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North Korea: sanctions and marketization from below

What’s at stake: despite Western sanctions, North Korea has been in the news all summer. The country was in the spotlight for the death of American student of Otto Warmbier in June, and for the frequent missiles tests in July and August. We review recent contributions on the impact of economic sanctions.

By: Date: September 11, 2017 Topic: Global Economics & Governance

The Economist argues that Western sanctions have not had much effect on North Korean economy, which is probably growing at between 1% and 5% a year. The UN has attempted to block the country’s access to hard currency by capping the amount of coal it can export, and China, the buyer in 99% of North Korea’s reported coal sales, said that it would suspend all imports. Yet North Korean vessels have continued to dock at Chinese coal ports. Moreover, countries or individuals that help North Korea do business have not been subject to “secondary sanctions” that would further isolate the country and appear to have been instrumental in persuading Iran to seek a deal over its nuclear plans in 2015. But one additional reason why the country may be proving so resilient is that its economy has also been changing. Though still officially illegal, private enterprise has grown since limited reforms made it possible for individuals to generate profit. Satellite imagery shows markets growing both in size and number across cities. These limited reforms have allowed the regime to plug part of its dollar deficit, as North Korea’s new class of traders and businessmen buy themselves protection by making hard-currency “donations” to the government.

A recent report by the DailyNK investigates the state of North Korea’s market economy and the implications of proliferating marketization. In the absence of official data, the report relies on research efforts undertaken between 2014-2016 in collaboration with 32 specially-trained sources from North Korea, who reported from inside the country on conditions within their local General Markets. Daily NK was able to verify the existence of 387 officially-sanctioned markets, with residents selling from over 600,000 stalls. In population terms, over 5 million people (20% of the population) are either directly or indirectly reliant on the General Markets, solidifying their place in North Korean society.

The authorities seem to have largely embraced the ability of markets to provide for people, but the report details efforts to bring the markets under control. The newly affluent middle class (donju) has become deeply involved in real estate transactions and other financial activities, leading to widening income inequality and to the emergence of a new poorer class. DailyNK points out that policy options to deal with the North Korean nuclear program have been debated at length, but little if any time has been devoted to debating options that pursue change via the power of the markets. Targeting the market economy in North Korea as a key path towards improved quality of life for its citizens may represent the most realistic strategy for tangible progress.

Stephan Haggard – who wrote the preface to the abovementioned DailyNK report – thinks that the heightened aggressivity of North Korea is more a sign of weakness than of strength and it may signal that economic sanctions are actually biting. Since the nuclear crisis broke in 2002, North Korea’s trade with Japan, South Korea and most other countries in the world has fallen to virtually zero and he country has become increasingly dependent on China, at exactly the moment when the economy was becoming more open and dependent on trade. In August 2017, the US managed to get China to sign on to US Security Council sanctions that will dramatically cut North Korea’s access to foreign exchange. Kim Jong Un came to power promising a more forward-looking regime, with a great focus on the economy and material benefits, but to realize this dream requires that North Korea integrates into global markets. This is impossible under a heightened sanctions regime. Therefore, Kim Jong Un’s only hope is to drive political wedges between the tacit coalition that is forming among China, the United States, Japan and Korea, by heightened military aggression.

Henry Féron disagrees. Writing on the 38 North blog of the US-Korean Institute at Johns Hopkins SAIS, he argues that the recent Pyongyang’s construction boom along with other indicators of improved economic performance such as food production and foreign trade, provide further evidence of the ineffectiveness of current economic sanctions. Kim Jong Un has inaugurated a grand, new apartment complex nearly every year since he assumed power. North Korea observers have been perplexed by how the state can bear such construction costs given the breadth of economic sanctions imposed against the state. One way to explain North Korea’s construction frenzy is that it is overspending and exhausting its foreign reserves to import building materials, or it may be that North Korea’s special trade relations with China make it less dependent on such reserves than is often assumed. Because the trade has not been balanced for years, some commentators believe that by accepting the situation, China is hiding a de facto subsidization of the North Korean state. Féron however thinks that the single most important factor in Pyongyang’s ability to afford major refurbishment is the improvement in the North Korean economy.

Kent Boydston of the Peterson Institute for International Economics stresses that the story with North Korean sanctions is primarily about China and how tightly China agrees to tie its hands. China’s share of North Korea’s trade in 2016 increased from 64 percent to 88 percent after Park Geun-hye shuttered the Kaesong Industrial Complex in February 2016, cutting South Korea’s share from 30 to 5 percent. Assuming North Korea does not cease provocations, the question is where will sanctions go next? Much of the top five categories of North Korea’s exports to China are now banned. In terms of the top 5 product classifications—which comprise 88 percent of total China-North Korea licit trade—this leaves the two textile categories as the only remaining ones left completely untouched by the UN. The negative growth rate of the textile categories may suggest there is decreased demand on the Chinese side for North Korean products. This could be because in an increasingly sanctioned environment, investors may be reluctant to put more into the North Korean textile industry. Given the North Korean economy’s ability to adjust to sanctions, however, Boydston argues that a more effective response could be to require China cutting back its exports too.

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