Long regarded as the economic basket case of Northeast Asia, since Kim Jong Un’s accession to power there have been increasing signs that Pyongyang may now be serious about much needed economic reforms.
From announcing the creation of 20 new special economic zones, reforming foreign investment rules, and improving rules and salaries for farmers and workers, numerous developments since early 2012 have indicated that North Korean policy-makers are increasingly eager to experiment with capitalist approaches.
But despite the new policies, evidence also suggests that Kim Jong Un’s government often continues to prioritize politics over economic performance, with the closure of the Kaesong Industrial Complex in 2013 and recent ban of travel in light of the Ebola virus obvious examples of non-business friendly policies.
Yet beyond the state level, observers agree that significant changes are afoot on the ground in North Korea, with the significant growth of markets and private enterprise cementing the failures of Pyongyang’s once socialist credentials.
What then are the chances that Kim Jong Un will be able to implement major reforms and garner sustained economic growth in the medium to long term? And can rumors of significant forthcoming policy changes ever be expected to deliver given the particularities of the North Korean policy environment?
In part seven of the NK News specialist opinion survey series, three economists debated the state of North Korea’s current economic policy, what the biggest economic development has been in the past five years, and what the biggest threat to sustained development in the DPRK economy is today.
Additional reporting: Doyun Kim and Phebe Kim
1. How would you currently describe the state of the DPRK economy?
It is virtually impossible to answer questions about the state of the DPRK economy with any confidence. There are several different types of assessment, most flawed in one way or another.
First are those estimates ultimately based on North Korean quantity measures of output, most notably by the Bank of Korea (BoK). The BoK sees positive growth over the last three years, although still very sluggish by any standard at about one percent in real terms. If forced to make a guesstimate, this seems about right to me.
A second way of assessing developments is through the lens of the foreign sector. Over the medium-run—the last three to five years–Chinese trade and investment growth appears to be robust. But two developments cast doubt on whether this is a good indicator looking forward. There are ongoing rumors—reflected in missing data—that China may be limiting exports of oil or certain classes of oil products to the regime. Moreover, we have seen overt expressions of concern about sanctions on the part of the regime that seem at a more urgent level than we have seen in the past, suggesting that the foreign sector may not be helping to the extent it has in the past.
The BoK sees positive growth over the last three years, although still very sluggish by any standard at about one percent in real terms. If forced to make a guesstimate, this seems about right to me
A third way of assessing performance is to focus in on a few physical measures such as cell phone subscriptions (up, but perhaps leveling) and the harvest (improved over last year). But cellphones may be biased as an indicator for reasons I will explain and the harvest is nowhere near adequate to avoid localized shortages.
Fourth, we do have some price data, and here we can speak with a little more confidence of an improvement. Inflation was high in North Korea following the 2009 currency reform, perhaps as high as 100 percent a year; this inflation persisted well into 2013. Recently we have seen some evidence that price increases are abating, which is good.
Finally, there is the wildly impressionistic style of assessment that says “I just visited Pyongyang and….” or “A friend of mine invested in North Korea and…” There can be little question that Pyongyang is going through a mini-boom, including in housing and market activity. But this may or may not correlate with the performance of the economy as a whole if the boom is being supported by diversion of resources to the capital. This is the phenomenon I call the Pyongyang Illusion: the belief that what is happening in the capital city—clearly protected—extends beyond it.
The DPRK economy is the worst performer in the post-war era. It’s the most catastrophically underutilized human resource endowment on the planet.
Things seem to have been improving since the famine, but one has to remember that this is the regime, the leadership, that achieved famine with an educated, urbanized society during peace time. That’s never happened anywhere else in history.
When we think of the current state of the North Korean economy we should really think about three economies existing alongside each other. The first is the centrally planned economy that is the legacy of the state. This side of the economy has been in decline since the end of the Cold War and the Great Famine of the 1990s. In Pyongyang, this is most likely still the dominate source of income and goods with the state’s patronage system catering to the elite with some estimates that it supports up to 60 or 70 percent of the capital’s population.
The second North Korean economy consists of the informal markets that began to emerge in the 1990s in response to the famine. At times the state has both supported and suppressed the markets, most recently trying to curtail them in 2009, but has largely left them unregulated. For those living in rural areas this is their primary source of income and goods, perhaps providing nearly 70 percent of the rural populations’ needs. This aspect of the economy is continuing to grow, but there are also likely goods from the centrally planned economy leaking into and supplementing the markets.
When we think of the current state of the North Korean economy we should really think about three economies existing alongside each other
The third economy is that of the special economic zones such as the Kaesong Industrial Complex, Rason, and the spate of new zones that North Korea has announced over the last year or so. These zones are largely isolated from the rest of North Korea. Kaesong, for example, provides higher wages and other benefits to the North Koreans who work there, but the products produced there cannot be sold in North Korea. Beyond labor, minimal inputs from North Korea are utilized in Kaesong, with even electrical power coming from the South. While each of the zones has some unique characteristics, Kaesong and Rason are the two most fully developed.
Normally special economic zones are a means for an economy to experiment with economic reforms prior to spreading them to the rest of the economy, as was the case with China and other emerging economies. However, in the case of North Korea, it is not clear that this really is their ultimate intention.
While these economies operate independently, they are not completely isolated from each other and in time efforts will need to be made to regulate the private markets, privatize the state owned facilities, and better utilize the SEZs has a source of economic experimentation to rationalize the broader national economy.
2. What’s been the biggest development in the North Korean economy in the past five years?
The failed currency reform of 2009 is far and away the most important development in North Korean economy in the last five years. The growing role of China in North Korea’s economy is somewhat misunderstood as it reflects the absence of additional significant trading partners for North Korea, as Japan was North Korea’s largest trading partner prior to the imposition of sanctions over North Korea’s nuclear program and the abduction of Japanese citizens. Kim Jong Un’s various economic announcements have yet to have a significant impact on the economy. In contrast, the failed currency reform has likely entrenched markets as part of the North Korean economy and demonstrated that barring truly extreme measures that state will not be able to reassert the public distribution system and have the role of markets “gradually dwindle” as Cho Song-hyo of North Korea’s Central Bank indicated at the time.
One consequence of the reform effort has been that traders are increasingly moving to the use of dollars and Chinese yuan for both transactions and savings, creating a separate economy outside the control of the state
The currency reforms announced in 2009 were coupled with the closure of markets, a confiscatory limit on exchanging old currency into new, and a ban of foreign currencies. These policy shifts led to protests that resulted in a partial reversal of the currency exchange limits and a rare acknowledgement of mistake by North Korean officials after the reopening of the markets. However, one consequence of the reform effort has been that traders are increasingly moving to the use of dollars and Chinese yuan for both transactions and savings, creating a separate economy outside the control of the state. As more of the economy moves into currencies other than the North Korean won, it will become increasingly more difficult for the state to regain control of the economy.
The biggest development in the last five years has been the enormous surge of Chinese economic support.
It’s Chinese economic support that promises perhaps to transform the DPRK economy. It’s incontestably Chinese economic support that keeps the North Korean system alive today.
North Korean policy makers are desperately aware of their dependence on Beijing, and are trying very hard to diversify that support.
I would pick three important policy developments, although not all will have positive effect.
The first and most positive is the fact that the regime is probably relaxing its control on the market compared to earlier periods. Many outside observers, myself included, have been looking for policy statements that suggest a change in course. We looked for changes in the organization of the cooperatives or in managerial autonomy or towards large-scale legal initiatives. It looks to me like the regime did experiment or pilot reforms of this sort in 2012, but backed away from them. Rather, the regime seems content to maintain discretion but to allow somewhat greater scope for market activity, even in wholesale markets or in assets such as housing. This type of indirect reform is a plus, even if these activities are bound up with corruption and official involvement and therefore easily reversible if the political winds shift.
A second development is the push to increase foreign investment. If there is one reform area where the North Koreans have been trying to change policy it is with respect to investment, particularly through the SEZ initiative.
North Korean officials still do not seem to understand that the country is not that attractive an investment location, and that a myriad of small details—from testing missiles to arresting foreigners—all have a generally adverse effect investor sentiment
The problem with this strategy leads to the third development, which is generally adverse: the articulation of the byungjin line of seeking to develop the economy while simultaneously maintaining the nuclear program. North Korean officials still do not seem to understand that the country is not that attractive an investment location, and that a myriad of small details—from testing missiles to arresting foreigners—all have a generally adverse effect investor sentiment. The regime attributes weak interest to sanctions, but this is not the core problem: the regime simply isn’t credible on property rights protection and allowing firms to make money.
3. What will the greatest threat to sustained economic growth in the next five years?
There’s no sustained economic growth in North Korea.
North Korean economic growth is like a patient in an ICU ward with a lifeline of oxygen. Take away the Chinese aid today and North Korea goes back into crisis, famine and catastrophe.
The critical question is whether the North Korean leadership will decide to embark finally on a path of self-sustaining growth. But they have avoided that path for over 40 years.
The main issues are at the grand strategic level. Is North Korea going to make a strategic decision to pursue something resembling the Chinese route or is it going to limp along the juche/songun/byungjin path?
To me, the answer to that question lies almost entirely at the domestic political level and is surprisingly unaffected by either sanctions or inducements. I do not believe that sanctions will necessarily push the regime to reform, nor do I believe that offers of inducements, talks, a peace regime, lifting of sanctions or any other favors will have that much effect.
The new leadership has clearly not solved this most basic of all questions: what direction it really wants to go
The new leadership has clearly not solved this most basic of all questions: what direction it really wants to go. Until it does, the most we can hope for is that the process of what we call “marketization from below” will become so deeply entrenched and significant that the leadership has no choice but to follow it.
Despite efforts by North Korea in recent years to improve its management of the economy by reaching out to experts to help shape laws for special economic zones and to attract foreign direct investment, mismanagement of the economy has long been the greatest threat to sustained economic growth in North Korea, after its nuclear program, and is likely to remain so over the next five years.
Despite efforts to develop more investment friendly laws and in some cases having good laws or regulations on books, North Korea remains a nation of political whim rather than rule of law. The Kaesong Industrial Complex is a good example of this. Last year the complex was shut down for nearly half the year after North Korea withdrew its workers from the complex over its political disputes with South Korea. Now that the two sides are trying to attract foreign investment, one of the issues hindering that effort is the lack of access to the internet in the complex. Despite the regulations for Kaesong allowing for the use of internet in the industrial complex, North Korea has to date not allowed it.
The system needs to shift towards the rule of law and away from a system that is arbitrary and based on the leadership’s preferences at the moment.
For firms to invest in North Korea and for growth to be sustained, domestic and foreign businesses need for the state to properly manage the economy. This means the system needs to shift towards the rule of law and away from a system that is arbitrary and based on the leadership’s preferences at the moment. Contracts need to be honored and property rights enforced with legal recourse for when the state or its agents seeks to expropriate firms property as happened to the Xiyang Group from China in 2012.
While the private sector in an economy as large and open as the United States can overcome a short period of economic mismanagement and maintain growth, the markets in North Korea are likely too fragile to do so and the state lacks the resources, institutional framework, and the connection to international financial institutions necessary to deal with a future shock to the economy.
Nicholas Eberstadt – political economist and a demographer by training, is also a senior adviser to the National Bureau of Asian Research, a member of the visiting committee at the Harvard School of Public Health, and a member of the Global Leadership Council at the World Economic Forum. He researches and writes extensively on economic development, foreign aid, global health, demographics, and poverty.
Stephan Haggard – currently professor of political science at the the School of International Relations and Pacific Studies at UC San Diego. He was interim director of IGCC (1997–99). Haggard’s research interests center on the international relations and comparative political economy of East Asia and Latin America.
Troy Stangarone – joined the Korea Economic Institute (KEI) in December of 2005 and is the Senior Director of Congressional Affairs and Trade. Mr. Stangarone has written extensively and has been widely quoted on U.S.-Korea relations, South Korean trade and foreign policy, and North Korea.
Pictures: Eric Lafforgue
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