a traveler. While the Wind fruitlessly attempts to blow away the coat, the Sun uses its warmth to induce the traveler to disrobe.

Analogously, engagement was originally conceived as an instrument: The point was to encourage sufficient systemic evolution within North Korea to establish a meaningful basis for reconciliation and, ultimately, national unification. While this means that the North must feel secure to reform, ultimately the success of the policy must be judged on how effectively it has encouraged the evolution of North Korea in constructive directions.

The problem, of course, is moral hazard. Proffering aid - which may help address real needs in North Korea and make the regime feel more secure - may also discourage precisely the long-run evolution in the North Korean system that the policy seeks. Not all forms of engagement are equally commendable.

One can think of a number of criteria for the evaluation of specific integration policies or projects. Perhaps the simplest is the division between humanitarian and development assistance. North Korea’s chronic food emergency is once again intensifying, a product of economic and political mismanagement, bad weather and rising global food prices. Under such circumstances, it would seem reasonable to divorce humanitarian assistance from politics, and South Korea has offered aid.

Long-term development assistance is a different matter, however, and placing a greater emphasis on policy conditionality and reciprocity would be warranted. The experience the world over is that support is most effective when coupled with domestic reform. In the absence of reform, aid may have little impact, or may even perversely encourage temporizing behavior by reluctant authorities.

To the extent that North Koreans have any interaction with foreigners, it is often with government agencies or NGOs. Given the North Korean milieu, it is quite natural for North Koreans to think of such engagement as a form of political bargaining.

But an important long-run task of engagement is to educate North Koreans about the functioning of market economics, and to reorient their conception of engagement away from one-way resource transfers or political tribute and toward mutually beneficial exchange. Private sector involvement is important to promote this learning and bring the discipline of the market to the engagement process.

South Korea should commit to the principle that engagement should be done on efficient, transparent terms. The fundamental issue is that as long as the state maintains direct and indirect influence over specific capital allocation decisions by financial intermediaries, it will be tempted to use this influence to promote its policy toward the North.

Cooperation projects should minimize discretionary state involvement either directly or indirectly through public sector financial institutions or other state-owned enterprises. Subsidization of engagement with the North can be justified from a social standpoint (it may promote evolutionary economic and political change in the North) but it should be clear, limited and transparent, and implemented as neutrally as possible with respect to specific projects and firms.

The simplest way of accomplishing this would be to put provisions into the tax code that would create an incentive for South Korean firms to invest in the North instead of moving operations off-shore to other destinations such as China and Southeast Asia. This approach would be a way to capture the possible social benefits of engagement with the North on the basis of microeconomic efficient behavior of private firms.

Market-compatible engagement would have the added benefit of encouraging learning on the part of the North Koreans [...] that the road to riches is through the efficient transparent provision of services.

Lastly, a successful engagement strategy should incorporate a multilateral dimension. Multilateral cooperation not only reduces the chances that North Korea will play the interests of outside parties against one another, but will also provide additional resources for the tremendous investment ultimately required for North Korea to successfully integrate into the global economy.

International financial institutions such as the World Bank and Asian Development Bank have a role to play in this process as providers of nonpoliticized technical assistance and policy advice, as well as capital.

The ongoing six-party talks, if ultimately successful, could spawn regional economic initiatives as well, including the development of Northeast Asian transport and energy links, as well as facilitating cooperation on other transnational issues such as the environment and drug trafficking, embedding the process of inter-Korean reconciliation in a broader regional fabric.

As in the Aesop’s fable from whence it drew its name, Kim Dae-jung’s Sunshine Policy was originally conceived as an instrument: The purpose was to encourage enough internal change within North Korea to establish a meaningful basis for reconciliation and, ultimately, national unification.

An alternative view regards engagement less as a tactic to achieve a transformative goal, than as a goal in and of itself, a stance into which the Roh Moo-hyun administration appeared to drift.

The answer to the question of which of these conceptions of engagement - as a means or as an end - will prevail in the coming years, will have a profound impact on not only the nature of North-South relations, but on North and South Korea themselves.

From this long-term perspective, the controversies that have marked the early days of the Lee Myung-bak administration and its new “coexistence and co-prosperity” policy should not be overdone.

But engagement should and will continue because it is consistent with the fundamental interests of both Korean states.

The current dispute is not over engagement itself, but the terms on which it will proceed.

*Marcus Noland is a senior fellow at the Peterson Institute for International Economics. He was a senior economist at the presidential Council of Economic Advisers in the United States. He has devoted serious scholarly effort to the problems of North Korea and the prospects for Korean unification, and won the 2000?01 Ohira Memorial Award for his book, “Avoiding the Apocalypse: The Future of the Two Koreas.”

By Marcus Noland

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