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Why Sanctions Can Hurt North Korea

Interviewee: Marcus Noland, Deputy Director and Senior Fellow, Peterson Institute for International Economics
Interviewer: Jayshree Bajoria, Staff Writer, CFR.org
August 4, 2010

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The United States will soon introduce new sanctions against North Korea, aimed at strengthening existing international sanctions to prevent proliferation and illicit activities. The sanctions will also target individuals and financial institutions that help fund North Korea's nuclear and missile programs by publicly naming them, isolating them from the international financial system. Additionally, they seek to halt the import of luxury goods, but these are less likely than financial sanctions to hurt the Pyongyang regime, says Marcus Noland, deputy director of the Washington-based Peterson Institute for International Economics and a non-resident senior fellow at the East-West Center. This is because China--North Korea's largest trade partner and central to the efficacy of any sanctions regime--is more likely to cooperate on financial sanctions, as it has in the past, than on traditional trade sanctions, Noland says. He notes the North Korean regime is likely to continue to expand its control over commercial activity in the country and, given the political uncertainties emerging from a possible regime succession, that major economic reforms are unlikely.

Do you think these new sanctions--especially the financial sanctions planned by the United States--will prove effective?

These are the latest sanctions building on other sanctions passed by the UN Security Council in response to earlier North Korean nuclear tests. The sanctions in the financial sector have an interesting history. There were people within the Bush administration who believed financial sanctions would be effective against North Korea because the North Koreans have very thin and fragile financial links to the rest of the world. A large share of their international financial transactions [went] through a limited number of financial institutions.

The Bush administration launched an action against a small bank in Macao called Banco Delta Asia (BDA), which was believed to be facilitating missile and nuclear activities as well as essentially money laundering for other criminal or illegal activities--such as currency counterfeiting, drug trafficking, and smuggling. When the United States announced the sanctions against Banco Delta Asia, it had a ripple effect that even the policy's proponents did not anticipate. Other financial institutions were afraid of becoming ensnared in this action, so as a consequence, they began severing their ties with BDA and with North Korea, essentially for reputational reasons.

China--which had been essentially unwilling to implement the sanctions on luxury goods--cooperated with the sanctions against BDA. The reason [for that cooperation] is it was not the Chinese foreign ministry or the customs administration, but rather the Chinese ministry of finance and central bank implementing these sanctions. Their concern was that they had much more at stake with respect to Chinese banks' [access] to the lucrative U.S. market than they ever would have dealing with some small bank in Macao or possible financial transactions in North Korea. The lessons from this seem to be that financial sanctions--that play on banks' desire to maintain a good reputation, stay within the increasingly stringent international rules on money laundering, and maintain a good relationship with the United States--play to our strengths in terms of the U.S. financial system and the increasingly well-defined and articulated set of international norms and agreements on money laundering. [Financial sanctions] will be more successful than the traditional trade sanctions that are oftentimes implemented less than rigorously.

By trade sanctions, do you mean sanctions such as those on luxury goods?

Yes. The luxury goods sanctions come out of UN Security Council Resolution 1718 that was originally passed in 2006.The problem is that they allowed individual countries to administer their own sanctions, and there was no common definition of what a luxury good was. China, which is North Korea's largest trade partner, never published the sanctions list. Moreover, if you take the lists published by other countries and examine trade in those product categories between China and North Korea, it appears that China did not implement any sanctions at all. So China will notionally go along with something in the Security Council, but do nothing to actually implement, versus the financial sanctions, in which the Chinese, however reluctantly, got very much involved. You can see why the administration is putting more emphasis these days on financial sanctions than traditional trade sanctions.

What is the scale of North Korea's illicit activities and their share of the country's economy?

We're likely to see continuing poor economic performance, continuing food insecurity for significant parts of the population, and probably a continuation of this relatively anti-reform stance that has been evident since 2004-2005.

We don't have a good idea of how big the official economy is, much less how big the illicit economy is. The share of the North Korean economy that is effectively not state-sanctioned, that is outside of the official economy, is quite large internally. Over the last ten years or so, a lot of North Korean economic policy is [geared toward trying] to come to terms with the enormous expansion of this unofficial economy. The recent trends have been quite negative in the sense that the state has increasingly tried to repress that economy.

I've tried to estimate myself how much revenue the North Koreans may get from illicit arms trade, from currency counterfeiting, from smuggling of various goods including cigarettes, and so on. At one time, those activities may have accounted for something on the order of 40 percent of total export revenues, but those numbers have come down in large part due to increased interdiction activities. Today, the share of export revenue coming from illicit or criminal activities is probably less than 20 percent.

The government implemented currency reform last year, aimed at eroding private markets and consolidating control over commercial activity. The policy was revoked earlier this year, but how has it affected the private markets?

The November 2009 currency reform was the last straw in a series of actions that the government had been taking from around 2004-2005 to increasingly criminalize unofficial economic activity and to increase the penalties associated with it. With the currency reform, [it tried] to effectively wipe out the working capital of the class of entrepreneurs and traders that had developed over the previous ten to fifteen years.

The reform was poorly designed and terribly implemented, and it created chaos. In the short run, it disrupted lives of many North Koreans and contributed to a huge surge in inflation, which remains a problem. But in the end, the state simply did not have the capacity to operate the economy without these unofficial markets and was forced to retreat and to issue an unprecedented apology. At least at the retail level, for things like household goods, the markets appear to be back and they appear to be operating with the same degree of intensity that they had in the fall of 2009.

How much international food aid really reaches the people in North Korea and how much of it is appropriated by the elite?

It's been a constant tug of war between the North Koreans and the aid agencies to improve the degree of monitoring, and, frankly speaking, it's never been particularly good. When you estimate how much aid is diverted, it depends on what your definition of diversion is. If the aid was supposed to go to its intended recipients gratis--food to be delivered to a pregnant woman or a widow or an orphan for free--then the share actually being delivered on those terms was probably quite small, on the order of 10 percent. If you adopt a more relaxed view of the rules, so that it got to the school child or the guy in the hospital, but they had to pay for it, then the share diverted was not that big--maybe half.

The food situation in North Korea remains difficult. Recent actions [such as currency reform] have contributed to a worsening of that situation. [In past interviews, a large number of refugees from North Korea] expressed that they were not recipients, that the food went to the military, and they are profoundly embittered by that experience.

Are there steps international aid agencies take knowing this fact?

In the most recent period in which the United States was providing any significant aid to North Korea, agencies managed to get some of the private NGOs to be able to use Korean speakers, for example, which had not been the case before. Apart from negotiating the specifics, there are some broader things we can do that would increase the likelihood that aid gets to the intended recipients. One of these is one the Bush administration did, which was to insist that a certain percentage--I believe it was 75 percent of our donations to [the UN's World Food Program]--had to go into the ports in the Rust Belt of the far northeast, which is the worst-affected area. So if you think that food aid is going to be diverted, at least send it to the worst-affected part of the country. The intended recipients may not get it for free, but it will increase the supply of food available in this very hard-hit area.

A second thing that the United States has done a much less good job of than other donors is to donate food in forms that are not preferred for elite consumption. Rice is the staple starch of the elite; other grains such as barley or millet are less preferred. So basically sending barley and millet into the Rust Belt port cities of the northeast would, regardless of the specifics one can negotiate about monitoring, more likely put food into the bellies of food-insecure families.

[W]e find that people involved in the market not only have more negative views of the regime than their counterparts, they are much more likely to actually communicate these views to their peers.

Last year you wrote: "Leadership has reverted to a more control-oriented (PDF), even Stalinist, approach to economic policy." Do you think the government will continue to tighten its grip on the economy?

This is a very insecure regime, and it is insecure about the market and what the market represents. The market represents an alternative pathway to wealth and prestige and potentially political power outside of the government's control. In some of the survey work I've done with the refugees, we find that people involved in the market not only have more negative views of the regime than their counterparts, they are much more likely to actually communicate these views to their peers. So the market may be emerging as a kind of semi-autonomous zone of social communication and, potentially, political organizing. In those terms, the state is right to fear the market.

I expect that the state will try and continue to bring greater shares of economic activities under its direct control. The problem is the state simply doesn't have the capacity to operate the economy or to put food on the table. So, as we saw between November 2009 and the end of February 2010, [when] the government implemented a policy that was expressly and quite explicitly aimed at destroying the market, it was unable to make that policy stick and was forced to retreat.

If you add in uncertainties about Kim Jong-Il's health and political transition, it's unlikely we're going to see any kind of major reform effort. Instead we're likely to see, essentially, stagnation. There's probably not a lot of stomach among the elites to try another major anti-market reform like they tried at the end of last year, which ended so badly, but I certainly don't see them embracing reform in any way. We're likely to see continuing poor economic performance, continuing food insecurity for significant parts of the population, and probably a continuation of this relatively anti-reform stance that has been evident since 2004-2005. They managed to hold on to power even though they are delivering policies and outcomes that are abysmal for significant parts of the population. That's really the tragedy of North Korea: that this regime is so unaccountable it has a virtually limitless capacity for inflicting misery on its own population.

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