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DONG Yong-Sueng

The North Korean Economy Five Years Later

DONG Yong-Sueng

June 27, 2007

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Market forces and central planning are still colliding five years after North Korea implemented economic reforms. Under the reforms, Pyongyang cut government subsidies and encouraged producers to raise prices in order to more accurately reflect production costs. While these measures undoubtedly bolstered the planned economy over the short-term, the government failed to strengthen key supply mechanisms. As a result, the reforms unveiled on July 1, 2002 have codified the co-existence of a planned and market economy in North Korea.

I had a chance to visit Pyongyang in mid-June. At the capital's airport, I noticed a sharp difference to several years ago. Most surprising was far more North Koreans clearing customs with foreign goods, most of them from China. I also found a similar scene at the Pyongyang rail station near the Goryeo Hotel.

Likewise, commerce, in general, seemed to be more in the open with increased participation by the general populace. Both children and adults were enjoying drinks or ice cream on the street. In addition, cars with yellow license plates were running, most of which I learned were privately owned. Finally, I visited several processing firms where managers were seeking more orders and workers seemed to move enthusiastically, seemingly because they were paid based on performance.

Are the differences I observed in North Korea a direct result of the 2002 reforms? While things have certainly changed, in many ways the reforms simply formalized what already was occurring. The 2002 measures mandated firms to pay living expenses based on workers' performance. In addition, the measures also tried to ameliorate problems caused by the inefficient Public Distribution System. More specifically, the reforms were accompanied by the higher prices and wages and normalization of foreign exchange rates. Overall, these measures were designed to induce those who left work in the 1990s back into collective farms, factories and companies.

In reality, however, the measures have not affected a fundamental change in how the North Korean economy works, particularly in the supply of raw materials and electricity. North Korea's economy cannot afford to supply raw materials and subsidiary materials, and so has used its nuclear weapons program as a means to extract outside assistance. Two phenomenon, however, have intensified since the reforms.

First, the circulation of foreign currency in the North Korean economy has noticeably increased. With North Korea's economy traditionally shut off from the international economy, the amount of foreign currency used in market transactions is somewhat surprising. The use of the US dollars, euros and Chinese yuan in North Korea is related to a more vibrant export sector and the need to hedge against price instability. A revaluing of the North Korean won against the dollar was a major reason for the 2002 reforms. Moving from an official exchange rate gap of 200 times to roughly 10 times, government officials wanted to stabilize the currency. What has occurred, however, is that foreign currencies have become popular as a means to hedge against inflation.

At the same time, robust trade has heightened demand for foreign currency. Trade conducted with China is currently priced in either dollars or yuan. Traders are able to obtain foreign currency and purchase goods from China, ultimately selling the goods domestically (minus distribution costs) for a substantial profit.

Second, the reforms have marginally changed how firms operate in North Korea. Under the reforms, a majority of firms became responsible for worker wages as well as raw material and electricity costs. The main drawback to this plan, however, was the government's backward distribution system, which made it nearly impossible for manufacturers to purchase enough raw materials. In addition, manufacturers have trouble purchasing enough power to produce. Yet, more factories and companies are paying wages to their employees than before the reforms were introduced. Of course, because of still low capacity utilization rate producers who cannot afford to pay wages outstrip those which can.

In order to make up for the shortfall, firms are increasingly looking to import raw materials. Currently, starting a trading company in North Korea is quite easy after acquiring government approval. However, trading companies cannot import goods without dollars. Therefore, they attempt to link themselves with domestic markets and merchants to access foreign currency. Even a relatively large-scale trade is possible with factories procuring some of the necessary goods and merchants importing the remaining inputs. Factories short of foreign currencies borrow foreign currencies from merchants and use the money to import raw materials and pay production costs.

Some of the dollars coming into the hands of the government go out into markets because those trading firms have the right to exchange the dollar with North Korean won at official rates. A North Korean defector's testimony confirmed this system, explaining that the government's official foreign currency clearing houses exchanged North Korean won for dollars at the market exchange rate.

The North Korean authorities had hoped that adjustments in wages and currency would enable the official economy to re-establish itself as the main commercial channel. On the contrary, the 2002 reforms have reinforced and expanded the black market's influence as a key arena for connected merchants and government officials to capitalize on arbitrage opportunities. In short, the black market (market economy) conducted in foreign currency continues to encroach on the official, planned economy. Indeed, the government's inability to improve supply and distribution to enterprises has further motivated black market vendors to increase efficiency and product offerings.

In recognition of this fact, the government is moving to restrain the market economy. Goods imported from China are controlled and inspected. Prohibitive measures against rice trading and direct use of foreign currencies have appeared. In particular, the government has tightened its control on the economy after agreeing to dismantle its nuclear program in exchange for economic assistance.

The catchphrase, 'Revive the economy (build the economic power)' alone catches the eyes in the Pyongyang. Authorities view reinvigorating the supply capability of the central government as the best way to enrich the lives of the people. This necessitates providing energy and food, above all. It is imperative for the government, not individuals, to provide raw and subsidiary materials to factories and companies so that factories can operate. That seems to have led North Korea to ask for US$80 million worth of raw materials for light industry from South Korea and react sensitively to 400,000 tons food supplies.

In conclusion, I see the clash behind the market and planned economy in North Korea as a key event that will undoubtedly determine its future political direction. In order to deal with this problem, North Korea may have to enhance its economic cooperation with the international community.

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