by Marcus Noland, Peterson Institute for International Economics
Testimony before the Subcommittee on East Asian and Pacific Affairs
United States Senate
July 8, 1997
It is an honor to appear again before this Subcommittee. As former Vice President Mondale once observed, anyone who calls themselves an expert on North Korea is either a liar or a fool. Since I try to avoid both appellations, I will not claim to be an expert on North Korea. Rather I am simply a conventionally trained economist who has spent some time analyzing the North Korean situation. Today I intend to discuss the difficulties facing the North Korean economy, including its immediate problem with respect to food, and then speculate as to possible developments over the next several years. Throughout my presentation you should keep Vice President Mondale's wise words in mind.
The North Korean Economy
The North Korean economy is organized along lines similar to other centrally planned economies (CPEs). The distinguishing feature of the North Korean case has been the extremes to which central planning has been taken under the juche ideology of self-reliance of founder Kim Il-Sung. Indeed, North Korea's successive central plans were timed so as to frustrate economic linkage even with its socialist allies.
Foreign observers (including those from fraternally allied socialist states) had concluded that the North Korean economy was already experiencing serious problems by the late 1970s when its ability to grow "extensively" through the mobilization of resources began to reach its limits. These difficulties were exacerbated by a series of macroeconomic shocks in the late 1980s including the withdrawal of Soviet aid, economic disengagement with its former socialist allies in the East Bloc, and bad weather which intensified the secular crisis in North Korean agriculture.
Assessing the degree of economic distress in North Korea with any precision is difficult. Virtually all economic and social data are regarded as state secrets. A number of individuals and organizations have attempted to estimate North Korean national income, but figures invariably cited in public discussions are the official South Korean estimates of North Korea's economy produced by the Bank of Korea (BOK). These figures are apparently derived by taking classified data on physical output generated by South Korean intelligence agencies and then applying South Korean prices and value-added weights to indices of physical production. Because the original estimates of physical output are classified, there is little opportunity to check their plausibility, nor is it obvious that South Korean prices and value-added weights are the most appropriate ones available. Furthermore, the ultimate growth rate figure is reportedly subject to interagency bargaining within the South Korean government.
With these caveats in mind, the BOK data indicate that the North Korean economy shrunk by roughly 30 percent between 1991-1996, certainly a significant amount, but not unprecedented in the experiences of other transitional economies. (Interestingly, an estimate of a similar magnitude has been publicly affirmed by high-ranking North Korean officials, though it is unclear whether the North Koreans truly believed this, or were simply parroting the familiar South Korean line to establish credibility with a foreign audience.) However, the estimated fall in national income may well overstate the reduction in household welfare, since it is unlikely that services (housing services and education to give two examples), which are undercounted in the socialist accounting system and are not amenable to physical measurement, have declined as much as manufactured output. These considerations would appear to caution against interpreting the national income estimates as indices of hardship or political discontent.
Somewhat less uncertainty surrounds North Korea's external economic relationships. In principle one can obtain estimates of trade and capital flows by aggregating the data reported by North Korea's trade partners after adjusting for misreporting, transportation costs, etc. Three conclusions stand out: North Korea runs chronic trade deficits in the hundreds of millions of dollars, trade is concentrated with a few partners, and most tellingly, trade volumes are falling. If the deficits that North Korea runs with China, obtaining imports on concessional terms, and the surpluses that it runs with South Korea, generating export revenues, are considered in effect to be politically determined, China and South Korea together implicitly support most of North Korea's trade deficits.
Still, North Korea appears to confront a financing gap on the order of hundreds of millions of dollars. Aside from exports, the largest source of hard currency earnings are probably remittances, principally from ethnic Koreans residing in Japan. Again, the amounts of these remittances are hard to pin down with any degree of precision. They have been variously estimated by the amount of currency that visitors from Japan could legally carry on their person, profits from the pachinko industry (a form of gambling popular in Japan in which ethnic Koreans play an important role), and as a residual of the balance of payments accounting constraint. Not surprisingly given these varied approaches, estimates of the annual amount of remittances vary enormously from $2 billion to the low millions, with estimates typically running in the hundreds of millions of dollars (again consistent with private comments of North Korean officials), though recent scholarship tends toward lower figures, perhaps less than $100 million.
In response to its current predicament the regime has begun some modest and hesitant reforms, most notably the establishment of a special economic zone, modeled after China's, in the extreme northeast of the country. But such tinkering, however politically contentious it might be within North Korea, is unlikely to be sufficient to reverse the secular decline of the economy. The bottomline is that the economy is in bad shape, but for almost all economic aggregates of interest, the margin of error in the estimates is on the order of hundreds of millions of dollars.
Minimum Survival Requirements
An alternative approach to this problem would be to ask what would be the level of external assistance required to maintain the North Korean population biologically. It is important to keep in mind that the problems of North Korea's agriculture are primarily systemic in nature: while the flooding of the past two years has exacerbated the problem, North Korea had already appealed for, and was receiving, food assistance from South Korea and Japan before the floods. The bureaucratic collectivist nature of North Korean agriculture contributes to inefficiency, and the single-minded maximization of short-run output has meant the adoption of unsustainable practices. Continuous cropping and the overuse of chemical fertilizers has led to soil acidification, while soil erosion and silting due to the denudation of hillsides has contributed to flooding. This environmental damage will take decades to repair. In any event, North Korea should be exporting mineral products and manufactures and importing food — not trying to achieve self-sufficiency.
A variety of organizations and individuals have analyzed the food situation in North Korea, and the rough consensus is that North Korea is experiencing an annual grain shortfall of roughly 2 million tonnes. (Again, these estimates are constructed in a variety of ways based on little systematic observation of conditions on the ground and may be subject to substantial error.) The shortfall is partly due to bad weather and flooding, but at base it is structural in character, and provision of food aid is only a short-run palliative in the absence of more fundamental economic reforms.
Like agriculture, the situation with regard to energy is clouded by a lack of information. North Korea is reliant on imported oil to generate fuels and fertilizer for use in transportation and agriculture. Oil imports have been squeezed by foreign exchange shortages and the reduction in subsidized supplies from Russia and China (though reports continue to crop up of arms for oil swaps.) Electricity is mainly generated using coal and hydropower. Electricity generation is hampered by difficulties extracting increasingly inaccessible and low quality domestic coal reserves. Beyond the problem of lack of energy inputs, the power grid (largely underground for security purposes) is said to suffer from extraordinarily large transmission losses.
Energy problems will be partly addressed through the U.S.-North Korea Agreed Framework which provides for provision of fuel oil during the construction of light-water nuclear reactors and the rehabilitation of the electrical grid. Nevertheless, North Korea will need additional energy inputs beyond those specified in the Framework Agreement if it is to reattain its peak level of electrical consumption.
If these estimates are correct and the Framework Agreement is implemented, the actual cost of purchasing the estimated shortfalls in grain and energy inputs would not be very large, on the order of hundreds of millions of dollars. There is anecdotal evidence that both the central planning mechanism as well as public food distribution system is fraying under stress of this ongoing crisis, but this should not be overstated. The impression that one gets is that the central government continues to act with a relatively high degree of coherence (and a relatively high degree of acquiescence by the population). It may well be that hunger is a relatively localized phenomenon falling disproportionately on certain socio-economic groups (in particular non-farm workers in the rural areas) and that this reflects conscious decision-making by the political elite.
Indeed, the sums of money required to maintain population survival appear to be within the margin of error of what we think we know about the North Korean economy. It is in the realm of possibility that North Korea can survive (in a biological sense) with only modest external assistance. In the short-run China, Japan, or South Korea could keep North Korea afloat (in this narrow sense). Indeed, both the Japan and China at present appear to have surplus government grain stocks that could be used to make up the North Korean shortfall with minimal expenditures.
At the same time, it should be reiterated that this analysis is based on highly fragmentary information. It is quite possible that a "silent famine" similar to what took place in China during the Great Leap Forward is unfolding in North Korea. Among the worst (and least understood) famines in this century took place in socialist countries in which governments were to a greater or lesser extent successfully able to restrict the flows of information and people both internally and externally. North Koreans have been conditioned by nearly two generations of extreme regimentation. It is not implausible, given the terrain and the instruments of social control at the disposal of the current regime, that it could prevent the mass population movements observed during famines in Africa or the Indian subcontinent. If a famine were to occur in North Korea, the killers would be tuberculosis and spontaneous abortions, not kwashiorkor, and we would probably learn its full magnitude a decade hence reading a graduate student dissertation, not watching CNN. If such a famine does materialize, its roots will be in political decisions made in Pyongyang, not material resource constraints.
The obvious question then is what are the capabilities and interests of the North Korean regime? Neither question can be answered definitively. Since the death of Kim Il-Sung the state has appeared to be on a kind of extraconstitutional autopilot: as of this writing political (and biological) heir Kim Jong-Il has not formally assumed his late father's offices, the national assembly has not met and the terms of the sitting members lapsed, and the government budget, the sole piece of economic information that the government regularly announced has not been released for several years.
At the same time, the regime has managed to pull off some achievements. The Agreed Framework was successfully concluded with the US, a trade and investment conference in the special economic zone of Rajin-Sonbong attracted hundreds of foreign participants, and critical institutions such as the public food distribution system appear to be functioning. While there have been indications of system fraying (the defection of Hwang Yang Jop, economic exchange outside the central plan as local political and military leaders attempt to satisfy the needs of their constituencies) the overall impression one gets is that the government is performing at a reasonably high level of coherency and efficiency given the strains the current crisis.
The question then becomes what are the interests of the regime? Here the analysis of the situation must by its nature be highly speculative, and frankly outside my area of comparative advantage. Nevertheless, one can imagine a variety of generic strategies that the government might pursue in addressing its economic problems.
First, the government might pursue policies of fundamental economic reform. This would involve decisively liberalizing and marketizing the economy. In this regard, the experiences of China and Vietnam may be misleading. At the time of their reforms, these economies were far more agrarian than North Korea and their ability to shift extremely low productivity labor out of agriculture and into the emerging non-state-owned light industrial sector has been a key to their success thus far. Successful reform of a more industrialized economy such as North Korea is likely to be far more difficult for purely technical reasons, and would imply tremendous change for the North Korean economy. The economy is so distorted that North Korea could increase its output by more than half its pre-decline level under favorable conditions. The share of international trade in national income could rise five-fold, and much of this trade would be with Japan and South Korea — two states with which North Korea has highly problematical relations. Moreover this transformation would involve hundreds of thousands of people moving from the countryside to the cities, and literally millions of people changing jobs. Reform, therefore, would be a high-risk, big-payoff strategy. Change on this scale would likely unleash political changes that the regime would find destabilizing and it is highly doubtful whether the current regime has either the skill or the guts to go this route.
Moreover, policymakers in China and Vietnam were able to undertake reform under conditions of relatively secure political and military conditions. The existence of a prosperous and democratic South Korea poses enormous ideological challenge for the North — while reformers in China and Vietnam were able to construct tortured rationalizations for why marketization really was what Marx had in mind, reform in North Korea could call into question the regime's whole raison d'etre: why be a second-rate transitional economy when you can join South Korea?
Indeed, it is hard to imagine North Korea undertaking significant reform without a more secure external environment. Although it is possible that the military, probably the most coherent institution in the society, with privileged access to economic assets, could be a prime beneficiary of reform, it may well oppose reform if it believes that this will endanger the nation's military security. This suggests that economic reform is unlikely to occur before some rapprochement with South Korea. And taken together these considerations suggest that North Korea is unlikely to undertake wide-ranging reforms of its own volition.
Collapse and Unification
Alternatively, the regime could stand pat and do nothing. This holds the promise of short- run political stability, though 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 introduction of misguided policies, North Korea's current agricultural problems appear to be the culmination of policies undertaken for two generations.
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.
The most obvious point of comparison in this regard is with the German experience, which has proved more protracted and costly than analysts anticipated at the time of unification. Transfers have been larger and have gone on longer than expected. And even with this largesse, East Germany has gone through a truly wrenching transformation: the immediate effect of unification and the depression that ensued was a collapse in the birth rate and a rise in the mortality rate completely unprecedented in German history (including the inter-war years and the period of military defeat) and comparable only to disasters such as China's Great Leap Forward. And though some of the declines in marriages and births presumably represent time-shifting, and not permanent reduction, the same cannot be said for the increases in mortality rates.
In some ways the Korean case presents a gloomier picture than the German case: North Korea's population is relatively larger (about half as large as South Korea, compared to an East Germany which was one quarter as large as West Germany), and poorer (per capita in North Korea is only around one seventh that of the South, compared to East German incomes around one third to one half those of West Germany); North Korea's economy is probably more distorted than East Germany's was, and South Korea is not as rich as West Germany. On the other hand, demographically the combined Korea is younger than the combined Germany, and North Korea has a younger demographic profile than East Germany, which should facilitate adjustment with lower social expenditures than in the German case.
Still, if South Korea were to absorb North Korea as West Germany absorbed East Germany, the cost of unification, defined as the capital investment needed in North Korea to choke off the incentive for mass migration, would be on the order of $1 trillion — a figure so large as to be improbably attained. As a consequence, even under optimistic scenarios, there will be enormous economic incentives for North Koreans to move South, and the potential for such migration is enormous: assuming that a person carrying some belongings could travel 20 miles a day, 40 percent of the population of North Korea lives within in a 5 day walk of the DMZ, and computer simulations indicate that as much as three-quarters of the population might head south before stability was reattained.
Between the two polar extremes of reform and collapse lies "muddling through". In this regard, the experience of Romania may be instructive. The two countries are similar in population, income, social indicators, and composition of output, and shared central planning and its attendant maladies. Both experienced economic problems in the 1970s which were eventually manifested in difficulties repaying accumulated external debts. One striking difference is that Nicolae Ceausescu made the fateful decision to repay the debt, while Kim Il-Sung simply defaulted on his Western creditors. (The lesson here may be if one has to displease a constituency, foreign bankers are a better choice than the local populace.)
Romanian living standards began falling in the early 1980s as domestic consumption was compressed to free up resources for debt repayment, and conditions worsened in 1985 as the country was hit by severe weather while experiencing an energy crisis. Yet the first mass unrest did not appear until 1987 — six years after the decline in living standards began — and it was not until two years later in 1989, with other socialist regimes beginning to collapse and the economy entering free fall, that the Ceausescu regime toppled. This would suggest caution in drawing too deterministic a link between economic hardship and political failure, a caveat reinforced by the contemporary experiences of countries as diverse as Cuba, Iraq, and (until recently) Zaire. The willingness of foreign powers to support the incumbent regime may also differ greatly in the Romanian and North Korean cases.
Moreover, Ceausescu's removal had more the air of a regime-preserving coup than a genuine revolution. Subsequent Romanian experience suggests that muddling through may indeed be a viable strategy. As far as can be divined, North Korea and Romania exhibited similar rates of economic growth during the mid-1980s. Romania subsequently suffered a sharper contraction in output than North Korea has experienced. However, once the reform process was initiated in 1990, the Romanian economy began to stabilize, and by 1993 was registering positive if unspectacular economic growth.
Similar economic (and possibly even political) developments might occur in North Korea. The economic reform strategy in Romania has been strongly influenced by the political and economic interests of the former Communist Party embodied in (the only recently ousted) Ion Iliescu's Party of Social Democracy (PDSR). The state continues to be the dominant force in the economy. Political power is used to create and allocate rents which are channelled to politically influential groups and individuals either directly or informally through corruption. The process of restructuring has proceeded at a slow pace. It is not difficult to imagine Kim Jong-Il (or his successor) adopting a similar set of policies in response to the exigencies of economic hardship on the one hand, and the requirement of satisfying the regime's political base on the other. In the case of North Korea, these favored constituencies would presumably be the Kim clique, along with the military and possibly the upper echelons of the Korean Workers Party. Externally, the regime could expect tutelage and material support (presumably accompanied by conditionality) from China, an advantage the temporizers in Romania did not have.
North Korea is not Romania and one should not push such analogies too far. Most pertinently, the existence of a prosperous, democratic South Korea would seem to make it much more difficult for Kim Jong-Il (or his successors) to pursue apparatchik capitalism as a long-run development strategy. (Indeed, even in Romania, Illiescu's PDSR was driven from power in the last election.) Nor does ad hoc coping ensure success — some of the "muddlers" among the states of the former Soviet union have experienced output declines of 50-80 percent. Nevertheless, the experience of Romania suggests that muddling through may last for years before a more permanent turn towards reform or chaos, especially if external powers find this solution to be in their interests.
Indeed, it may well be the case that China, Japan, Russia, and arguably even South Korea, would prefer a muddling, domesticated, North Korea to a unified, capitalist, and possibly nuclear armed state on the Korean peninsula. China (and for similar reasons Russia and Japan) may prefer continued economic engagement with South Korea, and would be willing to expend some resources to maintain North Korea as an allied buffer state. Unification along the lines of the German model would complicate the strategic planning of China and Japan, and would further reduce Russian influence in region. At least in the short- to medium-run, one can envision China providing North Korea with aid and technical assistance, South Korea engaging China (and possibly North Korea) economically while protected by the American security umbrella, and concerns of a Sino-Japanese military imbalance submerged by the American counterweight.
In contrast, the US would bear little of the unification's direct costs, and unification would hold forth the promise of eliminating the direct threat posed by North Korea to US troops currently stationed in Northeast Asia, as well as the prospect of ending North Korean proliferation of weapons of mass destruction. While there may be some benefit to the US in playing the regional security role outlined above, long-run US interests are surely better served by unification, and in this regard the US may be unique.
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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