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C O N F I D E N T I A L SEOUL 000423 
 
SIPDIS 
 
C O R R E C T E D  C O P Y - PARA (1) DATE CHANGED 
 
SIPDIS 
 
STATE FOR D, EB AND EAP 
NSC FOR WILDER AND CHA 
PASS USAID FOR DCHA/PPM/BRAUSE 
MOSCOW HOLD FOR VLADIVOSTOK 
 
E.O. 12958: DECL: 02/07/2026 
TAGS: ECON EAID PREL PGOV KN KS CH JA
SUBJECT: DPRK ECONOMY: CHINESE EXPERTS FORESEE ECONOMIC 
 
REFORMS, BUT DOUBT ANY CHANGE IN ROLE OF MILITARY 
 
Classified By: EconMinCouns Kurt Tong, for Reasons 1.4 (b,d) 
 
SUMMARY 
------- 
 
¶1. (SBU) A January 18-19 academic conference in Beijing 
explored the potential for North Korea to change its 
"military first" security policy in order to realize more 
meaningful economic reform, faster economic growth and an 
increase in international aid.  The American organizers of 
the event worked hard to highlight the likely improvements in 
North Korean economic performance resulting from a "bold 
switchover" in North Korea's security stance, while also 
emphasizing the potential for increased inflows of 
development assistance from overseas in such a situation. 
Chinese and South Korean experts participating in the event, 
however, tended to discount the incentives for change in 
North Korea's security stance.  At the same time, they also 
doubted the potency of the disincentives to the DPRK 
maintaining its current hostile stance to the outside world. 
 
¶2. (C) While there was significant diversity of opinion among 
the Chinese think-tank experts assembled at the conference, 
the majority seemed to believe that it was most likely for 
North Korea to pursue a certain pace and degree of economic 
reform, while continuing to avoid risky changes in internal 
political alignment.  All the Chinese experts, however, 
agreed that North Korea would continue to try to strengthen 
its economic relationship with China, and many believed that 
North Korea will attempt to mimic China's economic reform 
path -- although the DPRK might not necessarily succeed.  End 
summary. 
 
NBR CONFERENCE TACKLES "BIG PICTURE" REFORM POSSIBILITIES 
--------------------------------------------- ------------ 
 
¶2. (C) Embassy Seoul EconMinCouns was recently invited to 
participate in a closed-door, off-the-record academic 
conference in Beijing focused on identifying the economic 
benefits to North Korea and the region of a "bold switchover" 
in North Korea's security stance.  The "bold switchover," as 
defined by conference organizer Nick Eberstadt of the 
American Enterprise Institute, refers to a curtailing of the 
DPRK's "military first" policy and substantial downsizing of 
the North Korean military -- including, by definition, 
de-nuclearization.  The event, which was convened and funded 
by the Seattle-based National Bureau of Asian Research (NBR) 
with assistance from China's State Council Development 
Research Center (DRC) and the PLA-affiliated Chinese 
Foundation for International and Strategic Studies (CFISS), 
was somewhat unique (as Track II events go) for the variety 
of opinion presented by the Chinese experts in attendance, as 
well as the frankness of their commentary.  This message was 
coordinated with Embassy Beijing. 
 
DPRK CAUGHT IN A TRAP OF ITS OWN DESIGN 
--------------------------------------- 
 
¶3. (C) Keynote speaker Zhao Huji of the Central Party School 
kicked the proceedings off on a pessimistic note by 
explaining the chicken-and-egg dilemma of North Korea's three 
"structural crises:" in economics; political legitimacy; and 
military affairs.  Zhao persuasively argued that the DPRK's 
economic reforms had reached an impasse; without broader 
opening to the outside, accelerated economic progress could 
not be anticipated.  However, Zhao asserted that the North's 
chronic food shortage and limited economic reforms that have 
taken place to date have already established a "second 
economy" throughout the country, which constitutes a 
potential political challenge to North Korea's leadership. 
Meanwhile, on the military and security front, the DPRK is 
trapped in a "military first" policy that exaggerates 
external threats to the country in order to compensate for 
the absence of a strong philosophical underpinning for the 
government. 
 
¶4. (C) Thus, Zhao concluded, a "bold switchover" is 
difficult, given that North Korea is also loathe to rely 
 
entirely upon China or Russia for its security.  Zhao 
believes the July 2002 economic reforms have already had a 
large impact on the North Korean economy, but he forecast 
ultimate failure for the reforms given the inability of the 
North Korean regime to contain the macroeconomic 
instabilities generated by the reforms.  In short, Zhao said, 
North Korea needs a "bold switchover" to succeed in economic 
reform, but the leadership cannot risk such a fundamental 
realignment due to its own lack of political legitimacy. 
 
ECONOMIC BENEFITS FROM A CHANGE IN DPRK SECURITY STANCE 
--------------------------------------------- ---------- 
 
¶5. (SBU) Nick Eberstadt followed with a more positive spin on 
the potential for change in the North.  Like Zhao, Eberstadt 
concurred that the "military first" policy, the DPRK's chosen 
approach to state survival, actually precludes long-term 
success in state survival.  Taking a positive tack, however, 
he presented an econometric analysis based on data from other 
transition economies to loosely quantify the potential for 
economic growth if North Korea were to relinquish its current 
security policy stance.  Such a change, Eberstadt said, would 
free significant capital and labor resources for use in more 
productive ways.  Eberstadt also noted that considerable 
Western aid would be made available to the North if it were 
to undertake a "bold switchover," even absent any fundamental 
realignment of North Korea's centrally-planned economic 
system. 
 
¶6. (C) In commentary on Eberstadt's paper, Zang Hyoungsoo of 
South Korea's Hanyang University questioned how much 
incremental foreign aid would really be forthcoming for North 
Korea after a change in its security stance.  He also noted 
that the labor contribution benefits of a "bold switchover" 
might be exaggerated, given that the North Korean military is 
already an important participant in the economy; Zang foresaw 
greater benefits from reallocation of capital resources. 
Piao Jianyi of the Chinese Academy of Social Sciences chimed 
in with doubts about the earnestness of North Korea's 
economic reform efforts, or any real interest in changing the 
"military first" policy.  Piao explained that that he is 
convinced the DPRK's over-riding goal is to re-establish aid 
relationships so that it can return to the relative stability 
it enjoyed in the 1980's, under the umbrella of Soviet 
assistance. 
 
¶7. (C) Hu Angang of Tsinghua University countered that North 
Korea is very interested in learning from China, as well as 
simply garnering Chinese economic aid and deepening trade and 
investment relations with China.  This, Hu said, is why Kim 
Jong-il had chosen to visit China just as the Chinese 
government was in the midst of writing its next Five-Year 
Plan (China's primary instrument for medium-term fiscal 
policy planning).  Hu then proceeded to outline the reasons 
for the success of China's transition development model: 1) 
macroeconomic stability; 2) political stability based around 
Deng Xiaoping's determination to catch up with the outside 
world; 3) gradualism, starting with agricultural sector 
reform; and 4) external opening and a stable relationship 
with the United States.  Hu suggested that the United States 
should invite Kim Jong-il to the United States, as it did 
Deng Xiaoping in the 1970's.  China, meanwhile, should open 
its markets wider to North Korea, and accelerate investment 
in North Korean infrastructure, human resources and 
agricultural reform programs, Hu said. 
 
¶8. (SBU) Yoon Deok-ryong of the Korean Institute for 
International Economic Policy (KIEP) followed with a 
presentation outlining the details of South Korean economic 
cooperation with North Korea, concluding that "peace" between 
North and South will result in substantial economic benefits 
for both sides.  In the North, economic reform and opening 
will accelerate growth, while in the South, "peace" will 
improve the ROK's credit rating and provide new opportunities 
for profitable investment and trade with North Korea and 
Northeast China.  Yoon asserted that ROK government 
investments in economic cooperation with North Korea in the 
current timeframe will not only help hasten the arrival of 
 
this economic "peace dividend," but also lower ultimate 
reunification costs in the long-term. 
 
¶9. (C) Commenting on Yoon's presentation, Marcus Noland of 
the Institute for International Economics downplayed the 
significance of North Korea's July 2002 economic reforms, 
describing them as nothing more than a coping strategy to 
ratify, legalize and thereby control ongoing marketization. 
Noland also explained his view that official assistance to 
North Korea in the current situation could actually inhibit 
further economic reform, rather than accelerate it.  Cheng 
Yujie of the China Institute of Contemporary International 
Relations (CICIR) chimed in with a somewhat superficial 
presentation about the need for caution and gradualism in 
approaches to North Korea, due to the unlikelihood that the 
DPRK leadership would buy into sudden change.  Given that the 
military is already integrated into the DPRK economy, rapid 
marketization could destabilize the government through both 
challenges to ideology as well as confusion among political 
and economic stakeholders. 
 
¶10. (SBU) Masahiro Kawai of the Asian Development Bank and 
former World Bank official Bruce Babson wrapped up the first 
day's proceedings with presentations on the potential for 
post-"bold switchover" economic assistance from Japan and the 
international financial institutions (IFI's).  Kawai noted 
that de-nuclearization and resolution of the abductions issue 
were mandatory preconditions for extensive Japanese 
assistance.  However, in the context of such changes, and 
normalization of Japan-DPRK ties, Kawai foresaw that a 
consequent Japanese aid package to North Korea could be on 
roughly the same scale (plus inflation) as that provided to 
the Republic of Korea at the time of Japan-ROK normalization 
in 1965. 
 
¶11. (SBU) In outlining the process for new members to join 
the International Monetary Fund and World Bank, Babson 
perhaps unintentionally ended up highlighting the 
difficulties that North Korea would face in accessing aid 
from the IFI's.  The DPRK would need to first accept the 
IMF's transparency and accounting norms, Babson said. 
Following that, the first stages of IFI assistance would 
likely center on technical assistance, and establishment of 
international donor coordination systems, rather than large 
immediate infrastructure investments.  Chinese participants 
in the conference reacted with some dismay to Babson's 
presentation, noting that the North Koreans would perceive 
all this as a threat to their sovereignty, without 
accompanying benefits.  Kawai of the Asian Development Bank 
tried to soften the blow by suggesting that the ADB would 
likely be more generous than the World Bank, and not require 
IMF membership first -- points which Babson in turn found 
distressing. 
 
BENEFITS FOR NORTHEAST CHINA? 
----------------------------- 
 
¶12. (C) For the concluding session on Day Two, Li Dunqiu of 
the State Council Development Research Center began the 
proceedings with a well-researched illustration of the 
rapidly deepening economic ties between North Korea and 
Northeast China.  Li foresaw large benefits for Northeast 
China stemming from economic reform and opening in North 
Korea, with the best case scenario being open borders between 
North and South Korea, which "would forcefully propel the 
economic development of China's northeast."  Foreign 
investors would find the Northeast China region much more 
attractive if military tensions in the region were eased, Li 
concluded. 
 
¶13. (C) Commenting on Li's presentation, contrarian Piao 
Jianyi of CASS asserted that a "bold switchover" in North 
Korea could also end up hurting Northeast China, via 
resulting political instability and refugee flows.  David 
Dollar of the World Bank's Beijing Office concurred with Li 
in identifying the benefits for Northeast China of changes in 
North Korea, although he cautioned that it would not be a 
panacea, since Northeast China also has its own 
 
internally-generated problems of lagging economic reform, 
bankrupt state-owned enterprises and widespread corruption. 
 
¶14. (C) Gao Jingzhu of Yanbian University noted that, as a 
factual matter, Chinese investment in North Korea to date 
remains quite small.  While there is some investment in 
minerals extraction, larger state-owned firms seem 
disinterested in investing in the DPRK.  The Chinese 
government has also done little to encourage such 
investments, Gao said.  He explained that although official 
export credits are available for trade with North Korea, both 
official and unofficial Chinese bankers are skeptical of 
lending to North Korea ventures, given the poor track record 
of past failures.  Ga added that the Tumen River Basin 
Development Project, despite its recent nominal extension, 
remains basically dead-on-arrival. 
 
WHY DID KIM JONG-IL VISIT CHINA? 
-------------------------------- 
 
¶15. (C) In a parallel presentation, Li Dunqiu also relayed 
his conclusions about Kim Jong-il's nine-day, January 2006 
visit to China.  First, Li said, the visit reflected strong 
desire to improve relations with China, as evidenced by the 
fact that Kim brought along such a large cohort of DPRK 
officialdom.  Second, Kim's visit signaled a clear desire to 
learn about the "China model" for transition and development. 
 Li saw signs of hope that -- unlike Kim's January 2001 visit 
when he looked only at China's largest cities and companies, 
perhaps without much comprehension of what he was looking at 
and how it was achieved -- on this visit Kim toured smaller 
cities and research institutes focused on more appropriate 
(less sophisticated) technologies, including agricultural 
industries. 
 
¶16. (C) Ren Xiao of the Shanghai Institute for International 
Studies concurred with Li, saying that analysts should not 
underestimate the importance of the Kim visit.  Several 
Chinese participants were in fact visibly excited by the 
possibilities generated by Kim Jong-il's China tour, which 
took place at the same time as the NBR conference.  Marcus 
Noland cast doubt on the impact of the visit, however, noting 
that it is impossible to tell what Kim Jong-il actually sees 
when he looks at China.  The January 2001 visit to Shanghai 
seemed to only generate a desire to have similar tall 
buildings in Pyongyang, Noland said. 
 
CONVERSELY, HOW BAD IS A NEGATIVE SCENARIO? 
------------------------------------------- 
 
¶17. (SBU) Noland followed with a paper outlining the likely 
negative economic costs for Japan, South Korea and China of a 
North Korean "nuclear breakout," defined as testing a nuclear 
weapon or transferring nuclear materials or technology to 
another country or non-state entity.  Noland concluded that 
while the trade impact of such an event would be small, given 
the small size of the North Korean economy, the impact on 
regional financial markets could be considerable.  In the 
worst case, South Korea could experience capital flight and 
significantly higher overseas borrowing costs, while China 
could see a worsening of U.S.-China economic relations.  The 
impact on Japan would likely be more temporary, although also 
tangible. 
 
¶18. (C) In response, Chinese and ROK participants in the 
meeting generally found fault with Noland's conclusions, 
calling them exaggerated.  The South Koreans questioned how 
lasting an impact a "nuclear breakout" would have on Seoul 
financial markets, while Ding Yifan of the State Council 
Development Research Center opined that U.S.-China and 
Japan-China ties could certainly weather the storm as well. 
The top Chinese concern seemed to be the possibility of Japan 
"going nuclear" in response to a North Korean "nuclear 
breakout."  Noland retorted that these conclusions only 
underscored his pessimism about the prospects for a North 
Korean "bold switchover" -- not only are the incentives to 
change smaller than portrayed (witness the discussion of 
World Bank aid), but the disincentives for "bad behavior" on 
 
the part of North Korea are also not perceived to be all that 
large. 
 
WRAPPING UP 
----------- 
 
¶19. (SBU) Alexandre Mansourov of the Asia Pacific Center for 
Security Studies gave the final presentation of the 
conference.  Mansourov concluded that many of the building 
blocks for an economic resurgence are being established in 
North Korea, including investment in livestock and other 
agri-businesses, growing trade with China and the ROK 
(including all-important fertilizer inputs from South Korea), 
and investment in "sweatshops" and other light industry 
infrastructure.  Mansourov did not perceive the "military 
first" policy as a fatal impediment to economic reforms in 
the DPRK, at least on the scale currently envisioned by 
planners in the North.  He also saw purely economic reforms 
as less risky for the North Korean regime than either 
tinkering with the "military first" policy or pursuing 
de-nuclearization via the Six Party Talks. 
 
¶20. (C) In short, calling into question the premise that a 
"bold switchover" would be needed for North Korea to pursue 
meaningful and effective economic reform, Mansourov presented 
changes in North Korea's security stance and economic reform 
as occurring along independent axes.  He predicted that the 
North will gravitate toward a quadrant that maximizes 
economic policy change and minimizes changes in the DPRK's 
security stance.  The North will do this, he said, in full 
knowledge that it will preclude economic cooperation and aid 
from the United States, Japan or the IFI's, because it is 
confident that it will still be able to enjoy the benefits of 
deepening economic relations with China and South Korea. 
Chinese participants in the conference did not find fault 
with Mansourov's analysis. 
 
¶21. (SBU) Finally, turning to the role of Russia, Mansourov 
was dismissive.  He called the trans-Korea gas pipeline, 
trans-Korea railroad and Russian investment in North Korean 
small enterprises the "three myths" of Russian economic 
engagement with North Korea.  In each case, Mansourov said, 
the cost is too high and potential benefits too low to 
attract concerted Russian interest.  Mansourov did note, 
however, that the Kremlin has historically been flexible 
about using debt forgiveness as a form of assistance, in the 
right circumstances.  For example, Russia has forgiven large 
debts owed by Iraq, Afghanistan, Syria and Mongolia, for 
mainly political reasons.  North Korea has considerable 
unpaid official debt incurred with the former Soviet Union. 
VERSHBOW