North Korea has been isolated since the disintegration of the Soviet Union in 1991. Significant amounts of communist aid ceased, and the fall of communism across Eastern Europe ultimately had a profound impact on the Democratic People’s Republic of Korea for the next two decades. North Korea was figuratively and literally off the grid as the country experienced severe shortages of electricity, energy, and food for many years. Society was more advanced around the time of Mao Zedong’s death in 1976 compared to today and the economy was much more productive. North Korea has been one of the few industrialized civilizations to experience famine during peacetime over the past 50 years. The state controlled media ranks second to last in terms of the World Press Freedom Index (if you’re curious, like I was, on the lowest rank on the planet – answer: Eritrea). With internet and cell phone access limited to the government elite, there are 25 million people in North Korea who have not been exposed to the rest of the world. Actions taken by North Korea over the past two-months could begin to change this.
With North Korea back in the news, for the first optimistic reasons in quite some time, it is interesting to review recent history. The Department of State has a 17-page country profile which I found informative. Here is a recap of North Korea’s journey down the rabbit’s hole:
- Sino-Japanese War (1894-95) and Russo-Japanese War (1904-05) – Japan wins across the board and Korea is annexed by the Japanese.
- Japan tightly controls Korea until the surrender of Japan after WWII (August 1945).
- Korea gets divided into two parts (North and South) and Kim Il-Sung with aid from the Soviet Union takes control of the northern part.
- North Korea launches a massive surprise attack on South Korea (June 1950).
- Korean War (1950-53)
- Armistice pact signed in 1953 but hostilities linger
- North Korea decides to ally with China and the Soviet Union.
- Some measure of growth is achieved through the 1970s and 1980s coinciding with the Soviet Union’s global sphere of influence.
- The Soviet Union collapses in 1991, and rather than slowly allow the emergence of a private sector within a communist system, like China and Vietnam, North Kore, led by Kim II Sung, focused primarily on maintaining absolute power and military might.
- This flawed approach led to a 20-year economic depression in North Korea.
- Nuclear ambitions and military spending have been a constant priority.
- November 23, 2010: North Korea launched an unprovoked submarine attack on the South Korean warship, Cheonan. The warship sank, killing 46 South Korean sailors.
- Kim Jong II dies in December 2011.
- Kim Jong-Eun, in his late 20s, takes over power.
For the past few months, uncertainty with regard to North Korea has been elevated. Speculation existed that the young Kim Jong-Eun would immediately attempt a display of force in order to send a message to the world. Fortunately, this type of speculation has been incorrect. North Korea’s per capita income is estimated around $1,600 per year. People literally can’t eat and the government has had to depend upon aid to procure food. Whatever the motives, Kim Jong-Eun has started to lead by taking a step forward and agreeing to suspend nuclear tests. Kim Jong-Eun has agreed to let the International Atomic Energy Agency inspect the Yongbyon nuclear facility, where Korea has been enriching uranium.
Some commentators have taken an excessively cynical view and expect things in North Korea to ultimately remain the same as they have for the past 20-years. With nothing more than intuition, I believe there will be change because when leaders die and power is transferred a powerful catalyst for change emerges on its own. Near-starvation is also not a sustainable equilibrium condition for North Korea. Kim Jong-Eun is young and his best chance to remain in power for many years is to engage the rest of the world.
The investment implications are difficult to see at present but the fall of failed communist states often leads to profound investment opportunities. The reunification of Korea could also eventually serve to solidify Korea as a top 10 economic power (right now South Korea on its own ranks 15th). The unification of Germany had profoundly positive influences on German ascendance over time. German unification was initially very tough on the socialist East Germany but there was a mini-boom for West Germany. A larger market for growth and infrastructure emerged for strong German companies. Cheap labor became internalized within Germany and companies in the west took advantage.
While positive change may be years away there are a few investment implications that come to mind:
- Bullish for South Korean GDP growth – at a minimum government spending on defense, which crowds out other productive activities, is likely to come down somewhat.
- South Korean steel, cement, construction, industrial, and machinery companies are likely to benefit from a multi-year build out in the North.
- China benefits as North Korea shares a border. Chinese industrials from Shenyang, Harbin, Tianjin, and Beijing are well positioned.
- Japan benefits as North Korea lurks right across the Sea of Japan. A denuclearized North Korea is a clear positive. Full stop.
Last year, the global economy and financial markets were rocked by a series of negative geopolitical developments including: Japan’s nuclear disaster, Arab Spring, and the European sovereign debt crisis. Many investors are on the look-out for a sharply negative European recession and/or geopolitical stress coming from Iran. Perhaps there are positive developments that will help support economic growth over many years taking place too. Some stability and global participation coming from North Korea could be a surprise positive event in 2012. The Kospi, Nikkei, and Hang Seng are all off to a very strong start to 2012 (up 11-18% in local currency terms). South Korean performance has lagged some other markets in Asia this year but there could be a positive backdrop and improving economic environment for a number of years to come.