by Stephan Haggard, University of California, San Diego
and Marcus Noland, Peterson Institute for International Economics
Op-ed in Newsweek International
September 17, 2007
© Newsweek International
North Korean leader Kim Jong Il once kidnapped a South Korean director and his wife when the local talent couldn’t recreate Kim’s grand visions on the silver screen. Is the Great Director now conjuring up a blockbuster tale, ending in a genuine breakthrough in the international confrontation over North Korea’s nuclear weapons program?
It is starting to look that way. The saga goes back to the deal US and North Korean negotiators reached in 1994, shutting down North Korea’s nuclear facilities. Tempers flared in 2002 when the United States accused North Korea of maintaining a secret weapons program. Pyongyang responded by throwing out UN nuclear inspectors, test firing missiles and, in October 2006, testing a nuclear device. The United Nations responded with sanctions. Yet only four months later the North Koreans were back at the bargaining table, agreeing to the return of the nuclear inspectors and the closure of acknowledged nuclear facilities. Last week at the APEC summit in Australia, they invited inspectors from the United States, China, and Russia to begin the nuclear disablement process.
We think we know why North Korea is softening, or at least appears to be. We’ve been working on an in-depth profile of the North Korean economy, and it is in serious trouble. The North Korean economy had been in weak but steady recovery since 1999, growing about 15 percent over the next six years despite its isolation and increasing backwardness. Then came a new setback. Last year the national income contracted by 1.1 percent, according to the South Korean government. Our research suggests the main reason for the downturn was that US-led sanctions hit harder than most people realize. Now more than ever, North Korea needs the financial benefits of a nuclear deal to survive.
The sanctions struck a feeble economy from many sides. The United States led actions to shut down North Korea’s missile trade, and put the squeeze on its illicit smuggling and counterfeiting revenue. The black market rate on North Korea's currency plummeted after a small bank in Macau, central to the North’s money laundering activities, was shut down. Japan effectively cut off a heavy flow of remittances to Pyongyang from North Koreans in Japan. We estimate that together with legal arms sales, revenue from contraband—including the production and trafficking of drugs, counterfeit cigarettes, smuggling of liquor, and endangered species parts, to name a few—may have accounted for as much as half of North Korea’s exports in the late 1990s but has fallen to roughly 15 percent in recent years due to sanctions. In the meantime, aid now finances 40 percent of imports. There are benefits to playing nice in the nuclear talks—or pretending to.
North Korea is famous for extracting financial concessions in these negotiations, and skeptics say it is hoodwinking the United States again. In return for mere promises, the North Koreans recently got out from under a US Treasury action aimed at alleged counterfeiting activities. Pyongyang’s cooperation—real or feigned—also serves to drive wedges among the five parties seeking to negotiate an end to North Korea’s nuclear program: the United States, Japan, China, South Korea and Russia. It’s no secret that South Korea, in particular, wants to engage Pyongyang, while the Bush administration has opted for isolation and threats, talking openly about regime change.
By appearing more forthcoming, North Korea makes it easier for South Korea and China to continue financial support. Next month South Korean President Roh Moo Hyun will travel to North Korea for a summit with Kim Jong Il, only the second such high-level summit in the postwar period. Last time around, South Korea sweetened the deal with at least $500 million in secret presummit payments. This time, talk is of an aboveboard $20 billion aid package (over 10 years), roughly equivalent to an entire year’s worth of North Korea’s national income. Kim’s interest is to pocket Roh’s concessions, appear congenial, and boost the electoral prospects of the South Korean left—which would help to ensure a continuing flow of aid in the future. Critics say excessive generosity will only enable North Korea to stonewall the nuclear talks. But the North Koreans, in their own inimitable way, may finally be getting serious about a deal.
The financial benefits of a nuclear deal could help Pyongyang stabilize a chaotic situation. North Korea never fully recovered from the loss of its old patron, the Soviet Union, which cut off aid in 1987. Pyongyang’s botched response produced one of the worst famines of the 20th century. From 1994 to 1998 as many as 1 million North Koreans—5 percent of the population—perished. The international community, led by South Korea and China, poured $2 billion in aid into North Korea, hoping to stave off collapse. As the communist economy broke down, people began scrambling for food, engaging in new, unregulated economic activities that would lead to recovery but also placed new pressures on the central government.
The grassroots marketization of the economy saw a boom in trade and investment, with goods such as bicycles and videos flowing across the Chinese border. The state lost control of these gray- and black-market activities, decriminalizing some of them only after the fact in reforms passed in 2002. Meanwhile, the old industrial economy collapsed and was only partly replaced by resource extraction, including mining and fishing, with most of these sales also going to China. What emerged was something resembling a 21st century hunter-gatherer society with one high-tech industry: missiles and nuclear weapons.
One striking result is a growing dependence on two big neighbors, China and South Korea. The North’s most successful attempt to create a free trade zone, the Kaesong Industrial Complex, is heavily subsidized by South Korea, which also bankrolls tourism projects and other ventures. Those subsidies are sure to grow fatter in the upcoming summit. Increasingly, firms from communist China behave like capitalists in North Korea, while firms from capitalist South Korea behave like socialist tools of foreign policy.
But that gives Seoul real leverage. Pyongyang seems to prefer limping along on aid than risking real economic reform and the political turmoil it could bring. The military has participated in the halting marketization process and may have a commercial stake in the resources a nuclear settlement could offer. South Korean aid could be one carrot to keep Pyongyang honest. No doubt, North Koreans won’t easily bargain away the nuclear program, their one major asset, and will present a big bill. And don’t expect a crystal clear ending: Kim Jong Il is a master, and the best movies are the ones that leave you guessing at the end.
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