Economic Reform in North Korea, Or Hype Springs Eternal

February 8, 2012 6:15 AM

In one of the early Republican presidential debates Tim Pawlenty (remember him? it seems so long ago) asserted that with a reduction of regulation, the secular growth rate of the US economy could accelerate to perhaps 5 percent.  Ron Paul laughed and said “why stop there?”—if we deregulated entirely and eliminated the Federal Reserve system, the US economy could grow at 10 percent a year, “even faster than China,” according to the Congressman.

Yonhap recently ran a summary of a report put out by Bank of America-Merrill Lynch that argued that the North Korean economy could grow up to 12 percent if the country integrated itself into the global economy.

Why stop there?

In a series of papers summarized in chapter 7 of Avoiding the Apocalypse Sherman Robinson and I modeled a variety of reform scenarios in which opening to the global economy did indeed play a major role and which the potential gains were even larger than those claimed by BoA. The specific pay-offs were functions of a number of factors:

  • the obsolescence shock (much of the North Korean capital stock would be worthless if the country were opened to international competition) which would have a negative effect on output,
  • technological change through the infusion of new technologies, management practices, etc. that accompany opening and have a positive effect on output,
  • the reallocation effect—the change in the composition of output along the lines of comparative advantage which would have a positive effect, and in the more radical reform scenarios could be quite large and ultimately involve millions of North Koreans switching jobs, and
  • a peace dividend that would be made possible if economic reform were accompanied by a reduction in diplomatic tensions.

Our models generated comparative static (i.e. a movement from one equilibium to another without an explicit time dimension) increases in output as much as 80 percent, depending on the specifics of the reform scenario. When, in a paper with Ligang Liu, we explicitly analyzed the dynamic path of the economy, in half the scenarios output initially fell before rebounding strongly, converging to a steady state path characterized by slowly decelerating growth on the order of 10-20 percent annually in the out years. 

The audacity of hype.

(Sorry, this morning the puns just keep coming.)

External opening would play an important role—there would be an enormous expansion of cross-border trade and investment and foreign investors could be expected to provide the literal product design blueprints as well as the worldwide marketing and distribution channels to turn the latent potential of the North Korean economy into products the rest of the world wanted to purchase.   

But actual opening has been hesitant at best, and limited by the weaknesses of North Koreas institutions. In our survey of Chinese enterprises operating in the DPRK, Steph Haggard, Jen Lee, and I found that institutional weakness deters trade, and particularly investment.  In some forthcoming work we show that these weaknesses adversely affect the financial terms that North Korean enterprises obtain in their dealings with Chinese counterparties. In short, the absence of reform in North Korea imposes large costs on the economy, even greater than those claimed by Bank of America.