HONG KONG: Reviving North Korea

Which country potentially offers the highest returns on capital? Answer: North Korea.

For that potential to be unleashed of course requires an extraordinary change in the mind-set of the leadership in Pyongyang, but its existence makes a useful reference point in the relationship between the two Koreas in the aftermath of the summit meeting between President Roh Moo Hyun and the North Korean leader, Kim Jong Il.

Most people in the South see reviving the North's economy as a cost to themselves. The price tag of the projects approved in principle between the two leaders is put at $11 billion.

A comparison is often made to the costs to the former West Germany of reunification with the East. But for South Korea, the burden would be many times greater, due to a larger income gap and different population ratio between the two sides. Even without formal reunification, it is assumed that the South would face a bill of hundreds of billions of dollars to rescue fellow Koreans from extreme poverty.

But there is another way of looking at this, one that is appealing to the South's big business groups. The better comparison may not be to the Germany of 1990, but to the one of 1945, a country with factories in ruins and a destroyed infrastructure.

North Korea's economy was never advanced; it was an industrial economy with similarities to the Soviet Union. Its population is largely urban, its housing is shoddy but relatively modern, its main centers are joined by roads, power lines and a railway system. Its people are literate, there is a history of technical training.

Given the right tools, re-industrializing the North would be a much simpler, quicker task than industrializing China. The productivity gains to be made, even with small inputs of working capital and market access, are enormous.

The South's businesses are fully aware of the rapid returns they could make if it were as easy to build a factory in the North as it is in China's nearby Shandong Province and then pay the Korean workers half of what Chinese workers would expect in Shandong.

Korean investment has had a huge impact on Shandong, population 90 million. Imagine the impact if half of those business could be moved to the North, population 23 million. Imagine, too, the impact on industry in South Korea at a time when demographics alone suggest that growth in the South will be slow.

Because of the potential for huge profits from the North that can be reinvested there, the actual cost to the South of the North's revival would be much smaller than is usually assumed - provided, of course, that Korea does not follow the German path and make income equalization more important than growth.

The snags are many. The North's comparative advantage is its abundance of very cheap, disciplined, technically literate, urbanized workers. But judging from reports of exchanges during the Roh visit, the North wants companies from the South to invest in higher-technology industries. That makes no sense to companies like Hyundai and Samsung. Unjustified pride and belief in juche - self-reliance - remains perhaps the single biggest barrier to reform in the North.

Next there is the issue of paranoia. The industrial zone of Kaesong, just across the border from the South, should be the North's equivalent of Shenzhen, the city that China created from paddy fields to attract capital and industry from nearby Hong Kong. But the few companies that have set up there report delays to deliveries of parts due to customs inspectors searching for politically subversive materials. Social controls on the North's workers prevent the interaction with southerners needed if they are to learn new ways of thinking and working.

Equally problematic is the role of Kim Jong Il and the personality cult based on his father, Kim Il Sung.

China could not begin reform until Mao's death put an end to the cult of personality and the Communist Party could both reassert and reorient itself. Kim Jong Il has seen enough of Shenzhen and Shanghai to know what can be done, but he is fearful of change.

There is scant sign so far that the North Korean Army and party will break free of the Kim mythology and embark on a reform program that can transform them from being a purely political elite to a quasi-capitalist class along Chinese lines. They need to adapt for their long term survival, but it is hard to see the North's mind-set changing while the Kim dynasty remains in power.

Korean and foreign capital will likely have to wait before Pyongyang becomes their favorite profit center.