North Korea's vulnerability to a China shock



exports and commodity prices 2North Korea is a small, increasingly dollarized, and increasingly open economy, and as such more vulnerable to developments in the global economy than most observers appreciate. North Korea’s external economic relations are highly politicized and most analysts who follow North Korea are non-economists who sometimes misattribute changes in North Korea’s economy or trade relations to diplomatic developments.  An example would be the 2007-08 period when China imposed an export embargo on grain in response to rising domestic prices which many north Korea watchers misinterpreted as diplomatic pique, ignoring that the embargo was applied to all trade partners and not just the North Koreans.

Something similar may be occurring now. The North Korean economy appears to be improving largely as a result of expanding trade, much of it with China. However, this trade expansion may be attributable in large part to rising prices for North Korea’s exports, not rising volumes. And what goes up can come down. The Chinese government is in the midst of trying to deflate property bubbles and their economy is slowing. Economic growth remains uneven elsewhere around the world.  Some observers claim that we have seen the end of a “super-cycle” in commodities.

Most of North Korea’s exports consist of primary products, particularly minerals.  The figure above reproduces North Korean merchandise exports, the International Monetary Fund’s index of metals prices, and the World Bank’s index of the prices of commodities produced by low and middle income countries (LMICs).  The series are highly correlated. In particular, the price series closely trace the run-up in North Korea’s exports since 2009.  But since peaking a couple of years ago, commodity prices have been on a downward trend, and may amount to a “leading indicator” of sorts for the trade data which are only observed with a lag.

This pattern has worrisome implications for North Korea, suggesting that the country could be vulnerable to a slowing of Chinese and global growth, and a slump in commodity prices. If such were to eventuate (and I am not making any predictions here, simply sketching out a plausible scenario), then the apparent recent gains in the North Korean economy could go into reverse.  A young and relatively inexperienced leader could find himself in a challenging environment without a lot of policy levers at his disposal to cushion the fall.  Indeed, if as some argue North Korea is initiating reforms, the reforms could be associated with or, in the extreme, even blamed for, deteriorating performance.

Kim Jong-un had better hope that Zhou Xiaochuan, Ben Bernanke, and Mario Draghi are good at their jobs.   They may have a bigger impact on his ability to govern than the usual suspects.

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