Risky Business.

By Peter Ritter

Afew years ago, Chris Devonshire-Ellis, a Beijing-based business and tax consultant, was in the bar at Pyongyang's Koryo Hotel when he ran into another foreigner. "The guy's name was Vlad," Devonshire-Ellis says. "He'd come from Moscow on a train to sell tractors to the North Koreans. He had all these guys around him. Turns out, they were his team of bodyguards. The North Koreans paid him in cash--1 million in U.S. dollars--and that's why he needed the bodyguards. He was comfortable doing business with the North Koreans. He said they always paid. But I must say, the guards with machine guns may be a bit much for the average Western businessman."

Such is the parlous state of commerce in the world's last Stalinist holdout. On Oct. 2, North Korea's dictator, Kim Jong Il, held a historic meeting with South Korea's President, raising hopes that diplomatic progress in the effort to get Kim to abandon nuclear weapons, along with an easing of the country's self-imposed isolation, might ultimately lead to economic reforms. And for foreign investors lured by what Devonshire-Ellis calls the "barren romance" of the place, North Korea holds obvious, if modest, attractions: a highly literate workforce with average daily wages that are about half what Chinese earn; abundant mineral resources, including coal, iron ore and gold; a cash-on-the-barrel economy; and virtually no competition. It's not hard to gain a first-mover advantage, after all, if everyone else is standing still.

North Korea would be an economic basket case if only it could afford the basket. It was once the industrial engine of the Korean peninsula, but decades of disastrous central planning have left its infrastructure in a state of advanced decrepitude and its citizens in de facto peonage. The U.S. government estimates the North's per capita GDP to be about $1,800, roughly the same as Zimbabwe's. Per capita exports are about $60 a year--less than 1% of South Korea's. Aside from fishing, mining and cement production, the North has only a hodgepodge of functional industries, including, weirdly enough, its animation studios, which have been used by several European companies. One of the few export industries to flourish, meanwhile, has been military hardware. Illicit trade in drugs and counterfeit products may net Kim's regime up to $1 billion a year--equivalent to one-fourth of the country's legitimate exports.

Yet North Korea continues to receive commercial support from neighboring countries, which hold out hope that Kim's hostile kingdom can be enlightened through greater integration with the global economy. China, North Korea's biggest trading partner, has increased its dealings with the North. Trade between the countries was up 5.4% in the first 11 months of 2006, to about $1.54 billion. Much of that commerce was one-way--Chinese food and electronics moving into North Korea--but about 150 Chinese companies are doing business there. "Once the political situation stabilizes and medium-size enterprises begin to discover North Korea, it will have a dramatic impact," says Alexandre Mansourov, a professor at the Asia-Pacific Center for Security Studies in Honolulu and a former Soviet diplomat in Pyongyang. "I don't see why North Korea should be an exception to the economic miracle in which every country around China is benefiting from Chinese economic growth."

North Korea is already benefiting--a little. In 2005, the Chinese trading company Tianjin Digital invested $650,000 to open a joint-venture bicycle plant in Pyongyang. "The conditions are really favorable," says Tianjin manager Liang Tongjun, whose company was granted a 20-year monopoly on bicycle manufacturing in the North. A month after the factory opened, the Dear Leader himself paid a visit.

China's links to its neighbor and ally consist mainly of investments by individual companies. But in South Korea, economic engagement with the D.P.R.K.--the Democratic People's Republic of Korea, as the North calls itself--is government policy. South Korea has invested heavily in two well-known public-private development projects: a resort area at Mount Kumgang and an industrial zone in Kaesong, about six miles (10 km) north of the Demilitarized Zone. There, 13,300 North Korean workers earning $70 a month churn out exports in conditions a former Western diplomat compares to a labor camp's. So far, 15 South Korean companies have opened factories in Kaesong, producing shoes, watches, mufflers and other low-end consumer goods; 150 others have signed on.

Largely because of Kaesong, North Korean exports to the South shot up 63.3% in the first half of 2007. Hyundai Asan, the South Korean conglomerate that manages the two projects and has invested nearly $1 billion in them, is convinced that North Korea is ready to embrace capitalism. "The North Koreans are really studying the market-oriented system," says Jang Whan Bin, Hyundai Asan's senior vice president of international business and investor relations. Such optimism is essential for South Koreans, for whom investment in the North is less an overture for integration than a hedge against their neighbor's collapse. Better, perhaps, to nudge the D.P.R.K. toward prosperity now than to inherit a ruined state later.

Roger Barrett, founder of the Beijing-based Korea Business Consultants and one of the few Westerners to regularly do business in Pyongyang, says the North seems eager to court new investment. "The D.P.R.K. government is very keen to demonstrate that joint ventures are welcomed," he says. Barrett, who has been facilitating business deals in the North for more than a decade, compares the country's current condition to that of South Korea's before it emerged from military rule to become one of the world's export powerhouses. "You start to see how North Korea can move along in similar ways," he says.

A few other pioneers are already there. Orascom, an Egyptian conglomerate, recently signed a $115 million deal to buy a stake in a North Korean cement company. And later this month, a British firm will begin offering subscriptions for the first ever D.P.R.K.-focused investment fund. Colin McAskill, director of the Chosun Development & Investment Fund, says it will concentrate on the mining industry. "You have to think off the wall in North Korea, because nothing conventional has ever worked there," he says.

Deals in the North do have a marked tendency to go south. For example, a Thai telecom's plan to develop a mobile-phone network faltered after Kim's regime banned cell phones in 2004. Kelvin Chia, a Singapore-based lawyer who has worked with North Korean joint ventures since 2004, says many investors were spooked by the country's October 2006 nuclear test and the international fallout. "One of my clients was looking at going ahead with a substantial investment in a mineral-processing project," Chia says. "Before he went in, he had an indication from financiers it was doable. But then the nuclear issue blew up, and it became impossible."

In addition to the considerable political risk in partnering with a charter member of the "axis of evil," there's the North's underwhelming track record when it comes to development schemes. Casting about for new investors after the collapse of the Soviet Union, the D.P.R.K. in the 1990s started a free-trade zone in Rajin-Sonbong, a remote area near the country's northeastern frontier. The experiment failed: the zone didn't attract much beyond a few hotels and a casino catering to Chinese tourists. Another special economic zone in Sinuiju, across the Yalu River from the Chinese city of Dandong, faltered in 2002 after the Chinese-Dutch orchid entrepreneur handpicked by Kim to run the place was arrested by China for fraud.

The North was emulating an obvious precedent: Shenzhen, the special economic zone where China first experimented with capitalism. In January 2006, Kim made a rare foreign visit, traveling by train (he reportedly abhors flying) to the booming southern Chinese city. Kim may see China as more than a path to prosperity. "To him it's an assuring message," says Mansourov. "Even if you open up economically, you can still maintain political control for his regime and his family."

Yet just as often as North Korea has opened the door a crack, it has slammed it shut. In 2005, for instance, the government suddenly reversed its decision to allow private markets, forcing many North Koreans back into food-rationing. And at April's meeting of the Supreme People's Assembly, Kim's government sacked Prime Minister Pak Pong Ju, who had led a Cabinet-level economic think tank and was seen by some as friendly to reformers. "All of a sudden the wind seems to have gone out of the sail," says Brad Babson, a former North Korea specialist at the World Bank.

Real reform, Babson says, would require North Korea to abandon its pipe dream of agricultural self-sufficiency--with a dearth of arable land, the country is literally dirt poor--and invest in labor-intensive manufacturing. But rebuilding the country's roads and ports and installing a reliable electrical grid would take billions of dollars in international loans--hardly a bright prospect given the country's history of defaulting on its obligations.

Skeptics, meanwhile, see North Korea's current eagerness for investment as another in Kim's endless series of feints designed to keep his opponents off balance--and the foreign aid handouts flowing so the country stays fed. "The North Korean economic approach has always been to extract resources from outsiders," says Nicholas Eberstadt, a political economist at the American Enterprise Institute and the author of The North Korean Economy. "It's like what they say about champagne: In success, you feel like you deserve it. In failure, you need it."

The possibility of failure is omnipresent. According to South Korea's central bank, the Bank of Korea, the D.P.R.K.'s economy shrank 1.1% in 2006 after eight years of moderate growth. Under pressure from international sanctions, nearly every sector of the North's lilliputian economy contracted, with new construction plummeting 11.5%. Torrential rains in August, meanwhile, destroyed an estimated 11% of the country's rice and corn crops, again raising the specter of a mass famine like the one that killed as many as a million people in the mid-1990s.

At six-party talks in Beijing in late September, North Korea agreed to dismantle all its nuclear facilities and disclose the scope of its nuclear program by the end of the year in exchange for 950,000 tons of fuel oil or the equivalent in economic aid. And at this month's summit in Pyongyang between Kim and South Korean President Roh Moo Hyun, the two nations agreed to pursue a formal peace treaty to officially end the Korean War and made broad, if vague, plans for increased economic cooperation.

But there are no certainties on the Korean peninsula. Should Pyongyang renege on its promise to dismantle its nuclear program, crippling U.S. sanctions will almost certainly continue. And South Korean presidential elections in December could usher in a new government with a less conciliatory stance toward its deadbeat neighbor. To see just how far North Korea still has to go, you need only visit the Sino-Korean Friendship Bridge linking the booming Chinese metropolis of Dandong with the sooty failed economic zone of Sinuiju. Commerce between the two nations is limited to a trickle of trucks on the bridge's single lane. At night, the contrast is vividly instructive: Dandong's bustling waterfront turns into a riot of neon, while Sinuiju is pitched into nearly total blackness. How will North Korea ever pull itself out of the dark ages if it can't even keep the lights on?

With reporting by With Reporting by Austin Ramzy / Beijing, Jennifer Veale / Seoul