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Why North Korea Will Muddle Through

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APPARATCHIK CAPITALISM

After consulting with their superiors, the guards at Rajin harbor allowed us to exit. Apparently two Americans on a morning jog were not thought to pose a grave threat to national security. As we ran up the hill overlooking the harbor, I noticed a small military installation. On our way down I watched two soldiers stealthily working their way through the dilapidated structures, eventually reaching an isolated corner of the base, far from their comrades. Like two characters from a B movie, the soldiers looked left and right before kneeling. One removed his knapsack and placed it between them in the dirt. He opened it and withdrew two . . .

Bananas. At that moment his colleague glanced upward and spied us on the ridge above. The soldiers leaped to their feet and turned their bodies to shield the bananas from our view. The presumably banana-laden knapsack was stashed at the base of a wall, and, checking that they otherwise had not been observed, the soldiers headed back toward the center of the base.

One can easily conjure up myriad interpretations of a surreptitious trade in bananas at an isolated North Korean military installation in the autumn of 1996. But any consideration of the state of the North Korean economy presents policymakers with two fundamental problems. First, there is an acute lack of information, a vast gulf between fragmentary anecdotal evidence on the one hand and highly uncertain estimates of economic aggregates on the other. Second, there is really no reliable theory linking economic distress or deprivation to political change. Even a reasonably persuasive analysis of the economy does not necessarily provide much guidance for political decision-making, much less for assessing the stability of the regime.

The North Korean economy is in bad shape, and a famine of unknown magnitude is under way in parts of the country, but it appears that minimum survival requirements can be maintained with little or no external support. Kim Jong Il's regime appears to have been largely successful in fusing juche (self-reliance) ideology to Korean nationalism, and unlike the countries of Central Europe, North Korea has no institutions capable of channeling mass discontent into effective political action.

Rather, in light of its domestic politics and geopolitical position, North Korea is likely to muddle through, along the lines of Romania in the 1980s, with support from China and possibly Japan and South Korea, which would like to avoid its collapse. Ironically, the reduction of North Korea to a dependency would represent the inversion of the ideology of its founder, Kim Il Sung, and a restoration of the status quo of much of the last millennium.

PROFITS FROM PACHINKO

The North Korean economy is organized like other centrally planned economies. Its distinguishing feature has been the extremes to which central planning has been taken under juche ideology. As a result, the economy is shrinking, but the margin of error for estimates of almost all economic aggregates of interest is on the order of hundreds of millions of dollars.

Foreign observers, including those from other socialist states, concluded that by the late 1970s the North Korean economy was experiencing serious problems when its ability to grow "extensively" through the mobilization of resources was reaching its limits. A series of macroeconomic shocks in the late 1980s -- including the withdrawal of Soviet aid, economic disengagement with its former socialist allies in the Eastern bloc, and bad weather that worsened the crisis in agriculture -- exacerbated those difficulties.

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 cited in public discussions are invariably the official South Korean estimates produced by the Bank of Korea. Those figures are apparently derived by taking classified data generated by South Korean intelligence agencies on physical output and then applying South Korean prices and value-added coefficients to indexes 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. Furthermore, the final growth rate figure is reportedly subject to interagency bargaining within the South Korean government.

With these caveats in mind, Bank of Korea data indicate that the North Korean economy shrank by roughly 30 percent from 1991 to 1996, certainly a significant amount, but not unprecedented for a transitional economy. However, the estimated fall in national income may well overstate the reduction in household welfare, since it is unlikely that such services as housing and education, which are undercounted in the socialist accounting system and are not amenable to physical measurement, have declined as much as manufactured output. These estimates of national income are therefore not necessarily indexes 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 and transportation costs. Three conclusions stand out: North Korea runs large and chronic trade deficits, its trade is concentrated with a few partners, and, most telling, 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 deficit with the rest of the world.

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 is probably remittances, principally from ethnic Koreans residing in Japan. Remittances have been variously estimated as the amount of currency that visitors from Japan could legally carry on their person, as profits from the pachinko industry, a form of gambling popular in Japan in which ethnic Koreans play an important role, and as the portion of the balance of payments that cannot be explained in other ways. Not surprisingly, given these varied approaches to tallying remittances, estimates of the annual total vary enormously, from the low millions to $2 billion, typically running in the hundreds of millions. The figure is probably less than $100 million, an assessment that Nicholas Eberstadt shares in his article in the May 1996 issue of Asian Survey.

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 southern and coastal provinces, in the far northeast of the country. But such tinkering, however politically contentious within North Korea, is unlikely to reverse the decline of the economy.

WITH A LITTLE HELP FROM CHINA

An alternative approach would be to ask what level of external assistance would be required to maintain the North Korean population at a subsistence level. With help from the Chinese or others, North Korea can avoid widespread famine. If catastrophic famine does occur, it will be due to political decisions made in Pyongyang, not shortages of food.

The government's attempts at food self-sufficiency were wrongheaded and unsustainable. The bureaucratic collectivist nature of North Korean agriculture is decidedly inefficient and has involved the inappropriate cultivation of land and application of chemical fertilizers. The denudation of hillsides has contributed to soil erosion and worsened the flooding that has recently plagued the country, wreaking environmental damage that 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 North Korean food situation, and the consensus is that North Korea is experiencing an annual grain shortfall of roughly two million tons. That shortfall is partly due to bad weather and flooding, but its roots are structural, and the provision of food aid is only a short-run palliative in the absence of fundamental economic reforms.

As with agriculture, a lack of information clouds the energy picture. North Korea relies on imported oil for fuel and fertilizer. Foreign exchange shortages and the reduction in subsidized supplies from Russia and China have squeezed oil imports, although there have been recent reports of arms-for-oil deals with countries in the Middle East. The electrical system relies primarily on coal and hydropower and is hampered by difficulties extracting increasingly inaccessible and low-quality domestic coal reserves. The power grid -- largely underground for security reasons -- is said to suffer from extraordinarily large transmission losses. The 1994 U.S.-North Korea Agreed Framework, which provides for fuel oil during the construction of light-water nuclear reactors and the rehabilitation of the electrical grid, will address some of these energy problems. Nevertheless, North Korea will need additional energy if it is to retain its estimated 1991 level of electrical consumption.

If these assessments of the agricultural and energy picture are correct and the Agreed Framework is implemented, the cost of purchasing shortfalls would not be very large, on the order of hundreds of millions of dollars. While anecdotal evidence suggests that both the central planning mechanism and the public food distribution system are fraying under the stresses of the ongoing crisis, these indications should not be overstated. The central government continues to act with a relatively high degree of coherence as well as the population's acquiescence. Starvation may be relatively localized and falling disproportionately on certain socioeconomic groups, particularly rural nonfarm workers, and could reflect conscious decision-making by the political elite.

Indeed, the sums of money required for the survival of the population appear to be within the margin of error of what is known about the North Korean economy. It may well be that North Korea can subsist with no or relatively modest external assistance. In the short run, China, Japan, or South Korea could keep North Korea afloat. Both Japan and China appear to have surplus government grain stocks that could make up the North Korean shortfall at minimal expense. Food is already flowing from China into North Korea. Some represents grant aid, some represents state trading on unknown terms, and the remainder is commercial exchange. North Korea has also had some success procuring food through barter.

However, it should be reiterated that this analysis is based on highly fragmentary information. A famine similar to that which took place in China during the Great Leap Forward may be unfolding in North Korea, and some U.S. intelligence officials already put deaths from starvation in the tens of thousands. Some of the worst (and least understood) famines in this century took place in socialist countries where governments were 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. Given the country's terrain and the instruments of social control at its disposal, the current regime plausibly could prevent the mass population movements observed during famines in Africa and the Indian subcontinent. If a widespread famine were to occur in North Korea, the killers would be cholera and miscarriages, not kwashiorkor, and outside observers might not learn its full magnitude until a decade hence. If such a famine materializes, its roots will be in political decisions made in Pyongyang, not material resource constraints.

BETWEEN SHOCK THERAPY AND THE PACIFIC WAY

The North Korean leadership faces three broad options: it can adopt fundamental economic reforms in an attempt to reverse the economic decline, recognizing that reform may unleash forces that threaten the character of the political regime; it can stand pat and try to ride out the current crisis, risking collapse; or it can muddle through, making ad hoc adjustments as circumstances dictate. In the end, North Korea will most likely follow Romania in a form of apparatchik capitalism in which growth will follow the initial decline in output that results from the relaxation of central control.

REFORM

The reform option offers potentially enormous payoffs: North Korea could probably increase its output by more than half its pre- decline level under favorable conditions. However, the reform path would not be easy. A variety of considerations suggest that North Korea is unlikely to undertake wide-ranging reforms of its own volition.

Crudely put, the conventional wisdom has it that there are two ways to reform a centrally planned economy -- the successful, Asian, gradual approach, and the unsuccessful, European, "big bang" approach. According to this view, North Korea is an Asian country, ergo it will adopt the successful, gradual approach and grow ten percent a year upon the commencement of reform. But gradual reform of a centrally planned economy requires resources to cushion adjustment in the heavy manufacturing sector. Auspicious initial conditions may have benefited successful agrarian countries like China and Vietnam, where the state-owned heavy industry sector was relatively small. Those countries were able to initiate reforms in the agricultural sector, where price liberalization spurred rapid efficiency gains, freeing up low-productivity surplus agricultural labor to be absorbed by the emerging non-state or semi-private light manufacturing and service sectors. In theory, these new, expanding sectors could be taxed to provide state revenues to cushion the transition in the heavy industry sector (though in fact few such transfers have occurred). But the initial conditions in China and Vietnam were unique, and such a path does not appear to be viable for more industrialized centrally planned economies. Piecemeal reforms have not been successful in those economies when they faced economic crises. The more interdependent nature of industrial enterprises means that a host of reforms -- macroeconomic stabilization, rational pricing, liberalization of international trade and introduction of a convertible currency, and overhaul of the tax system, bankruptcy laws, and the social safety net -- are a seamless web and must be carried out simultaneously to be economically successful and politically sustainable. Even in China and Vietnam, adjustment in the old state-owned heavy industry sector has proved difficult.

North Korea also faces the enormous ideological challenge posed by a prosperous, democratic South Korea. Once North Korea begins reforms, the state's raison d'àtre will be called into question. In Vietnam and China, Marxist ideologues were able to manufacture tortured rationalizations for market-oriented reforms. Maintaining such a facade is likely to be much more difficult for the North Koreans. The scale of change that will accompany significant liberalization is also likely to be tremendous. North Korea is probably the most distorted economy in the world. Liberalization would mean huge changes in the composition of output and employment. International trade would become far more important, and most of that trade would be conducted with South Korea and Japan, two countries with which North Korea maintains problematic political relations.

Finally, it is hard to imagine North Korea undertaking significant reform without a more secure external environment. Although the military -- probably the most coherent institution in the society, with privileged access to economic assets -- could be a prime beneficiary of change, it may well oppose reforms that it believes endanger the nation's security. Economic reform is therefore unlikely to occur before some rapprochement with South Korea.

COLLAPSE AND UNIFICATION

The regime's second option is to stand firm and do nothing. Although this path promises short-run political stability, if current trends continue, economic distress will eventually put a significant share of the population in peril, if it is not already. Moreover, North Korea differs in some significant ways from other socialist regimes that were able to survive self-inflicted famines earlier in this century. First, the Kim government is not a revolutionary regime, but the dynastic continuation of a leadership that has held power for nearly 50 years. Surely neither this government nor the governed have the same capacity for enduring hardship that would accompany a period of revolutionary fervor. Second, North Korea is a relatively industrialized, urban society, which curtails 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 straightforwardly by their removal. North Korea's current agricultural problems appear to be less a function of bad weather or the sudden introduction of misguided policies than the culmination of two generations of bad policy.

Even if the North Korean regime appeared to be teetering on the verge of collapse, the costs of unification would be so great that the South would try to prevent it. The most obvious point of comparison is German unification, which has involved more protracted and costly transfers than analysts anticipated at the time of unification. Even with that largess, East Germany has gone through a wrenching transformation: unification and the depression that ensued brought a collapse in the birth rate unprecedented in German history, including the interwar years and the period of military defeat, and a dramatic rise in the mortality rate. Although some of the declines in marriages and births presumably represent delay, not permanent reduction, the same cannot be said for the increase in mortality rates.

In some ways Korea presents a gloomier picture than Germany. North Korea's population is about half as large as South Korea's, while East Germany's was one-quarter the size of West Germany's. North Korea's per capita income is only around one-seventh that of the South; East German incomes were 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, the combined Korean population is younger than the combined German population, and the North Korean population is younger than the East German population, which should facilitate adjustment with lower social expenditures.

Still, if South Korea were to absorb North Korea, 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 unfeasible, even if spread over a time period of 10 to 25 years. Even under optimistic scenarios, North Koreans will have powerful incentives to move to the 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 a five-day walk of the demilitarized zone. The level of migration will depend on whether political unification accompanies economic integration.

South Korea can discourage migration in two ways: by maintaining the demilitarized zone as a method of controlling population influx and by encouraging capital investment in the North to lessen the incentives to emigrate. While the former option is fraught with political difficulties -- elected officials might hesitate before turning machine guns on a third of the electorate -- the alternative has important implications for South Korean domestic policy. South Korean policy will strive to minimize the burden imposed on South Korean taxpayers by financing the economic reconstruction of the North. This task will require policies to encourage foreign capital, specifically foreign private capital, to flow into North and South Korea. Historically, South Korea has been inhospitable to both foreign direct and portfolio investment. However, in this case liberalization not only would bring its traditional benefits but would facilitate private capital inflows to unified Korea, or alternatively substitute in South Korea for capital invested in the North prior to political unification. South Korea needs to continue to improve its foreign direct investment regime and encourage the development of efficient domestic bond markets that are capable of mobilizing large sums of capital when the need arises. The capacity to mobilize global private capital quickly will be important if economic integration is accompanied by political integration and South Korean laws and institutions are extended throughout unified Korea.

Some international public capital should also be available. The World Bank, for example, maintains a special program for peace and sustainable development in the occupied territories in the Middle East. A similar program, scaled to the much larger North Korean population, would imply World Bank investments of $4.4 billion annually. Furthermore, North Korea and Japan have yet to settle post-colonial claims. Taking the 1965 settlement between South Korea and Japan as a base and adjusting for changes in the price level, population growth, and accrued interest, the Japanese payment would be about $12 billion. These amounts are small, however, relative to the $1 trillion that would be required.

MUDDLING THROUGH

Between the extremes of reform and collapse lies muddling through. Here the experience of Romania may be instructive. Romania and North Korea are similar in population, per capita income, social indicators, and sectoral distribution of labor, as well as central planning and its attendant maladies. Both combined rigid internal orthodoxy with symbolic independence in external affairs. Both experimented with socialism in one family; Nicolae Ceausescu's inspiration for the development of a cult of personality is said to have been a 1971 visit to Pyongyang.

Romania and North Korea both experienced economic problems in the 1970s as their central planning approaches began to fail. Although they were temporarily papered over by an inflow of recycled petrodollars, the underlying problems eventually manifested themselves in difficulties repaying accumulated external debts. One striking difference is that Ceausescu made the fateful decision to repay the debt, while Kim Il Sung defaulted on his Western creditors.

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, when the country was hit by severe weather during an energy crisis. Romanians were forced to live and work in freezing conditions, and draft animals were substituted for agricultural machinery. Nevertheless, mass unrest did not appear until 1987 -- six years after living standards began to decline -- and it was not until 1989, with other socialist regimes collapsing and the economy going into free fall, that the Ceausescu regime toppled. That sequence of events suggests 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. With the willingness of foreign powers to support North Korea's incumbent regime, that link may prove even more tenuous.

In Romania, Ceausescu's removal had more the air of a regime- preserving coup than a genuine revolution. Subsequent experience suggests that muddling through may indeed be a viable strategy. Both Romania and North Korea grew at a 2.5 percent rate in 1985. Romania subsequently suffered a sharper contraction in output than North Korea. However, once the reform process was initiated in 1990, the Romanian economy began to stabilize, and registered positive if unspectacular growth by 1993.

Similar economic and even political developments might occur in North Korea. The political and economic interests of the former Communist Party embodied in Ion Iliescu's recently ousted Social Democratic Party of Romania have strongly influenced that country's economic reform strategy. The state remains the dominant force in the economy. Political power is used to create and allocate excess profits that are channeled to politically influential groups and individuals, either openly or through corruption. Restructuring has proceeded at a slow pace. Kim Jong Il or his successor could well adopt similar policies to deal with economic hardship while satisfying the regime's political base. These favored constituencies would presumably be the Kim clique, the military, and possibly the upper echelons of the Korean Workers' Party. The regime could expect tutelage and material support from China, an advantage the temporizers in Romania did not have.

THE POWERS THAT BE

China, Japan, Russia, and arguably even South Korea may well prefer a muddling, domesticated North Korea to a capitalist and possibly nuclear-armed unified state on the Korean peninsula. China, Russia, and Japan may prefer continued economic engagement with South Korea and be willing to expend some resources to maintain North Korea as an allied buffer state. China has begun to pick up some of the slack left by Russia, North Korea's former patron, though the extent to which Chinese exports of food and other essentials are on concessional terms is unclear. Nor is it known what kind of economic or foreign policy conditions are attached to these exports. Beijing's dual goals of continued support for the North and enhanced economic engagement with the South is a delicate diplomatic conundrum, as was starkly apparent during the February defection of high-ranking North Korean official Hwang Jang Yop in the Chinese capital. Hwang's defection has made North Korea more suspicious of China's intentions and complicates the potentially constructive role China could play vis-‡-vis the North. Yet North Korea's diplomatic isolation is so profound that even a China walking a diplomatic tightrope between the two Koreas is still likely to be the North's most effective patron.

Unification along the lines of the German model would complicate strategic planning for China and Japan and further reduce Russian influence in the region. One can envision China giving North Korea aid and technical assistance, South Korea engaging China and possibly North Korea economically while protected by the American security umbrella, and concerns over a Sino-Japanese military imbalance submerged by the American counterweight.

The United States would bear little of unification's direct costs, and unification would hold the promise of eliminating the direct threat posed by North Korea to American troops stationed in northeast Asia and the prospect of ending North Korean proliferation of weapons of mass destruction. While there may be some benefit to the United States in playing the security role outlined above, long-run U.S. interests are surely better served by unification. In this regard the United States may be unique.

North Korea is not Romania, and such analogies should not be taken too far. A prosperous, democratic South Korea will make it much more difficult for Kim Jong Il to pursue apparatchik capitalism as a development strategy. Even in Romania, Iliescu's party was driven from power last November. Nor do ad hoc measures ensure success -- some of the muddlers among the states of the former Soviet Union have experienced declines in output of 50 to 80 percent. Nevertheless, the experience of Romania suggests that North Korea may muddle through for years before turning toward reform or chaos, especially if external powers find this solution to be in their interests.

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