Noland and Haggard: Kim Jong Il’s Palace Economy Is Broken

North Korea is a land made in the vision of John Edwards:  to a greater extent than almost anywhere, there are two North Koreas.  That division is even preserved by a semi-official, hereditary caste system.  That’s why it wouldn’t be completely accurate to say  that North Korea’s economy is near collapse; one of the North Korean economies — the peoples’ economy — collapsed  a dozen  years ago.  What was left of it was severely disrupted by the Great Famine, when hundreds of thousands of people left the gutted factories that no longer paid them to become fugitives in China, vagabonds in their own country subject to internment in so-called 9/27 camps, or corpses. 

Then there’s the palace economy:  the system of privileges, rations, and benefits that sustains the military, the party, and the system of control.  Its favors range from Japanese televisions and bicycles reportedly made in a prison camp in Chongjin to Mercedez S-Class sedans.  That’s the economy that sustains Kim Jong Il’s luxurious life and his grip on power.  Last year, I reported in exhaustive detail about how the palace economy was devastated by the  Treasury Department’s crackdown on the illegal proceeds that fuel it.  More recently, we learned the interesting fact that last year, the North Korean economy declined for the first time in years.  I speculated (see also, third item) that Treasury’s enforcement measures might have been a cause of this, a fact that the  original  South Korean report conspicuously did not bring up.  My theory now has some strong new support from two of the foremost experts on the subject.

In a new article for Newsweek, Marcus Noland and Stephan Haggard — fresh from their appearance on this humble blog — are also talking about the significance of those developments.  They believe that this time, North Korea really is ready to disarm and reform because it’s out of options, and because the absence of other options means that this time, we’re negotiating from strength:

We think we know why North Korea is softening, or at least appears to be. We’ve been working on an in-depth profile of the North Korean economy, and it is in serious trouble. The North Korean economy had been in weak but steady recovery since 1999, growing about 15 percent over the next six years despite its isolation and increasing backwardness. Then came a new setback. Last year the national income contracted by 1.1 percent, according to the South Korean government. Our research suggests the main reason for the downturn was that U.S.-led sanctions hit harder than most people realize. Now more than ever, North Korea needs the financial benefits of a nuclear deal to survive.

The sanctions struck a feeble economy from many sides. The United States led actions to shut down North Korea’s missile trade, and put the squeeze on its illicit smuggling and counterfeiting revenue. The black-market rate on North Korea’s currency plummeted after a small bank in Macau, central to the North’s money-laundering activities, was shut down. Japan effectively cut off a heavy flow of remittances to Pyongyang from North Koreans in Japan. We estimate that together with legal arms sales, revenue from contraband–including the production and trafficking of drugs, counterfeit cigarettes, smuggling of liquor and endangered-species parts, to name a few–may have accounted for as much as half of North Korea’s exports in the late 1990s but has fallen to roughly 15 percent in recent years due to sanctions. In the meantime, aid now finances 40 percent of imports. There are benefits to playing nice in the nuclear talks–or pretending to.  [Newsweek, Marcus Noland and Stephan Haggard, emphasis mine]

This article is  too fascinating and too significant  not to read in its entirety, even if I don’t agree with Noland and Haggard that North Korea has made a strategic choice to reform or disarm.  North Korea will remain true to form and try to hide as much as possible and change as little as possible.  Like all of the other announced “breakthroughs” with North Korea before this one, any still-unrealized reforms will only seek to recognize the economic realities that have already spun out of the regime’s control.  To the extent it recognizes them, it will only be to reestablish its control.

The  real question is whether it will succeed.  The more repressive the state, the more powerful the pressures for change that build within its society.  In North Korea, probably the most repressive state of all,  those pressures are potentially explosive.  Any relaxation of official control could spark that explosion, and Kim Jong Il knows it.  Yet as time passes, it becomes progressively more difficult and more expensive to contain those forces.  Who will pay for all that barbed wire and concrete?  Will it be us?

Kim Jong Il might have been forced to choose between utter bankruptcy and terminal reforms a decade ago, but South Korean aid allowed Kim Jong Il to choose neither.  I agree with Noland and Haggard that the palace economy is unsustainable without outside aid, and in the wake of this year’s floods, I don’t think that’s ever been more true.  So much depends on our next move, and that of Lee Myung Bak, South Korea’s presumptive next president.  A coordinated strategy between the two ex-allies — along with Japan — might just force the softest landing for North Korea that can be conceived. 

Or, we could decide to keep feeding this beast.