North Korean Economy Watch

Peterson Institute for International Economics Working Paper
May 2008
Stephan Haggard, University of California, San Diego
Marcus Noland, Peterson Institute for International Economics
Erik Weeks, Peterson Institute for International Economics

Download the paper here

Abstract:

North Korea is on the brink of famine. As detailed [in this forthcoming policy brief], the margin of error between required grain and available supply has virtually disappeared. Local food prices are skyrocketing even faster than world prices. Aid relationships have been soured and the regime’s control-oriented policy responses are exacerbating distress.  Hunger-related deaths are nearly inevitable and a dynamic is being put in place that will carry the crisis into 2009, even if as expected, the US announces that it is sending 500,000MT in return for a signed nuclear declaration.
 
The US can provide aid in ways that maximize its humanitarian impact while limiting the degree to which aid simply serves to bolster the regime.  We know that aid is diverted.  Yet given the fragmented nature of markets in North Korea, diverted aid often finds its way into markets in the catchment area where it is delivered.  Geographically targeting aid to the most adversely affected regions and providing it in forms such as barley and millet that are not preferred by the elite can increase the ameliorative impact of assistance.  The Bush Administration has taken up the first part of this equation–requiring that most of its contribution to the World Food Program be targeted at the worst affected regions–but it could do more on the second part: providing aid in forms less preferred for elite consumption. It can also encourage others such as South Korea to follow suit.
 
The US should also exercise quiet leadership with respect to the refugee question as well. The Chinese government’s practice of returning North Korean refugees may reflect a natural self-protective response against the threat of a flood of migrants and even the breakdown of the North Korean regime; it was, after all, the notorious “hole in the fence” that helped precipitate the collapse of the Eastern European regimes. But the policy of returning refugees does not conform with China’s obligations under the refugee treaty and does not in the end serve the country’s underlying political objectives either; it simply serves to cutoff another escape valve, however small, that has contributed to taking pressure off of a rapidly deteriorating situation.

Andrei Lankov is the first in the media to construct a narrative which details the series of decisions that have led to North Korea’s current food crunch.

From his article:

Merely a year ago, North Korean leaders were optimistic. The good harvest of 2005 persuaded them that food shortages were behind them, and that North Korean agriculture had begun to recover. The 2005 harvest was merely 4.6 million tons, well below the 5.2 million tons which are necessary to keep the entire population alive. Still, it was clearly an improvement.

Lankov’s assertion that 5.2 million tons of grain are needed to sustain the DPRK population comes from the UN.  Recent work by Marcus Noland estimates that this number is closer to 4.6, although exact figuress are not possible because the actual size of the DPRK population is unknown.

In addition, for a decade South Korean administrations have maintained their Sunshine policy of unilateral concessions and unconditional food aid. Since 2000, about 450,000 tonnes of food have bee delivered to North Korean granaries from the South every year, free of charge. Its distribution was almost unmonitored. Pyongyang leaders came to believe that such aid would continue for the foreseeable future. Additionally, increasing Chinese involvement with North Korea, while not necessarily welcomed by Pyongyang, was seen as a sign that additional food would be coming - and Chinese shipments were roughly equal to those of South Korea. Finally, the basic agreement with the US on the nuclear issue was perceived in Pyongyang as a sign of Washington’s willingness to pay generously for rather minor concessions.

As noted by many besides Lankov (here), this good fortune prompted the DPRK government to reimpose elements of the planned economy which failed long ago: 

In 2005, authorities claimed that the public distribution system would be completely revived, and banned private trade in grain. This ban was generally ignored and eventually failed, but subsequent moves were more successful. In late 2006, authorities banned male vendors from the country’s marketplaces. In 2007, women under 50 years old were also prohibited from engaging in business in markets. The assumption is that every able-bodied North Korean should go where he or she belongs, specifically to the state-run factories of the Stalinist economy.

The government also staged some campaigns against semi-legal private businesses that had been tacitly tolerated since the late 1990s. After 2005, authorities successfully cracked down on the trafficking, smuggling and illegal labor migration occurring on the border with China. There was also a remarkable increase in the volume of anti-market rhetoric in the official Pyongyang propaganda.

The economic problems they were attempting to achieve at home through these policies, however, were only the first of several shocks to hit the DPRK economy in the last year: 

1. Low harvest numbers

First of all, the 2007 harvest was a failure. It was estimated at only 3.8 million tons, well short of the critical 5.2 million ton benchmark [and Noland’s 4.6 benchmark]. As usual, floods were officially blamed (as if the impoverished North does not share the same small peninsula with the prosperous South, where no signs of food shortage have been seen in decades).

2. Drop in aid from South Korea

The presidential elections of December 2007 led to a change of leadership in Seoul. The new government, led by right-of-the-center pragmatist Lee Myong-bak, said that the era of unconditional concessions to the North was over.

3. International food prices rising

The situation was aggravated by the explosive rise of international food prices. The North Korean press has reported the trend widely obviously in an attempt to,place the blame for the current crisis on factors clearly beyond the government’s control. On April 20, Nodong Sinmun, the major official daily newspaper, ran an article that described food supply difficulties worldwide and mentioned a dramatic increase on food custom duties in “certain countries”.

4. Cold shoulder from China

The worldwide price hike means that the amount of food coming to North Korea via foreign aid channels is likely to decrease. China, preoccupied with the Summer Olympic Games in August, and increasingly annoyed by North Korean antics, is not too willing to help the North out of its trouble which, as some people in Beijing believe, were brought on Pyongyang by its own stubborn resistance to the Chinese reform model.

So what is Lankov’s prediction?

In North Korea, the domestic food situation is deteriorating fast. The sudden hike in food prices seems to be a sign of deepening crisis. There were reports about farmers who refuse to toil the state-owned fields, stating that they are too weak to work (but still willing to work on their private plots). There are rumors of villagers starving to death even though observers believe the food shortage has not yet developed into a famine. If the shortage of fertilizer damages this year’s harvest, a famine may develop by the end of this year.

The political consequences are unclear. Knowledge about the situation inside North Korea remains grossly inadequate. If the past is an indication, however, nothing of great political significance will happen if a few thousand fresh graves appear in the hills of North Hamgyong province. In all probability, Kim Jong-il’s government will use its time-tested tactics: the political elite and the best units of the army will receive full rations; the residents of major cities, police and common soldiers will get barely enough to survive; and the “politically unreliable”, largely villagers from the remote northwest, will be left to their sorry fate.

There is hope the government will momentarily halt its counter-offensive against free market economics, and will ease its border controls to allow more people to China - but even such moderate measures are unlikely. Isolated revolts are possible, but the government seems to be supremely confident. After all, the disorganized, isolated population, deprived of any opportunities to organize or even communicate between themselves, is not capable of challenging the system.

Read the full story here:
North Korea stoic in the face of famine
Asia Times
Andrei Lankov
4/30/2008

Even as realtions sour between North and South Korea, the South plans to donate US$1.18 million worth of anti-malaria supplies to the North via the UN World Health Organization.

Seoul has made similar anti-malaria donations since 2001, reducing the DPRK’s malaria cases to about 7,500 last year from some 300,000 in 2001.

Read the full article here:
South Korea to provide anti-malaria supplies to North Korea
Associated Press
5/2/2008

North Korea has requested that the German Red Cross continue providing medical aid beyond ithe 2009 deadline.

The request was made when Rudolf Seiters, president of the German Red Cross, visited Pyongyang on April 22-26 and met with Kim Yong-nam, chairman of the Presidium of the Supreme People’s Assembly to discuss his group’s overrall programs to aid the communist state.

The German group has sent medical kit that includes pain-killers, antibiotics and nutritional injections, as well as medical equipment such as blood pressure cuffs and stethoscopes to some 2,000 local hospitals and clinics across North Korea since April last year. About 8.8 million North Korean residents benefited from the aid, Koch said.

The German government has provided 4 million euros (US$6.2 million) worth of aid to the North every year since 1997, the spokeswoman added.

Read the full article below:
German Red Cross asked to continue helping N.K.: report 
Yonhap
5/1/2008

On April 23, the Korea Institute for International Economic Policy (KIEP)hosted, “The Lee Myung-Bak Administration’s Policy toward North Korea: Denuclearization or Disengagement.”  In this seminar they essentially answered this question with a ‘yes’.

According to the Daily NK coverage of the event:

[Dong Yong Seung, the Chief of the Security and Economics Department of the Samsung Economic Research Institute stated,] “While economic exchange between North Korea and China has been business-to-business, in the case of Kaesong, the exchange has been controlled from a single control tower, the North Korean regime. That is, the condition has been set up for government-to-government economic exchange to facilitate North Korean government’s planned economy. Economic cooperation in the style of South Korea’s has been obstructing North Korea’s rational transformation.”

In a sense, he is arguing that South Korea’s support for the Kaesong Zone yields results more similar to foreign aid than private economic exchange.  If this is the case, South Korea, and just about everyone else, could learn from China’s strategy for investing in North Korea.

As Judge Posner put it:

All the problems that foreign aid seeks to alleviate are within the power of the recipient countries to solve if they adopt sensible policies. If they do not adopt such policies, then foreign aid is likely to be stolen by the ruling elite, strengthening its hold over the country, or otherwise squandered. What we can do for poor countries is reduce tariff barriers to their exports. With money saved from eliminating foreign aid, we could compensate our industries that would be hurt by import competition from poor countries and thus reduce political opposition to tariff reform.

Institute for Far Eastern Studies (IFES)
NK Bfrief No. 08-3-13-1
3/13/2008

International fuel and food prices are skyrocketing, while the cost of Chinese goods continues to rise, so that this so-called ‘triple-threat’ is sending shockwaves through the North Korean economy. In this year’s New Year’s Joint Editorial, North Korea championed the banner of a ‘strong and prosperous nation’, and declared that this year would focus on the economy, however this ‘triple-threat’ will likely make it extremely difficult for the North to meet its policy goals.

With oil prices peaking at over 110 USD per barrel, if these high oil prices continue, North Korea, which imports crude and refined oil from China, Russia and other countries, will face a growing import burden. In accordance with the February 13th agreement reached through six-party talks, South Korea, the United States and others will provide some heavy fuel oil, and the agreement stipulated the amount of oil to be delivered, rather than the value, so this will not be affected by rising prices. However, this oil does not cover all of the North’s needs, and as for the remaining portion, either the amount imported will have to be reduced, or the North will have no choice but to invest considerably more in fuel. In addition, as a large portion of North Korea’s oil is imported from China, Pyongyang’s trade deficit with its neighbor will also grow.

According to the Korea Trade Investment Promotion Agency (KOTRA), North Korea imported 523,000 tons of crude oil from China in 2005, 524,000 tons in 2006, and 523,000 tons last year, each year accounting for approximately 25 percent of total oil imports. North Korea’s trade deficit with China has shown a steadily growing trend, reaching 212,330,000 USD in 2004, 588,210,000 USD in 2005, and 764,170,000 USD in 2006. With grain prices also skyrocketing, and North Korea depending largely on China and Thailand for rice and other grain imports, the burden on the North’s economy is growing, and this is one factor in the instability of domestic prices in the DPRK.

According to the Chinese Customs Bureau, North Korea imported 81,041 tons of rice and 53,888 tons of corn last year, increases of 109.9 percent and 37.4 percent, respectively. North Korea’s corn, rice and oil imports from China are subject to market price controls, so that rising international prices directly affect the North’s cost burden. Last year, the price of Chinese goods rose 4.8 percent, recording the largest jump in ten years, and this trend extends to a wide variety of goods. 80 percent of disposable goods in North Korea are produced in China, and rising Chinese prices are directly reflected in North Korean import costs, which is passed on to DPRK citizens.

As North Korea emphasizes the building of its economy, it appears unlikely that residents will feel any direct effects of Pyongyang’s promise to prioritize the stability of its citizens’ livelihoods.

…against Japanese encephalitis, meningitis

The one-day campaign on Feb. 29 was a pilot project to study the feasibility of introducing both vaccines to the north’s routine inoculation program, the Seoul-based International Vaccine Institute said in a statement.

Some 3,000 children in Sariwon, south of Pyongyang, received the encephalitis vaccine, while the others in the city of Nampo, southwest of the capital, were administered with a vaccine against Haemophilus influenza type B - a bacteria that causes meningitis, it said.

Read the full story here:
6,000 North Korean children receive vaccines against Japanese encephalitis, meningitis
Associated Press
3/12/2008

…does not sound like very easy job based on the most in-depth media coverage of their operations published in the Washington Post.

The story portrays the sad state of the DPRK’s medical facilities and shows just how much local doctors struggle to serve their patients.  According to Eugene Bell Foundation Chairman Stephen Linton:

“I’ve seen doctors who tried to capture sunlight by reflecting it from a mirror,” [during surgery] he says.

By North Korean standards, [this] patient is fortunate. She’s been given a local anesthetic, which is rare in a country where surgeons routinely etherize patients, strap them down and try to finish the operation before they come to.

and  

Like most hospitals and care centers in North Korea, the facility employs a direct-fluoroscopy machine, an X-ray device that irradiates the patient from behind while the doctor examines an image projected on a fluoroscopic plate of glass between them. “The negative is the doctor’s retina,” says Linton, who frequently admonishes physicians for submitting themselves to the machines’ potentially fatal doses of radiation. Most physicians in North Korea use them regularly, and suffer the consequences. The radiologist at Kosong, for example, has receding gums and low hemoglobin, common signs of radiation sickness. Three of his colleagues have died over the years — one from radiation overdose, another from cancer and a third from tuberculosis.

But the toll poor infrastructure takes on the provision of good health care is only exacerbated by the difficulties the DPRK bureaucracy puts in his way:

Of the 36 NGOs that began operations in North Korea as famine gutted the rural population in the mid-1990s, all but a handful have left in frustration. And Linton is particularly demanding: He insists on delivering his supplies personally, lest they be diverted to another facility or end up on the black market. When government officials balk, Linton refuses to resupply the site. So each of his two resupply visits annually is preceded by lengthy and sometimes rancorous negotiations.

“They say they want to save wear and tear on the vehicles, so they need to cut our sites by a third. Fine. I’ll cut theirs as well. Mary, I’ll need a red marker.”

Most of the cancellations involve small sanatoriums in rural areas — the very sites his donors are so keen to support. Linton suspects his hosts want to avoid those facilities because, relative to the urban care centers, their poor sanitation makes them legitimately hazardous. And the wear-and-tear issue isn’t just a red herring. Spending days crisscrossing the countryside on unpaved roads takes a huge toll on the delegation’s fleet of SUVs — vehicles that, between Linton’s visits, the ministry is allowed to use for its own purposes. In resource-starved North Korea, even government officials must barter to replace broken fan belts and transmissions. The last thing the bureaucrats want is to risk losing a precious automobile.

Linton is also apparently given a curfew when he is required to be back at this guest house in Pyongyang.

It seems Tuberculosis is running rampant at the moment:

South Korean sources suggest that tuberculosis has affected as much as 5 percent of North Korea’s population of 23 million. Linton estimates the Eugene Bell Foundation has treated up to 250,000 patients, 70 percent of whom might have otherwise died.

The whole article is well worth reading.

Donations can be made here.

The full article can be found here:
Giving Until It Hurts
Washington Post
Stephen Glain
3/9/2008, Page W16

Yesterday’s post on accountability and South Korean aid to the North got me thinking about game theory again.

The South Korean Ministry of Unification has a dominant strategy to lend/give/invest in North Korea for ostensibly two reasons: 1. If the MoU does not, their raison d’etre goes away.  2. South Korea will ultimately see a payoff if a development strategy works in the DPRK.

Contracting with North Korea, however, is essentially a prisoner’s dilemma (see chart above), and North Korea has the ability to cooperate or defect.  However, the North Koreans have rational expectations, so they know the Ministry of Unification has a dominant strategy to cooperate.

Therefore the Nash equilibrium is for the South to keep cooperating and for the North to keep defecting.  In a repeated game, cooperation evolves over time as trust develops and defection decreases.  Because of South Korea’s dominant strategy,however, the North never has an incentive to cooperate–so we end up with an “anti-folk theorum” where defection is the only incentive compatible outcome over time.

Addendum: The game could be radically different for private investors, however, who are in a more credible position to say “no”–leading to defect/defect moves (because South Korean investors are not as politically constrained and can recognize sunk costs).  These moves result in neither gains nor losses for either side, however, because both sides have the ability to bargain, cooperation that is mutually beneficial can evolve over time as it should.

On February 8, it was announced that the South Korean Ministry of Unification, the agency responsible for official interactions with the North, would not be merged with the Foreign Ministry (full story)–dealing an early policy blow to the newly elected South Korean President’s efforts to reduce the size of the South Korean government.

However, just three days later, on February 11,  the Chosun Ilbo reported that a South Korean government cash donation to North Korea (cash donations are apparently unlawful) has [surprisingly] gone missing:

In March last year South Korea gave US$3.8 million worth of aid, including $400,000 in cash and building materials, to North Korea to build a center for inter-Korean video-link family reunions in Pyongyang. But North Korea has not even started construction on the site, it was known on Sunday.

The donation violated a ban on cash aid to North Korea, but South Korea’s Ministry of Unification said at the time that there would be no room for suspicious dealings because the North agreed to inform the South where the money was spent and the South agreed to visit the construction site to find out whether the money and materials were used properly.

It has been almost a year since the aid was delivered, but it is not clear what the North has done with the cash and building materials. The South Korean government has demanded that it be allowed to visit the construction site, but the North has brushed off the requests, saying it will show the site “next time” or after the center is dedicated.

[and…] 

On eight occasions from early April to late August last year, South Korea delivered to the North building materials such as cement, iron bars, electric cable, tiles, drills, adhesive glue, interior furnishings, elevators, and air-conditioning and heating equipment. It also sent 10 buses and six Rexton SUVs.

When sending the materials, Seoul demanded five times that the North allow South Korean officials to visit the construction site and provide details on where the materials were used. All such demands were rejected. (Chosun Ilbo)

Today, February 14, South Korean military authorities admitted to knowing (since 2003, when the previous Roh Moo-hyun administration was inaugurated), that North Korea has transported rice supplied by the South for humanitarian purposes to front-line units of the Korean People’s Army.

The South Korean military has admitted it found no fewer than 200 South Korean rice sacks transported to North Korean Army units on about 10 occasions to the demilitarized zone including Gangwon Province between 2003 and recently.

This is the first corroboration by the South Korean military of testimony by North Korean refugees that the food aid provided by South Korea is being diverted for military purposes. But despite their knowledge of this fact, neither the South Korean government nor military authorities protested to North Korea or asked it for an explanation, apparently for fear of provoking Pyongyang. (Chosun Ilbo)

Updated: 2/21/2008: North Korea denies it diverted food aid to military. 

Now, I personally favor some kind of engagement policy with the North, but implementing an effective strategy is difficult.  Strict transparency and accountability are absolutely necessary to avoid mismanagement of public funds.  This is admittedly difficult, even in the OECD, much less in a secretive communist state.  Under the current circumstances, however, the North is treating the South like an unwanted lover, and this is not a healthy outcome. 

Handing out public funds with weak- or no-strings attached (as the South has done for years) creates markets in political corruption in the North.  The North Koreans know that the Ministry of Unification has a bureaucratic incentive to spent the money on aid.  If they don’t, it will not be appropriated in the next fiscal cycle.  This is why government budgets almost never go down, and agency heads go on a spending spree just before the fiscal year ends–use it or lose it.  The North Koreans have simply learned how to say the right things, etc., so the Ministry of Unification can check the box and pay up, because they know there will be no consequences when they fail to deliver.

So what is the solution?  If the South Korean government demonstrated some desire to monitor development aid, and reduce it if necessary (say “no” once in a while), they might encourage the North Koreans to do with the money as they claim (at least more so).

Another option available to the South Korean government is to stop using public funds to develop North Korea and instead free the South Korean business community, and other individuals, to take their chances contracting with North Korean entities themselves.  Putting their own Won on the line will definitely encourage private investors and venders to keep an eye on their balance sheets, and will help depoliticize the development of a country with a poor reputation.  

See the gratuitous game theory here.

You can read the referenced articles below:
S.Korea Knew Its Rice Feeds N.Korean Military
Choson Ilbo
2/14/2008

N.Korea May Have Diverted Cash Aid
Chosun Olbo
2/11/2008