As a result of the economic collapse throughout this decade, North Korea now faces the biggest crisis since its foundation. North Korean authorities claim that natural disasters are mainly responsible for the distressed economic condition in North Korea. We argue that a more accurate explanation for this decline begins with the severe deterioration of North Korea's external economic relations since the collapse of the Eastern Bloc in 1989. A severe curtailment of public transfers from the former Soviet Bloc to the North Korean economy has taken place since 1989. However, this rapid decline in most foreign aid may have merely exposed what is likely an even larger problem of structural weakness and inefficiency in the North Korean economy.

North Korea's economy has atrophied to the point where almost all of its sectors no longer function properly. The central command system has been losing its power and public order has become a serious problem as the entire North Korean society faces disintegration. Shortages of raw materials, energy, food, daily necessities, and foreign exchange have been continually growing problems for the past 10 years. Each of these disasters has debilitated the central distribution system; consequently, the majority of the North Korean people now depend on farmers' markets and other market transactions for much of their necessities. Moreover, our investigation of the economic and living conditions in North Korea reveal that the severity of the crisis is far more serious than most observers believe. In September 1997, North Korean authorities reported to the International Monetary Fund (IMF) that in 1996, its economy had shrunk to less than 50 percent of the levels recorded in 1992. The North Korean authorities have announced that their GNP per capita fell to US$480 in 1996 from US$1,920 in 1979.¹⁾

The North Korean economic crisis has had a great impact on a variety of domestic and external areas. The first noteworthy change in domestic economic behavior is that the North Korean government, which had completely suppressed capitalistic transactions in the past, now implicitly permits some forms of private transaction in the farmers' markets and largely ignores 'illegal' private cultivation. The breakdown of previous food distribution practices has resulted in a dilution of official control over private transactions, job desertions and migrations of people to where food and economic opportunities exist. Since the onset of the economic crisis, the amount of goods distributed through official rationing stations and government stores has sharply declined, while activity in farmers' markets has become brisk.

The paralysis of official distribution channels and the resulting increase in activities in previously unheard-of private markets is causing a breakdown of the social system in North Korea. Crimes, such as smuggling, embezzlement, and theft, are increasingly common, as is the migration of ordinary citizens. The drastic food shortage incites a great number of inhabitants to move to other relatively affluent regions. Previously, North Korean citizen had not been able to travel to other provinces without official permission. However, North Korean authorities can no longer prevent the migrations of large amounts of people in search of food and opportunities to make a living.

In fact, North Korean authorities have been unable to carry out detailed economic planing since the mid-1980s. This widespread breakdown in many of its official functions has severely weakened North Korea's socialist planning system. As the past nexus between industries has been almost completely destroyed and decentralization has grown as a result, the prospects of North Korea ever rehabilitating its centralized economic planning system has grown dim. North Korean authorities now control only the largest and most important enterprises, while instructing all others to fend for themselves under the slogan of 'self-reliance.' The government has begun to permit individual corporations to participate in partial overseas trade and procure production factors without having to first receive official permission. These developments have further contributed to the decentralization of the North Korean economy.

North Korea's economic difficulties are limiting its policy options. It is obvious that North Korea needs foreign assistance to overcome its current economic difficulties, and the North Korean authorities appear to recognize that it cannot maintain its policy of self-reliance any longer. The government has changed its policy stance toward foreign investment to one more welcoming than in the past, breaking with the past position of maintaining "the great Juche (autonomous) of Chosun (North Korea)."

Table : Economic Indicators of North Korea,1992-96

Source : Data provided by the North Korean government to the IMF. IMF(1997)

Despite the recent encouraging developments in relations between North and South Korea, prospects for the North Korean economy remain clouded by much uncertainty. We identified the following three points as major factors which will fundamentally shape the future prospects of the North Korean economy: the North's intention to open and reform its ailing economy; South Korea's policy towards the North Korea; and the response of the international community, notably the U.S. and Japan. The starting assumption for our analysis is that the policies of North Korea and those of South Korea and other countries are all interrelated. For instance, as long as South Korea and the US do not provide full-scale economic assistance to North Korea, it is unlikely that North Korea would attempt to make a transition to a market economy. On the other hand, even if South Korea and other allies assist North Korea on a full scale, there is a possibility that North Korea may continue to adhere to its policy of limited openness.²⁾

Currently, North Korea's approach shows an increasing tendency to embrace diplomatic relations with non-socialist countries. Of course, this is largely, if not solely, due to its need for foreign assistance. North Korea is also trying to boost the sagging level of its foreign reserves through the promotion of foreign investment into its domestic market, and by increasing its exports. While the government continues to extol the virtues of self-reliance to its citizenry, in actuality, North Korea continues to become increasingly dependent on foreign assistance and trade. The increase in the importance of foreign assistance and trade also augments the importance of diplomacy and foreign relations in maintaining these economic ties. Already, this economic dependence has grown so deep that North Korea now occasionally makes concessions to foreign governments. Previously, it had been extremely unusual for the North Korean government to make any kind of concessions to a foreign government. However, North Korea recently apologized for its submarine infiltration into the South and for the diversion of food aid away from the intended recipients.

The North Korean government apparently has not yet decided on a clear course of action during this transitional period. During the process of policy change in North Korea, there will be conflicts among elite groups. Already, we have seen conflicts between the Ministry of Foreign Affairs and military authorities when North Korea decided to apologize for its submarine infiltration into South Korean waters. As the clash over the apology for the submarine incursion demonstrated, the transition and uncertainty will generate acute conflicts between the traditional conservative/military elite and the economics and diplomacy-oriented elite over its policies toward South Korea.

For at least the short-term, North Korea will continue its two-pronged approach toward the South. On the one hand, economic cooperation with the South will be maintained; on the other hand, intentional measures to retard the improvement of political relations with the South will be undertaken. More concretely, this Janus-faced approach will take the form of the North resorting to its conventional political approach of brinkmanship and simultaneously seeking improvement of economic ties with the South. However, as the demand for more food and other material needs outweigh any other North Korean concerns, political issues are, at present, subordinate to economic priorities.

The current unification policy of the South Korean government is clear. The South Korean government prefers gradual economic integration prior to political integration. Although the South in fact prepares for the possibility, neither South Korea nor the US desire to see a scenario in which North Korea undergoes a sudden collapse. President Kim Dae-jung has enunciated a new "sunshine" policy for dealing with North Korea. At the heart of his North Korea policy is the principle of keeping politics separate from economics. This marks a major policy change from the previous government. President Kim announced in June 1998 that he would not oppose easing economic sanctions on North Korea by the U.S., and the U.S. has agreed in principle to ease economic sanctions. President Kim even asked the U.S. and Japan to promote economic relations with North Korea in order to induce North Korea to open its economy and change. The new administration of Kim Dae-jung clearly is trying to pave a road towards the enhancement of North-South economic relations.

The recent financial crisis certainly weakened South Korea's leverage and prompted the new government to develop a more realistic assessment of South Korea's strategic vision that is more compatible with its economic capabilities. Since the amount allotted for financial support to North Korea in South Korea's budget can only make a limited contribution to the rehabilitation of the North Korean economy, direct investment by the foreign private corporations and financial institutions may be of greater importance than aid from the South. However, without the endorsement of international financial institutions, it is unfeasible for substantial private investment to flow into North Korea in the current world economic order. Inducing North Korea to participate in the international community on official terms by first helping it become recognized by international financial institutions seems to be the most practical way of increasing the opportunities for larger-scale investments in the country.

Moreover, as economic support from the various international financial institutions would prevent North Korea from becoming economically dependent on any one particular country, there are clear incentives for the North Korean leadership to induce foreign investment by demonstrating its ability to maintain political stability. In fact, from as early as 1997, North Korea has consistently expressed a desire to participate in the international financial community. Given this development, the probability of relations between North Korea and international financial institutions improving seems to be increasing. However, in order to clear the way for North Korea to join the international financial institutions such as the IMF, World Bank and Asian Development Bank, the US-North Korea and Japan-North Korea relations will have to improve, and will continue to remain critical issues for both South and North Korea.³⁾

Confronted with economic difficulties and no alternative options for rehabilitating the economy without international help, North Korea seems to be inclining toward greater openness to South Korea and the U.S. There are increasing signs that North Korea's relations with the US and Japan, both political and economic, are likely to improve rather than deteriorate as long as the political regime of North Korea remains stable. On the other side of the table, South Korea and the U.S. seem to be moving toward broader ranged assistance to North Korea.

In the short term, there seems to be little likelihood that North Korea will undertake wide-ranging reforms; nevertheless, it is also unlikely that the North Korean regime will collapse in the near future. In the longer term, however, so long as North Korea maintains its internal political stability, it is likely to grow bolder with reforms, especially if South Korea and the international community remain supportive of the attempts at reform. A scenario of reform will likely entail the two Koreas entering into some period of peaceful coexistence, followed by gradual economic integration of the two countries. On the other hand, if political stability in North Korea begins to deteriorate as a result of such broad-ranging reformsC an implosion is likely to occur.

(Research Fellow at Korea Institute for International Economic Policy: KIEP, Seoul)

References

International Monetary Fund, 1997, "Democratic People's Republic of Korea - Fact- Finding Report," EBS/97/204, November 12. North Korea, Economics Dictionary, 1985.

Young, Soogil, Chang-Jae Lee and Hyoungsoo Zang, 1998, "Preparing for the Economic Integration of Two Koreas: Policy Challenges to South Korea," in Marcus Noland (ed.), Economic Integration of the Korean Peninsula, Institute for International Economics, Washington, DC, Chapter 14, pp. 251-271.

Zang, Hyoungsoo, Chang-Jae Lee and Young-Gon Park, 1998, Preparing for Korean Unification: Agenda for International Cooperation with a Focus on International Financial Institutions, Policy Analysis 98-11, Korea Institute for International Economic Policy, December 1998 (in Korean).

Note

–Dr. Myung Chul Cho earned his Ph.D. in Economics from Kim Il Sung University, Pyongyang, North Korea. Before joining KIEP, he taught economics at Kim Il Sung University and Nam-Gae University, Tenchien, China. Dr. Hyoungsoo Zang earned his Ph.D. in Economics from Brown University. Before joining KIEP, he worked for the World Bank. Correspondence: 300-4 Yomgok-dong, Socho-gu, Seoul 137-747, Korea. Phone (822) 3460-1153; Fax (822) 3460-1212; E-mail hzang@kiep.go.kr.

1) Economics Dictionary, 1985, p.221 (North Korean publication in Korean).

2) For more details, see Young, Lee and Zang (1998).

3) For some practical proposals along the line, see Zang, Lee and Park (1998).