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North Korea's Capitalist Experiment

Author: Esther Pan
June 8, 2006
This publication is now archived.

Introduction

The North Korean economy, after more than five decades of tight state control, is falling apart. The government spends half the nation's gross national product (GNP) on the military, and the command economy is failing to produce enough food to feed the country's population. A decades-long economic crisis and devastating famine in the 1990s sparked small-scale trade and barter among desperate North Koreans, and the government has formally approved some of this activity. The government has also lifted some restrictions on other types of trade. But economic modernization on the model of China or Vietnam holds high risks for the authoritarian regime of Kim Jung-Il: the more open the economy becomes, the more potential it has to threaten his hold on power.

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What is the North Korean government’s role in the economy?

North Korea is far from a free market. The government sets all wages, prices, and production levels, and all products are manufactured by state-owned industries. Nearly all property is owned by the state, and all imports and exports are controlled by the government. Labor unions are allowed, but they are also controlled by the government. Free enterprise—outside of a few state-approved marketplaces and special economic zones—is not permitted.

How is North Korea experimenting with capitalism?

A series of moves by Communist leader Kim Jung-Il over the last several years indicates a desire to introduce aspects of capitalism into the economy. The government has lifted some restrictions on investment, reduced some wage restrictions and government subsidies, made internal travel easier, created small, semi-private markets and shops, phased out a decades-old food ration system, and allowed farmers to own small gardens and sell their products at local markets. "The principal signs of early market reforms are the collapse of the public rationing system and its replacement by monetization of goods and services," says Daniel Sneider, associate director for research at Stanford's Asia-Pacific Research Center. Andrei Lankov, senior lecturer at the Australian National University, writes for Policy Forum Online, "What we have seen in North Korea over the past ten years can be best described as the collapse of what used to be rigid Stalinism from below... Now the government has neither money nor support nor the political will to revive the Stalinist-style central economy."

Why is North Korea flirting with capitalism?

The communist system cannot feed the country's 23 million people. The United Nations food program fed more than 6.5 million North Koreans in 2004—over a quarter of the population—and provided some 484,000 tons of food worth $171 million. Since 1995, the U.N. has poured $1.5 billion worth of food into North Korea, helping to prevent mass starvation. "Outside donors are still responsible for probably a third or more of North Korea's daily food consumption," Sneider says.

"The current system is an inherent failure," says Daniel Poneman, senior fellow at the Forum for International Policy and a former National Security Council official. Since 1970, when North and South Korea had roughly equivalent economies, South Korea has soared ahead. Seoul had a gross domestic product (GDP) of $811 billion in 2005. North Korea's GDP for 2005 is estimated by the U.S. Central Intelligence Agency at $40 billion, a figure derived from purchasing power parity calculations, which make it equivalent to U.S. costs for purchasing goods and services.

How extensive is the market system in North Korea?

The collapse of the Soviet Union removed one of Pyongyang's main benefactors, leading to the failure of the formal, state-controlled economy in the 1990s: from 1991 to 1999, the North Korean GNP halved, and some 600,000 people starved to death during a devastating famine in 1996. In response, there was an explosion in the informal economy. Small private traders, many of them women, flooded the informal markets with goods for barter, food stalls, and even prostitution services as their husbands waited for work in North Korea's idle factories. Koreans with family connections to Japan or China used hard currency transfers from abroad in a variety of trading ventures and helped create a vibrant shadow economy. Pyongyang's state-sanctioned Tonggil Market, opened in 2003, has more than 150 stalls offering everything from Japanese TVs to Korean dog meat. "It's fairly limited, but—especially compared to the past—there are now remarkable markets that create the semblance of a free market system," Sneider says.

However, Sneider says, the North Korean economy is still divided into three tiers: the formal economy, controlled by the state; the military/industrial economy, dedicated to producing goods and services for the country's enormous army; and a third "court" economy, which procures special goods and services for the three million or so political elites.

How effective are the economic reforms?

They're mostly skin-deep, some experts say. "It seems to follow a cyclical pattern, where from time to time—whether due to internal pressures or from watching the Chinese—you see the North Korea [government] experimenting with economic reforms," Poneman says. Sneider agrees, saying that after introducing some reforms in the summer of 2003, Kim tried to restrict many of them early this year. "Every time people get out from under a rock, they get quashed again," Poneman says. North Korea is still ranked dead last out of 157 countries by The Heritage Foundation's 2006 Index of Economic Freedom, which looks at measures like property rights, regulation, and government intervention.

"It's fairly limited, but—especially compared to the past—there are now remarkable markets that create the semblance of a free market system," Sneider says.

Why is the country reluctant to move faster on reforms?

Many experts say Kim Jung-Il is acutely aware that reforming the economy could threaten his grip on power. "He recognizes that there is trouble for the regime in failing to meet the needs of its people," Poneman says. "At the same time, opening the economy is a huge risk for political instability." Donald Oberdorfer, a former longtime Washington Post reporter and current journalist-in-residence at SAIS, quotes Kim in his book The Two Koreas: A Contemporary History. In 1984, Kim admitted his country was behind the West, but said he couldn't open it up economically because of its strategic position. According to Oberdorfer, Kim said that opening North Korea would be "naturally tantamount to disarmament" unless it happened after unification with South Korea.

What are the country’s main products?

The nation's economy is evenly divided between agriculture, industry, and services. Its agricultural products include rice, corn, potatoes, soybeans, cattle, pigs, and eggs. Its industrial production includes electric power, chemicals, coal and iron mining, metallurgy, textiles, and fishery products. North Korea's estimated 2004 trade volume —$2.85 billion—is the country's highest level since 1991, before its decades-long economic crisis. The North Korean government is also seeking hard currency, establishing a series of legitimate and less-than legitimate businesses across Asia to earn it. Pyongyang operatives run a 160-room hotel—complete with sauna and nightclub—as well as an Internet service provider and software company in the northern Chinese city of Shenyang. Government agents also sell a North Korean version of Viagra on the Chinese market and operate Korean restaurants in dozens of cities from Siam Reap, Cambodia to Vladivostok, Russia. And within North Korea, "there's a cross-border flow of goods and services from China, especially of Chinese consumer goods," Sneider says.

Pyongyang also reportedly has a large and profitable stake in the black market economy. It is believed to earn hundreds of millions of dollars a year from selling missiles, drugs, and counterfeit items including cigarettes, over-the-counter drugs, and currency. The Economist estimates North Korea earns some $100 million per year from counterfeiting money. The United States estimates that some $45 million to $60 million in counterfeit U.S. dollars created by North Korea—mostly in $100 denominations—are in circulation today. But even this is not enough to keep a country going. "Compared to the economy of a nation, the counterfeiting is peanuts," Oberdorfer says. Sneider says the criminal income goes to the highest officials, anyway. "The illicit activity is designed to provide hard currency to the elite," he says.

Which countries are North Korea’s major trading partners?

China, South Korea, Japan, Thailand, India, and Russia. China accounts for slightly more than a third of North Korea's total foreign trade, South Korea for slightly less than a third, and Japan, 16 percent. South Korea's investments are driven by its policy of economic engagement with the North. "Seoul is clearly influenced by the intention to stabilize North Korea," Sneider says.

Thailand has also stepped up as a major trading partner; its trade with North Korea doubled between 2002 and 2005. Some experts say Thailand—which is a net importer of fuel and exporter of fertilizer—is engaging in off-the-books barter deals with North Korea, which trades cheap fertilizer, some acquired as aid from South Korea, for Thai oil.

Is China encouraging the North Koreans to reform?

Many experts say yes. The two countries exchanged some $2 billion in bilateral trade last year. China is also Pyongyang's largest benefactor, providing what some experts estimate is as much as 70 percent of North Korea's food and energy needs each year. Kim regularly seeks Chinese guidance and encouragement, visiting the mainland several times each year to tour special economic zones and meet with the leadership. "China is clearly the paradigm for North Korea right now," Sneider says. "We've been watching the senior North Korean leadership traipsing in and out of China on a regular basis." But China's role is not all benign: U.S. officials accuse Beijing of being complicit in the counterfeiting by allowing banks in Macau to accept counterfeit U.S. dollars from North Korea and put them into international circulation.

How long can North Korea’s economic system last?

Indefinitely, some experts say. Pyongyang is hanging on, sustained by investments and aid from China and South Korea; in addition, last year there was a good harvest. "They're not doing well, but they're not collapsing, either," Oberdorfer says. But other experts say the end is inevitable. "The system cannot meet the political, spiritual, or economic needs of the people. At one point, at some uncertain date, it will fail," Poneman says. Kim's regime, he says, "is like a kid's loose tooth. It's just hanging there, and will fall either with the next bite of the apple or in a couple of days."

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