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Nick Eberstadt is one of the few people in this business who annoys more people than I do. I thought of Nick when Steph Haggard passed along a UPI piece by Elizabeth Shinn titled “Kim Jong Un's economic plan targets foreign investment.” Coming the same week that the North Koreans abruptly disinvited UN Secretary General Ban Ki-moon from visiting the Kaesong Industrial Complex, North Korea’s showcase attempt to attract foreign investment, this headline struck me as pretty amusing. My response to Haggard: “’Noland’s lifestyle plan targets flat abs.’ Wake me up when it’s over.”
The reason I thought of Nick, who earlier this week played the skunk at the party at a shindig sponsored by the Chosun Ilbo, is that his presentation crystalized something that I have argued time and time again in rhetorically less effective ways: that the government of North Korea has a fundamental credibility problem and until it builds some credibility, it will have a hard time attracting investment, which after all, is an irrevocable bet on the future.
Steph Haggard and I have written a series of survey based papers which documented the challenging North Korean business environment as seen by Chinese and South Korean firms and enterprises. In them we have argued that the weakness of the North Korean business environment limits the volume of cross-border exchange, pushes firms towards trade rather than investment (which is subject to expropriation), limits transactional complexity, and generates a risk premium that punishes North Korean counterparties financially. I have toyed with doing a counterfactual in which I calculated what the effect would be of giving North Korea the quality of institutions of say, China, much less Denmark.
Well, Nick beat me to the punch. His calculation is a simpler one running off the Heritage Foundation’s Index of Economic Freedom, which scores countries according to rule of law, the fiscal position of the state, regulatory quality, and the ability to engage in trade, investment, and financial exchange. He ignores the two-way causality between institutional quality and the level of development (are countries rich because they have good institutions, or do good institutions help you get rich) and just looks at the simple correlations. The results are eye opening.
[A correction: I misread the powerpoint. He actually has the lagged values of several controls in addition to the Heritage Foundation measure on the right hand side of the regression. So these results reflect more than mere simple correlation. Which makes the results even more eye-opening. My apologies. 22 May 3:43pm.]
Nick does two counterfactuals: what would North Korea’s income level be and what would its volume of international trade be if it had the institutions of Zimbabwe, China, or South Korea? As the charts below demonstrate, in this calculation, adopting Zimbabwe’s institutions would be associated with a near doubling of income per capita, and a near tripling of international trade:
North Korea and Zimbabwe have a long history of cooperation; I wonder if Comrade Bob is available for consulting?
This is not to say that North Korea will find it impossible to attract foreign investment, particularly in the extractive sector where investment is a virtual necessity, albeit a highly risky one due to the hold-up problem. And just this week, South Korea's Federation of Korean Industries announced that it was setting up an office in Pyongyang. The point is simply that the lack of credible protections on property rights and systems to adjudicate commercial disputes is a real drag on North Korea's development, one made worse by the country's saber-rattling.
