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The Chosun Ilbo recently ran a piece titled “Economic Freedom Improves in N. Korea” describing the rise of market based activities. It gave the example of an entrepreneur who managed to scrape together $30,000 from family and friends and launched a textile factory in Chongjin. According to the article, the unnamed businessman forks over 30 percent of the factory’s monthly revenues to the authorities as “a de-facto corporate income tax.”
This is a potentially revealing anecdote.
My colleague Nick Lardy makes the point in his recent book Markets Over Mao: the Rise of Business in China that retained earnings—not bank credit or other sources—have financed “the vast majority of investment in China in the reform era.” If retained earnings are taken as a rough proxy for efficiency, this means that over time comparably efficient enterprises will expand capacity and grow relative to less efficient enterprises. Although this would seem obvious, even trivial, that’s not how things work in a classical centrally planned economy where enterprises turn over all profits to a central authority which would then allocate resources available for investment according to a central plan. In the case of China, a reform in 1978 that allowed state-owned enterprises to retain profits coincided with a dramatic decline in the share of SOE investment financed out the state fund—and a dramatic sustained acceleration in the Chinese growth rate.
It would be fascinating to see an accurate flow of funds table for North Korea encompassing capital raised through family and friends, on-the-books bank lending, off-the-books bank lending, formal taxes, informal payments, etc. My guess is that the North Korean authorities themselves really do not have an accurate picture of these financial flows. But the issue is important: as the state loses its grasp either via formal reforms (as happened in China) or through informal system fraying (which has been occurring for 20 years in North Korea) the marginal efficiency of investment may rise and act as a stimulus for economic growth.
