Follow the Money: North Korea's External Resources and Constraints

Stephan Haggard (PIIE) and Marcus Noland (PIIE)

Forthcoming article in 2008 Korea's Economy

January 1, 2008

During the 1972 US presidential campaign, “Deep Throat,” later revealed to be Associate Director Mark Felt of the FBI, counseled Washington Post journalists Bob Woodward and Carl Bernstein to “follow the money” to unravel the Watergate scandal. In his final paper, “How North Korea Finances Its International Trade Deficit: An Educated Guess,” Edward M. Graham, to whom this volume is dedicated, plowed similar terrain in seeking to unravel Pyongyang’s external accounts.

This paper represents an extension of that earlier effort. We summarize an effort to construct an internally consistent balance of payments for North Korea, adopting the conventions embodied in the International Monetary Fund’s Balance of Payments Manual (5th ed., 1993). We consider licit and illicit merchandise trade, services, current transfers, and capital flows and attempt to separate out transactions occurring on a commercial basis from politically determined transactions such as aid. We also pay careful attention to the degree of uncertainty surrounding each of these estimates.

We find that—despite the constraints on the country associated with its political isolation and the onset of the nuclear crisis—trade, the current account deficit, and by implication capital inflows have all showed steady growth since the famine of the mid-1990s. Like Graham, we conclude that some oft-cited estimates of illicit transactions are probably exaggerated; these transactions appear to account for a declining share of trade. The country remains significantly dependent on aid to finance imports, principally from South Korea and China. The nature of integration with these two partners is very different, however: China’s interaction with North Korea appears to be increasingly on market-oriented terms while South Korea’s involvement has a growing noncommercial or aid component. This finding has important implications for the purported logic of engagement, which claims that increased economic openness will socialize North Korea toward greater commercial interaction with the world economy. High dependence on aid could in fact have the opposite effect, reducing pressure for economic reform.

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Stephan Haggard Senior Research Staff
Marcus Noland Senior Research Staff

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