The ICAS Lectures

2011-1014-WBB

Prospects for North Korea's Adaptation of Chinese Style
"Reform and Opening-Up"


William B. Brown


ICAS Fall Symposium

October 14, 2011
United States House Rayburn Office Building Room B 318
Capitol Hill, Washington, DC 20515

Institute for Corean-American Studies, Inc.
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Biographic sketch & Links: William B. Brown

Prospects for North Korea's Adaptation of Chinese Style
"Reform and Opening-Up"


William B. Brown


It's a great topic, so great that I wrote a paper on it for CIA back in 1985. That paper is still classified but the title is not: North Korea Looks at Chinese Economic Reform, April 1985. The key word here is "looks". I was asked to write the paper since Kim Il Sung had just made trips to Russia and China suggesting some changes might be in the works. We assessed that Kim was grooming his son, Kim Jong Il, to be his successor and some thought that the father might be giving the son room to adopt Chinese style reforms but that in the end we thought these would be too dangerous to the regime and thus unlikely. Twenty-six years later the son, Kim Jong Il, is the one travelling to China and Russia, and the grandson, Kim Jong Un, waits at the Sinuiju train station. I think most of us would assess that the regime still is only looking at Chinese reforms.

This is not to say North Korea has not changed in the interim. Even by 1985 economic growth was slipping and weakness compared to South Korea was evident. But the collapse of the Soviet world had not yet happened and in some ways, particularly in heavy and military industry, and in electric power, North Korea was doing pretty well. The famine had not yet occurred nor the industrial collapse that preceded it. And on the other side of the Yalu, China's adoption of pro-market policies was still considered an experiment, although one that was, even then, beginning to work very well.

Other than the famine, the biggest change I've seen in North Korea over these years is the related collapse of the country's central planning system, or command economy, and its replacement by a half market, half command system that works badly, so badly that the population is continually under threat of starvation, rations for all kinds of commodities and services are unfilled, and net investment is probably negative-the country is eating up its capital stock. Inequities and irrational situations abound--much of the country's coal resources are under water since there is no electricity to pump the mines, the electricity shortage due to lack of coal to fire the power plants.

The best indicator of all of this change is the now widespread use of money-all kinds, North Korean won, Chinese RMB, Euros, and US dollars-in place of the command system's ration coupons. In some ways this most Marxist of all economies is paradoxically, one of the more "dollarized".

So again we ask the question; will the Kim regime adopt Chinese reforms, what the Chinese call "reform and opening up", and allow a legal market economy to develop, or will he give his son scope to do that once he is gone? "Not yet" is still probably the best answer. Nodong Shinmun a few weeks ago editorialized: "Reform and Opening much touted by the imperialists (Americans) and reactionaries (Chinese?) are not a remedy for the DPRK to weather its economic difficulties or to revitalize its economy". At least the official paper openly recognizes economic difficulties and the need to "revitalize" the economy-I believe using the same word Pak Chung He used in pressing his reform package on South Korea in the early 1960s. And the fact that it even mentions the reviled "reform and opening" construct in public media is probably a positive sign. All of this should pique our attention.

"Reform and Opening" Defined

Digging deeper we need to understand what they, and we, mean by "reform and opening" (kaehyok and kaebal in Korean, gaige and kaifang in Chinese). The important word here for me is "reform"; "opening up" is of secondary interest. Many of us naturally focus on the latter since it relates directly to our relationships with North Koreans but we make policy mistakes if we assume opening, under their terms, will lead to reform. It is clear in this context the North Koreans and Chinese take "reform" to be the development of a capitalist or market economy since that word was at the center of an ideological debate that occurred in China in the late 1970s over the pricing system. "Reform" was juxtaposed to "readjustment". China's planners and conservatives at that crucial time pressed only for a periodic "readjustment" of planned prices whereas the reformers became ever bolder in their arguments for "reform of the price system" meaning they would allow the competitive forces of supply and demand, rather than the plan, dictate prices, wages and, ultimately, interest rates. (The latter being the last impediment to China becoming a full-fledged capitalist economy.) So when Chinese or North Koreans speak of "reform" they mean establishing a capitalist market economy, and for that reason the word kaehyok is largely forbidden in North Korea. Professor Andrei Lankov tells me that Japanese press says that first son, Kim Jong Nam, used it in a conversation in his Macao sanctuary last February, indicating he is in favor, so it is interesting that the word seems to be gaining just a little traction among North Koreans. Again it's a matter we need to keep notice of.

Opening up is another matter. Kim Il Sung's North Korea opened up to western trade and investment in 1972, before China did, probably because of worries that the South was getting a big economic lead aided by Western investment. No market incentives existed in North Korea, however, so the billions of dollars of investment-mostly West European and Japanese--were poorly utilized and created insufficient exports to repay the debts. By 1976 the country had entered a disastrous default from which it has never really recovered. As with any debt default, much of the blame should be laid at the hands of opportunistic lenders, along their government insurers, who may have thought their friendly actions would help induce North Korean reform but which instead ostracized North Korea, closing it off from further credit and reform for at least a generation.

This pattern was replicated in the 1990s and 2000s with South Korean, Chinese, and US aid and investment-by that time the Europeans, Russians, and Japanese had learned their lessons and had essentially quit non-cash trade with North Korea. North Korean diplomats deserve Oscars for their remarkable record finding na´ve new friends who have wanted to "open" North Korea and in contriving all kinds of scams to scare outsiders into giving. Even as Kim Jong Il toured Eastern Russia last month, KCNA broadcast the regime's ambition of "flinging open the gate to a thriving nation in 2012, without fail." i Part of Kim's ambition now, apparently, is to seal a deal by which South Korea will invest in a natural gas pipeline from Siberia through North Korea. But on the day the Russian protocol was inked, North Korea expropriated and expelled South Koreans trying to preserve something of their half billion dollar investment in Kumgangsan. And less noticed was a Russian announcement that talks would open again on the issue of North Korea's multi-billion dollar debt to the former Soviet Union. If only "opening the gate" to investment and trade were so simple.

A Double Trap

The Figure below captures North Korea's economic dilemma as I see it. I used it in a Korea Economic Institute article earlier this year so some of you may have seen it before. The vertical axis represents economic efficiency, let's say productivity of capital and labor, and the horizontal axis represents the economic system, moving left to right from a command systems to liberal markets. In my view, and I think most would agree, a command system can create some efficiencies but much less than is created by a liberal market system. The tails though, slavery to the left or anarchy--and thus no division of labor--on the right, are probably worse. I like to say the left side is "rule by ration" and the right side is "rule by money"; money no doubt works best. But the largest problem for North Korea is the indeterminate middle where money and rations collide making for a disorderly and inefficient multiple price system. Additionally I have positioned a "poverty trap" line on the graphic indicating the level below which productivity is so low that everything is consumed with nothing left over to save and invest. When caught in a poverty trap a country, or a person, needs external assistance, external investment, or a big change in the way it functions-what economists call technological change-in order to climb out. North Korea, I assess, since the mid-1990s famine, has been in the unfortunate void between the two economic systems and as a result has been stuck in a poverty trap which, despite a large amount of foreign aid , it has not emerged. In theory, however, the country's position still is not hopeless. Lowering government consumption- especially military and security spending-would probably give it a small investable surplus. A bigger boost, as seen with China's reforms, would come from moving sharply to the right, allowing private incentives to give an efficiency boost. That, of course, is the way all of us see it. But the big problem is that a North Korean leader might look the other way and with some credence sense that a move to the left, more control, also would improve economic efficiency and without the risk of revolution of a move to the right.

It is apparent that what we have been observing over the past three decades have been movements back and forth in the middle of this graph with insufficient momentum being generated to either reestablish a working command economy or pressing forward far enough to build a working market economy. Crises arise from time to time-the 1994 famine, the 2002 price reform, the 2005 retrenchment, and the 2009 currency crisis-all of which have tended to turn the economy back in the other direction. Whenever the regime has been on the verge of losing control, and thus allowing a big shift to the right, Pyongyang has engineered large inflows of foreign aid, given to the central government, that have given it just enough resources to fill rations and push back to the left and against the markets. But whenever Pyongyang pushes too hard toward its regimented planned system-for example, the 2009 effort to create a "great leap forward" by putting hundreds of thousands of workers into a forced industrial march, culminating in the currency swap fiasco-productivity snaps and starvation and fuel shortages loom. Simply put, the state enterprises' and farming cooperatives' efficiencies are so low, and expenditure on the military is so high, that without a working plan the system cannot produce enough food or fuel for its people so the natural market economy keeps coming back.

An example of the confusion is the provision of electricity. The Marxist system prices electricity very cheaply since the price does not incorporate the large capital costs inherent in power production and in mining. So if one has access to electricity via the plan it is essentially free but if not there is no way to buy it off the grid. This means a firm with a plan allocation and an available, though illegal, market, will take advantage of its electricity to produce and sell electricity intensive goods at a big profit while ignoring distribution to other plan entities- for example, the coal mines that need electricity to power their pumps, since the plan's electricity prices are so low. This misuse of the plan, of course, ultimately means the power plants don't have enough coal and other state factories close for lack of electricity. The public, moreover, has to turn off its lights. The streets and alleys of Pyongyang might look rather dynamic since we see enterprising establishments, in this case using their free power allocations to charge automobile batteries, imported from China, and sold to wealthy citizens who use the batteries to run their TV sets but on a nationwide scale, across all industries, the corruption of the plan in this way by the market has virtually closed the country's once powerful steel, nonferrous metals industry, chemicals, and machine building industries. Just visit the Chongjin Kimchaek integrated steel mill complex, once one of the largest in Asia.

Irrational prices prevent integration with global economy

"Opening" the country to the world market economy in a situation where domestic prices are as irrational as they are in North Korea can create a semblance of reform but easily can lead to perverse and crippling decisions. This year, for example, we are seeing a large increase in Chinese purchases of North Korean anthracite coal. In the absence of sufficient foreign food aid, and insufficient rations, North Korean enterprises may be responding by increase exports and buying foreign grain, and these coal exports may thus be a sign that the economy is responding in a positive manner to market incentives. On the other hand, given the irrationality of the country's electricity prices, it is quite possible that the coal exports may be further exacerbating the country's electric power shortages. Which do they need more, earnings from coal export used to import grain or coal supplied to power plants to produce manufactured goods that could be sold for export, nonferrous metals for example? No one really knows, least of all the officials and entrepreneurs making these decisions. A richer country might be able to afford some of these inefficiencies. With North Korea already below the poverty trap line, any further inefficiency leads to real deprivation and even starvation of the people.

The world economic trading system has a remedy for this situation. It is known as the World Trade Organization and almost all countries in the world are members or are seeking membership. Within the WTO, countries generally are not allowed to discriminate in their tariff treatments and tariffs generally have been reduced to very low levels. A condition of membership, however, is the existence of market mechanisms that ensure prices are rational and not distorted by government planning. For trade with countries outside the WTO umbrella, much higher tariffs are allowed and are in fact needed to ensure trade is both efficient and fair. China went through an exhausting ten year period of negotiations with the WTO before surprising everyone and agreeing to far more price rationalization than anyone had expected, and finally joining on December 11, 2001. North Korea tried hard and successfully with the Bush administration to get itself removed from the US Trading with the Enemy Act, thus removing a major obstacle to overcoming an automatic US veto of its membership and eventually receiving normal instead of prohibitive tariff treatment from the important US market, but the Kim regime has, perhaps unsurprisingly, not taken advantage. One of the first and perhaps best indicators that Pyongyang had indeed decided to move ahead with reform would be just such an application.

Tilting left, now right?

Several shocks in 2009 and 2010, which may have been associated with Kim Jong Il's 2008 stroke and the beginnings of a leadership succession process, culminated in such a disaster for the economy that the regime now appears to have relented and is allowing a shift further to the right than we have seen in a long time. It may not have much choice. The December 2009 currency debacle opened the door to loss of confidence in North Korean money and an invasion of foreign currency into North Korean markets, followed by military misadventures with the Choenan and Yongpyongdo incidents which dried up foreign aid, has left the regime without the resources to supply the ration system. Pyongyang, surprisingly, has been able to get a grip on inflation but probably at a cost of not giving state enterprises the funds they need to pay living wages so that firms, workers and the public increasingly depend on market activities. "Dollarization" may be the regime's biggest worry as it threatens to drastically weaken its economic and social controls. This, and increased political and economic interactions with China is leading to much discussion of Chinese reforms.

It is hard to be too optimistic about North Korea taking that risky reform path, however, since in the past it has been able to find ways to push back toward the left. The easiest way for it to do this is to create an atmosphere of tension, as it did with the Cheonan sinking, pull back from the brink creating an atmosphere of relief that induces an inflow of foreign aid, and then using that aid to again clamp down on markets. It is a seeming endless cycle that has worked well for the regime but terribly for the economy, leaving it without a functioning economic system. Moreover, anyone looking closely at China's reform path will see what looks to be possibly insurmountable obstacles for the regime's pursuit of the same strategy.

China's policy toward North Korea is one of rather gentle prodding toward economic reforms. As other trade partners have fallen off over the years, China has come to dominate North Korean trade and investment, leaving only South Korea as a significant alternative, and trade this year is growing rapidly. Most importantly for the North is China's contribution of about 600,000 tons of crude oil a year, a rather steady flow of about 12,000 b/d, since the 1990s. This constitute all of North Korea's crude oil supply and is provided under a long term low interest loan that Pyongyang manages to never repay. Whereas the West argues this gives China leverage it should use to push North Korea toward reform, the Chinese claim such strategic aid is beyond discussion, as China will never allow North Korea to stumble so badly as to become unstable. This may be true but it also may be true that many Chinese really don't want North Korea to reform, seeing the status quo-a weak and poor North Korea that is dependent on China-as in Beijing's interests.

Still, economic problems in China's northeast and the large Korean population there argue for a more dynamic trade relationship especially as the border has become more porous and -with markets now on both sides of the Yalu and Tumen rivers-border trade is growing rapidly. Cross border and internal to North Korea cell phone service is helping this greatly. Beijing's official policy toward North Korea, moreover, is one we can all agree with and is rooted in the phrase , enunciated by Foreign Minister Yang Jie Chi in mid-2007, that with respect to trade and investment with North Korea: "Governments guides; the private sector participates; markets operate; everyone wins" ii

Kim Jong Il and his leadership circle must cringe at such words but the regime is tolerating a great deal of private market activity. Some visitors remark, for instance, that most of the consumer products seen in North Korean markets are made in China, and RMB circulates widely inside North Korea.

Differences with the China of 1978

Chinese economists looking at North Korea, moreover, assume an inevitability that North Korea will eventually follow in China's path and point to the development of markets and the use of money as strong indicators. They like to say that North Korea is as China was in 1978, when Deng Xiao Ping's revolution was beginning to sweep Chinese communal farming system off the map, leading to vast expansion of commercial activity and soaring productivity of labor and capital. One problem, however, is that Chinese have been using that date for ten years now, suggesting not much further progress in North Korea. They agree they see no evidence of the critical second step (1979-1983) in which private agricultural production rather suddenly took over China's vast interior and the collective system was dissolved. It is something to look for in North Korea-dissolution of the vast state farms and collectives would no doubt release a huge outpouring of individual productivity.

Several other important differences with China of the 1970s need to be pointed out: Does North Korea have a Deng Xiao Ping?

Given these differences it is tempting to give up on the Kim Jong Il regime, and by extension, its approved successor. Professor Lankov, for example, last month gave just such a speech here in Washington saying only an internally produced revolution will reform North Korea, and it was pretty convincing. What are the factors then, if any, short of revolution, that could shove this regime- meaning the Kim family and the ruling elite-sharply to the right? Clearly they have to see such reform in terms of their own private interests-either negative in the sense that otherwise they fear they will find themselves like other discarded regimes throughout the Soviet and now Middle Eastern worlds, or positive in the sense they can see private benefits flowing to them as the result of market reforms.

China's experience should cause us to consider the possibility that the North Korean regime might engineer a successful transition to a more productive market oriented economy. In the Maoist system, as with North Korea today, virtually all real property was owned by the state and administered by the Communist Party. With Deng Xiao Ping's leadership, much of this state and communal property was gradually transferred to private ownership and the political elite, that is Communist Party officials, often were the great beneficiaries. By now enough new private property is being created that the Party is no longer so dominant but the divestiture of the state's assets probably provided just enough political support from the Chinese political elite to keep the reforms on track. In other words the Communist Party leadership purchased reform by selling off state assets and thus avoided a political revolution.

So the question becomes whether or not Kim Jong Un and the elite among the Worker's Party could do something similar. The concept begins with the fact that the North Korean state, while financially bankrupt, is more illiquid than it is insolvent since it still owns virtually all the property of the country, both real and financial. Moves to liquidate some of this property-say in the sale of apartment units to workers in lieu of wages-could help Pyongyang balance its budgets and restore some faith in the currency. More importantly, it could allow a massive downsizing in collective farms, giving individual families production rights as Deng Xiao Ping allowed in China in the early 1980s, setting up a huge gain in farm productivity. Moreover, Pyongyang so far has retained a strong licensing ability-by fiat the Kim's can award, or sell, restrictive trade and production licenses to private interests that can quite quickly amass millions of US dollars in profits-especially given their lack of competition within North Korea and their huge wage advantages over producers in neighboring China, South Korea, Russia, and Japan. Pyongyang could keep some control over these firms and by creating rival enterprises and families-much like as occurred in South Korea-so as to diminish any one firm's economic power. These rivalries, again as with South Korea's chaebol, would create huge economic efficiencies and strong economic growth still tied to the structures and authority of the Pyongyang government.

We see a little evidence that this is beginning to happen spontaneously and from grass root levels but with little or no guidance from the top, and for that reason it is hard to be optimistic. In conversations with Chinese about economic reform, one thing we always end up agreeing upon; the essential role that Deng Xiao Ping performed in guiding the country through a risky and difficult process. Pak Chung He may have been of similar importance to South Korea. But if there is a similar person in North Korea he, or she, is hiding pretty well. Certainly young Kim Jong Un gives every appearance, so far, of being just like another one of Mao's "Gang of Four" reactionaries. So, at this point, as in 1985, I'd say we are still looking for North Korea reform but not seeing it, yet.




1 Bill Brown, ICAS Fellow, is retired from a career in the US Civil Service and serves on a full time contract as Senior Advisor to the National Intelligence Managers for East Asia and North Korea, Office of the Director of National Intelligence. This paper was drafted for oral delivery at the ICAS Fall Symposium in Washington D.C.,

October 14, 2011. Comments are welcomed and can be addressed to wmbbrown@hotmail.com.

i Open Source Center KPP20110822971140, KCNA in English, 1048 GMT 22 Aug 2011.

ii "Zengfu yindao, shirchang yuzuo, cuiye wei zhu, huli gongying" Open Source Center, 30 July 2007





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