by Marcus Noland, Peterson Institute for International Economics
Paper prepared for the Harvard Asia Pacific Review
© Peterson Institute for International Economics
On the Korean peninsula, the world confronts a face-off between what is surely one of the greatest success stories of the post-war era and one of the last of a dying breed of totalitarian dinosaurs. This situation creates fundamental policy dilemmas of enormous practical and ethical import for the rest of the world. Judged in terms of the share of population under arms or the share of military expenditures in national income, North Korea continues to maintain the most militarized society on Earth. It produces and exports ballistic missiles and is thought to possess large stores of chemical and biological weapons, and possibly nuclear weapons as well. It invaded the South once and in subsequent years engaged in state sponsored terrorism. Internally, it maintains a personality cult around Kim Il-Sung and his son Kim Jong-Il of religious proportions and has one of the worst human rights records of any state existent today. North Korea is in its ninth year of economic decline, and a famine has claimed the lives of perhaps ten percent of the pre-crisis population. This is fundamentally a systemic crisis, not a period of aberrant performance due to bad weather or unfavorable external shocks, though both have contributed to North Korea's current predicament. Yet to paraphrase Mark Twain, reports of the regime's collapse have been an exaggeration, and its durability has confounded numerous observers.
In the simplest terms, the North Korean economy no longer works. It does not generate enough output to sustain its population biologically, nor, absent fundamental economic reforms, will it do so in the future. Under current conditions North Korea will require external support for the foreseeable future. Yet the world community is unlikely to continue this support unless North Korea continues to pose a security threat to its neighbors. Economic collapse (presumably precipitating a significant alteration in or disappearance of the current political regime) would be disastrous in human terms and pose great risks to international political stability, especially if it were accompanied by civil war and military intervention by external powers. Surrounding countries—South Korea, China, and Japan — and the United States have demonstrated a willingness to provide this support and more, for fear of North Korea's collapse, or worse, an internal conflict or lashing out which could put millions of people in Northeast Asia in harm's way, including thousands of US troops stationed in South Korea and Japan.
The provision of this aid is tied to the existence of this security threat. If North Korea was simply a country with a broken economy and 22 million impoverished citizens, it is extremely unlikely that a multinational consortium would be pouring in billions of dollars of aid in the form of food and infrastructural investments. There are plenty of such countries in Central Asia and Africa, but the rest of the world does not build them light water nuclear reactors or refurbish their electrical grids. Indeed, one could argue that the famine does not even distinguish North Korea — the contemporaneous situation in the Sudan is as bad if not worse. Rather, North Korea's ability to extract such resources from the world community is intimately related to the threat it poses, and, in this sense, the status quo more closely resembles extortion than charity. The threat North Korea poses is its sole asset. It is unlikely to negotiate away this asset very easily.
Continuance of the status quo is not viable in the long-run, however. North Korea is already the largest recipient of US assistance in Asia. Maintaining this kind of largesse to an unreconstructed, vituperative, Stalinist dynasty is politically unsustainable in the donor countries, particularly in the US.
Coping with the Present
Faced with this situation, Pyongyang has pursued essentially two coping strategies. The first strategy has been the pursuit of "one-off" projects to generate foreign exchange without affecting the systemic conditions of the economy. These projects would include the Rajin-Sonbong special economic zone (SEZ) and the Mt. Kumgang tourism project. The October 1998 agreement between Hyundai and Pyongyang is important in this regard. First, payments committed to by Hyundai dwarf anything that North Korea could plausibly earn in Rajin-Sonbong, and second the Hyundai agreement extends the possibility of the construction of a new SEZ.
With respect to the former, Hyundai has guaranteed North Korea $942 over 75 months, with the payment schedule front-loaded for the first six months. (Indeed, the North Koreans used brinkmanship to extract upfront payments before the first tour visited Mt. Kumgang in November 1998.) At $300 per passenger, North Korea stands to make $450 million per year off the tourism agreement alone in the admittedly unlikely case that Hyundai is able to fill all its berths. To put this in perspective, this money, if properly deployed, would be enough to close the North Korean food gap and end the famine. Unfortunately, it is believed that the funds are going into the Macau bank account of "Bureau 39," a party organization controlled by Kim Jong Il, to be used to reward his cronies and prop up his rule. If this is how the Mt. Kumgang tourism project plays out, it will amount to a successful version of what Rajin-Sonbong is not — a regime-preserving hard currency earner with no real systemic implications for the organization of the North Korean economy or society.
In this respect, the rest of the Hyundai deal might be more significant. The agreement also calls for the development of a second SEZ in Haeju, north of Inchon. This appears to have far greater prospects than Rajin-Sonbong. First, the geographical location is far more auspicious. Second, it has the backing of Hyundai (and presumably the South Korean government). This is critical both from the standpoint that it provides the necessary infrastructure (which Rajin-Sonbong sorely lacks) and carries the imprimatur of Hyundai (and by extension the South Korean government). Thus, South Korean small- and medium-sized enterprises are far more likely to move light manufacturing operations to Haeju than Rajin-Sonbong.
The second has been the use of implicit or explicit threats in developing nuclear weapon and missile capabilities in order to extract resources from the rest of the world. In this regard, recent diplomatic interchanges represent a potential major step forward in stopping the North's nuclear weapons and long-range missile programs and in normalizing its relations with the rest of the world. In this view, the aversion of a military confrontation with the US in 1994 has given North Korea an opportunity to develop more effective means of extorting resources out of the rest of the world and pushing for the unification on their terms. North Korea's August 1998 public announcement of its missile exports and its test of a multi-stage rocket, and its apparently renewed nuclear-related activities perhaps give some indication of the country's future course. The marriage of the rocket and nuclear programs would give the North Koreans impressive tools with which to intimidate their immediate neighbors and create proliferation nightmares for the rest of the world. The truly frightening aspect of this reasoning is that this scenario would be a continuation of the status quo. Ironically, given obstacles to successful reform, such an externally high-risk strategy might be the path of least resistance internally to a weak and risk-adverse regime. North Korea could continue to play a strategy of attempting to extort resources out of the rest of the world, offering to abandon weapons development and export while continuing to make clandestine sales.
Prospects for the Future
The current regime (or some successor) could undertake the economic and diplomatic moves necessary to stabilize the economic situation and end the famine. Cooperation could be expected to yield economic benefits to North Korea in the form of enhanced trade and investment, assistance from multilateral development banks, and settlement of post-colonial claims against Japan. At the same time, to obtain these benefits, North Korea presumably would have to forego its current revenues from exportation of medium-range missiles and weapons of mass destruction, drug trafficking, and counterfeiting. Furthermore, North Korea would have to settle private claims arising from past international loan defaults were it to reenter international capital markets. Such a deal could well involve the alteration or renegotiation of the Agreed Framework upon which much of North Korea's economic interaction with the rest of the world is conditioned.
Reform of the North Korean economy would have two profound effects: first, there would be a significant increase in exposure to international trade and investment (much of this with South Korea and Japan, two countries with which North Korea maintains problematic relations), and second, changes in the composition of output would be tremendous, involving literally millions of workers changing employment. Both developments could be expected to have enormous political implications, or alternatively, these implications could be thought to present significant, perhaps insurmountable, obstacles to reform under the current regime.
As an alternative, the regime could stand pat and hope to ride out its difficulties. Although this is holds the promise of short-run political stability, even if economic distress is not currently putting a significant share of the population at peril, if current trends continue, it eventually will. Moreover, North Korea differs in some significant ways from other socialist regimes which were able to survive self-inflicted famines earlier in this century. First, unlike the others, the Kim Jong-Il government is not a revolutionary regime, but the dynastic continuation of one which has now held power for nearly 50 years. Surely neither this government (nor the governed) have the same capacity for enduring hardship that would exist in a period of revolutionary fervor. Second, North Korea is a relatively industrialized, urbanized society, and this reduces both its government's ability to squeeze resources out of the agricultural sector and the populace's coping mechanisms. Third, previous socialist famines have largely been precipitated by the introduction of counterproductive policies, and could be solved relatively straightforwardly by the removal of those policies. Less a function of bad weather or the sudden introduction of misguided policies, North Korea's current agricultural problems appear to be the culmination of policies undertaken for two generations.
Of course, this may simply mean that the crisis will not be resolved happily. Maintenance of North Korea as an independent state would involve varying mixes of domestic economic reform and external support and could imply varying degrees of national political autonomy depending on the degree of reliance on outside support. One could imagine a range of outcomes from significant reform and possibly successful transition into a market economy with enhanced national political status and capabilities to the economic equivalent of life-support and reversion to the status of a Chinese tributary state.
How this plays out, depends at least in part, on the intentions of the North Korean elite. If this elite has given up hope of reunifiying the peninsula on its own terms, its may be amenable to a reform process which could amount to "unification through golden parachutes" in which the elite uses its control of the state to channel rents for their own "soft landing" through a kind of "apparatchik capitalism." This endgame would be consistent with the retention of some weapons of mass destruction capacity to maintain double-sided deterrence—and a withering of conventional military capability which would no longer be necessary.
Alternatively, the North Korean elite could retain hopes of reunifying the peninsula on its own terms, and regard recent diplomatic openings as an opportunity to "play for time" and channel economic gains into a broad program of military modernization. A diplomatic settlement which could result in the removal of US troops from the peninsula could get them a long way down this road.
Today the North Korean elite appears to be split in this regard. Pyongayang's hesitant steps toward economic reform, for example, have a two steps forward, one step back character. But the question remains whether its system-preserving reforms in the form of tourism projects, mining enclaves, and special economic zones will be sufficient to maintain social stability and avert collapse. At some point developments may force the North Koreans to make a fundamental choice: either to continue down the extortionist's road (which requires periodic threat reminders) or to abandon this path and undertake the hard and uncertain task of economic reform. The first approach has yielded a stream of tactical payoffs, but these appear insufficient to reverse the secular deterioration of the economy: North Korea is winning the battles but losing the war.
Book: Witness to Transformation: Refugee Insights into North Korea January 2011
Peterson Perspective: North Korea's Immunity to Outside Pressure: Part I December 12, 2012
Policy Brief 10-1: The Winter of Their Discontent: Pyongyang Attacks the Market January 2010
Working Paper 10-2: Economic Crime and Punishment in North Korea March 2010
Paper: FTAs and the Future of US-Korean Trade Relations November 2009
Paper: Implementing the KORUS FTA: Key Challenges and Policy Proposals February 2008
Policy Brief 08-6: North Korea on the Precipice of Famine May 2008
Policy Brief 07-7: The Korea-US Free Trade Agreement: A Summary Assessment August 2007
Policy Brief 06-4: Negotiating the Korea–United States Free Trade Agreement June 2006
Working Paper 07-7: North Korea’s External Economic Relations August 2007
Book: Avoiding the Apocalypse: The Future of the Two Koreas June 2000
Book: Free Trade Between Korea and the United States? April 2001
Working Paper 08-4: Migration Experiences of North Korean Refugees: Survey Evidence from China March 2008