7 2000 special reports and integrationthe asia paciﬁc region and the united states. special...

Number 7

December 2000

M A R C U S N O L A N D

The two Koreas have embarked on

a process of national reconciliation,

but the starting points are not auspi-

cious. South Korea is still grappling

with the aftershocks of the 1997–98

financial crisis, while North Korea’s

economy has experienced a decade

of decline. Both governments are

officially aiming for a “one nation,

two systems” outcome, but the

North could collapse before this is

completed (or one side or the other

could attempt a forcible unification).

Central to the prospects for peaceful

coexistence are three questions: is

North Korea willing to change, is it

capable of successfully managing

change, and to what purpose would

it apply the fruits of change?

THE TWO KOREAS :

PROSPECTS FOR

ECONOMIC COOPERATION

AND INTEGRATION

SP

EC

IAL

RE

PO

RT

S E A S T- W E S T C E N T E R

E A S T- W E S T C E N T E R S P E C I A L R E P O R T S

The East-West Center is a publicnonprofit educational and researchinstitution located in Honolulu,Hawaii. Established by the U.S.Congress in 1960, the Center’smandate is to foster mutual under-standing and cooperation among thegovernments and peoples of the AsiaPacific region, including the UnitedStates. Principal funding comes fromthe U.S. government, with additionalsupport provided by private agencies,individuals, corporations, and morethan 20 Asian and Pacific govern-ments.

East-West Center Special Reportspresent a thoughtful synthesis ofknowledge on issues of importance tothe Asia Pacific region and the UnitedStates. Special Reports are authoredby scholars, journalists, and othercommentators. They are intended forthose who make or influence policydecisions in the United States, Asia,and the Pacific, including educators,scholars, journalists, business people,and individuals with a broad interestin Asia or the Pacific.

The views expressed in this publica-tion are those of the authors and donot necessarily reflect the views of theEast-West Center.

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E A S T-W E S T C E N T E R S P E C I A L R E P O R T S

Number 7

December 2000

THE TWO KOREAS :

PROSPECTS FOR

ECONOMIC COOPERATION

AND INTEGRATION

MARCUS NOLAND

C O N T E N T S Summary 2

Korean Reconciliaton: Recent Developments and Prospects 3

The Dream of Consensual Unification 4

Compromise and Reform Required 6

Challenges of Large-Scale Reform 8

What is the State of North Korea’s Economy? 10

Famine and the Difficulties of Accurate Evaluation 12

North Korean Coping Strategies 13

Elements and Effects of Economic Reform 13

Collapse is Possible 19

Preparing for Reunification—or Collapse 20

Fiscal, Military, and Social Considerations 21

Privatization, Chaebol, and Reparations 21

North Korean Interests and Intentions 23

Difficulties of Prediction 23

Policy Implications 24

Imperatives for South Korea 25

Conclusion 25

Endnotes 26

References 27

E A S T-W E S T C E N T E R

1601 East-West Road

Honolulu, Hawaii 96848-1601

2


S U M M A R Y

Marcus Noland is a

senior fellow at the

Institute for Inter-

national Economics

and an associate of

the International

Food Policy Research

Institute. He wrote

this report while at

the East-West Center

as a POSCO fellow.

His most recent book

is Avoiding the Apoc-

alypse: The Future of

the Two Koreas.

After nearly a half century of strident adherence to the principles of socialism and self-reliance,

North Korea may be on the verge of opening itself to outside aid and advice. Motivators include a

decade of economic trouble punctuated by declining output and famine as well as underdeveloped

infrastructures and reduction in foreign trade and material support. The limits of national self-

sufficiency may finally have become admissible in North Korea, as evidenced by recent diplomatic

negotiations and cooperative commercial projects with capitalist nations.

South Korea, meanwhile, is struggling to regain ground lost in the financial crisis and to correct

faults in its own political and economic systems. Among these is a history of military dictatorships

and extensive government involvement in economic planning. Free elections supplanted the dicta-

torships in 1987, and South Koreans subsequently have had the benefit of an increasingly open

political forum. As for government involvement in the economy, there has been a slow but steady

disengagement over the last two decades in favor of market-driven controls, although the trend

may have abated recently due to the uncertainties accompanying progress toward reconciliation.

Hindrances to further progress include North Korea’s reliance on military exports for revenue

and its reluctance to accept “capitalist” aid. Free exchange of information and reliable indications

of intent are still the exception to the rule in North Korea. Ideological volatility in both nations

presents another obstacle. Each involved nation has a vital interest in peaceful, expanded rela-

tions, but competing ideologies and old animosities must be overcome in the interest of mutual

advancement.

Surprisingly, current prospects for reconciliation, and perhaps reunification of the two Koreas,

seem better than ever. This can be attributed in part to new leadership in both nations. South

Korean President Kim Dae-jung has called for peaceful coexistence. He also has supported the

provision of aid and establishment of diverse bilateral economic projects. North Korean President

Kim Jong-il seems to have been accepted by party leaders, the military, and the citizenry. In this

more stable environment, denunciations of non-socialist nations have lessened, both from Kim

and the North Korean media. Kim has also overseen the normalization of relations with other

nations, while North Korea’s foreign minister has said his nation could consider a “one country,

two systems” model similar to Hong Kong and China.

In this light, South Korea’s investment strategy should emphasize tax incentives rather than

state-directed investment in the North to assure that efficiency guides decision-making. Further

progress will be best served if North Korea allows expansion and diversification of cooperative

projects, now few and tightly controlled; the ideal would be free investment throughout the North

by South Korean firms.

3


KO R E A N R E C O N C I L I AT I O N : R E C E N T D E V E L O P M E N T S A N D P R O S P E C T S

North and South Korea have embarked on a pro-cess of national reconciliation, but the startingpoints are not particularly auspicious. SouthKorea continues to grapple with the aftershocksof the financial crisis that shook the country in1997 and 1998. For a decade the economy ofNorth Korea has been in a state of decline. Itspolitical system experienced a shock with the1994 death of founding leader Kim Il-sung andthe accession to power of his son Kim Jong-il.In the face of these problems, North Korea haspursued two coping strategies. The first has beenstand-alone projects meant to generate foreignexchange without affecting the systemic organi-zation of the economy. These would include theRajin-Sonbong special economic zone and theMt. Kumgang tourism project. The second hasbeen the use of implicit or explicit threats in de-veloping nuclear weapon and missile capabilitiesin order to extract resources from the rest of the

world. The 1994 Agreed Framework betweenNorth Korea and the United States has resultedin the establishment of a multinational consor-tium to build the North two light-water nuclearreactors and provide heavy fuel oil during theperiod prior to completion of the reactor project.Brinkmanship has been used to extract addition-al resources from the world community in theguise of humanitarian aid for the North’s foodproblems.i Indeed, North Korea is now thelargest recipient of U.S. aid in Asia.

This strategy of minimal economic reformcombined with opportunistic resource extrac-tion may have begun to change in the aftermathof North Korea’s missile non-test in 1999.ii InAugust 1998, North Korea fired a multistagerocket over Japan. Ironically, this missile test,together with the proactive reconciliation poli-cies toward Japan pursued by South Korean Pres-ident Kim Dae-jung, contributed to a greatlystrengthened trilateral relationship among theUnited States, Japan, and South Korea. This wasmanifest in the September 1999 policy review

North Koreans walk

through the Suck Jang

Moon gate during a

sightseeing tour of

Changdokkung Pal-

ace in Seoul, South

Korea, August 17,

2000. They are among

100 North Korean

people selected for a

four-day reunion with

family members in

South Korea. The re-

union resulted from

the historic inter-

Korean summit in

June 2000.

4


led by former U.S. Defense Secretary WilliamPerry, and in a series of self-reinforcing actionsby the three allies beginning in August 1999,when the North Koreans began a buildup to asecond missile launch while demanding com-pensation from Japan. The Japanese did notblink, refusing to pay what amounted to an ex-tortionist’s ransom. Having been stiffed by theJapanese, the North Koreans in essence chosetheir next best option: to re-engage in negotia-tions with the United States over their missileprogram. Those negotiations yielded a NorthKorean moratorium on testing in return for alifting of U.S. economic sanctions—but no sig-nificant monetary compensation. Having failedto extract significant financial commitmentsfrom either Japan or the United States, the NorthKoreans were forced to turn to South Korea, re-starting the lapsed North-South dialogue, whichthe United States had made a precondition fornormalization of relations in the 1994 AgreedFramework.

The last several months have witnessed aflurry of North Korean diplomatic activity, in-cluding normalization of relations with a num-ber of countries, culminating in the June 2000North-South summit. These developments raisethree questions. First, having consolidated powerinternally, do the events of the past year heralda fundamental strategic reorientation on thepart of a newly confident Kim Jong-il, or is thissimply an elaborate tactical maneuver? If theanswer is affirmative—that is, these develop-ments signal a fundamental change on the partof the North Koreans—are they capable of suc-cessfully reforming their system? Finally, sup-pose the North Koreans do successfully reformtheir economy. What are their ultimate inten-tions? To what purpose would the gains fromeconomic reform be applied—to the pressing ma-terial needs of the North Korean people, or toother purposes such as military modernization?

Issues of economic integration and coopera-tion cannot sensibly be discussed without an-swering these questions, and to preview thisreport’s conclusions, it will be argued that theavailable evidence is ambiguous and, as a con-sequence, the circumstances under which eco-nomic integration and cooperation could take

place are quite varied. For the sake of concrete-ness, this report will focus on two possibilities.The first is national reconciliation through aprotracted negotiated process yielding some kindof confederation, or “one nation, two systems”outcome. This is the official preference of boththe North and South Korean governments asreaffirmed in the June 2000 summit.

The other option, of course, is the collapseof North Korea and its absorption into SouthKorea along the lines of the German experience.These two options are neither exhaustive normutually exclusive: The two states could enterinto a consensual process of reconciliation andthe North could collapse before this was com-pleted, or one side or the other could attempt aforcible unification. Nevertheless, the dichoto-my is useful for illustrating the effects of unifi-cation, as well as some alternative conceptionsof the economic precursors to unification.

The Dream of Consensual Unification

Both North and South Korea have expressed adesire for a consensual unification of the pen-insula. Kim Dae-jung has repeatedly indicatedhis disinterest in undermining the DemocraticPeople’s Republic of Korea (DPRK) and has in-stead called for peaceful coexistence.1 In his 2000New Year’s message, he called for commence-ment of installation of the core components ofthe promised light-water reactors, developmentof industrial estates on North Korea’s YellowSea coast, expansion of the Mt. Kumgang tour-ism project, increase in processing on commis-sion trade (the primary modality for inter-Koreantrade),2 and improvement in transportation sys-tems linking the North and South.

Three months later in his “Berlin Declara-tion” of March 2000, President Kim indicatedthat the South Korean government was willingto directly support the economic rehabilitation

Both North andSouth Koreahave expresseda desire for consensual unification ofthe peninsula

1 Kim’s engagement policy is not without its detractorsin South Korea. In a recent survey done by the Ministryof Unification, almost 60 percent of respondents indicatedthat progress on inter-Korean relations has been “on thefast side.” Presumably, Kim’s October 2000 receipt of theNobel Peace Prize will strengthen his hand domestically,at least in the short run.

5


of the North. Prior to the June 2000 summit,South Korea sent to the North 200,000 tons offertilizer, valued at roughly $60 million,3 andafterward sent another 100,000 tons. “Economiccooperation” was identified as one of the priori-ties for action in the June summit declaration,and working-level groups, operating along thelines specified in the 1991 Basic Accord and Sup-plemental Agreement, have begun negotiationsrelating to settlement of payments, investmentprotection, avoidance of double taxation, andarbitration of disputes. South Korea put forwarda plan for federation at the summit; this unifica-tion plan is gradual in the extreme, envisioninga process of unification lasting two generations.

For its part, North Korea has proposed a Con-federal Republic of Koryo to be governed by anational assembly consisting of an equal num-ber of representatives from North and South Ko-rea.iii The statement in a 1999 meeting at theCouncil on Foreign Relations by North KoreanForeign Minister Paek Nam-sun that North Ko-rea could consider a “one nation, two systems”model along the lines of Hong Kong and Chinacould be interpreted as a signal that North Ko-rea was open to this kind of engagement. SouthKorean National Intelligence Service head LimDong-won told a press conference in June 2000that the Korean Workers Party intends to re-move the section of its charter stating that “ourparty’s immediate objective is to complete na-tional liberation under a revolutionary people’sdemocracy and to build a juche society undercommunism.”4 Lim’s comment signaled a sym-metric scaling back of unification ambitions.

In a formal sense, one can imagine a series ofprogressively deeper steps of cooperation and in-tegration that the states could undertake. Thefirst steps presumably would be completion ofthe aforementioned agreements to create a legalframework for exchange between the two coun-tries, and perhaps some state-led “economicconfidence-building measures.” In the latter cat-egory, Kim Dae-jung has already expressed in-terest in opening two rail lines (one along theeast coast and one along the west).5 In econom-ic terms, South Korea today is effectively an is-land, and the successful opening of trans-NorthKorea rail links would allow South Korean firmsto transport goods to continental Asia, and ulti-mately to Europe, over land. These developmentswould promote economic exchange led by theprivate sector and economic integration betweenthe two economies, and would contribute toregional integration more generally.

Once basic economic exchange has been reg-ularized between the two countries, the nextformal step in economic integration would beformation of a free trade area, liberating tradebetween the two Koreas but permitting eachto restrict trade with third parties according totheir own interests. This would be equivalentto the North American Free Trade Agreement(NAFTA) in which trade is unencumberedamong the United States, Canada, and Mexico,but each country maintains its own trade poli-cies with respect to nonmembers. Even this firststep would appear to be far beyond anythingthat can be seriously expected in the mediumterm. The next step would be formation of acustoms union, which would involve applyinga common policy to trade conducted with thirdparties. This would be akin to the EuropeanEconomic Community.

South Korea’sunification planis gradual in theextreme, lastingtwo generations

2 Processing on commission, common globally in indus-tries such as apparel, electronics, and packaging, is usedto exploit cheap labor costs. It occurs when a firm sup-plies a factory (in this case a South Korean firm and NorthKorean factory) with all inputs, and the factory simply as-sembles (processes) the product. Because North Korea soseverely circumscribes foreign managers’ contact withNorth Korean workers, processing, rather than more com-plex fabrication activities, is about all that has occurredto date.

3 All uses of “$” or “dollars” in this report refer to U.S.currency.

4 Juche is a political philosophy espoused by North Koreanfounding leader Kim Il-sung that emphasizes national au-tonomy in all matters, including economics.

5 Discussions reportedly have already begun with respect toclearing mines from the demilitarized zone in order to es-tablish the rail links. It also has been reported that at theOkinawa G8 summit, Russian President Vladimir Putinasked Japanese Prime Minister Yoshiro Mori to cooperateon the east coast rail line, which could link Russia andSouth Korea.

6


Economic union would be a deeper form ofintegration, permitting the free movement offactors (labor and capital) as well as goods acrossborders, as exists today in the European Union(EU). A monetary union would involve adoptionof a single currency, as is taking place in someEU member states today. A social union wouldinvolve adoption of common labor and socialwelfare policies in the two states. The final stagewould be political union and the surrender of in-dependent claims to sovereignty. The EU hasmanaged to create an economic union and is inthe process of forging social and political union.Within this schema there are differing degreesof surrender of local authority to central govern-ments. Indeed, given the highly centralized na-ture of the governing systems of both North andSouth Korea, issues of local autonomy and con-trol would presumably be very contentious underany unification scheme.iv

Compromise and Reform Required

Thus the prerequisites for consensual unifica-tion would be maintenance of two independent

states and a sufficient degree of convergence ofeconomic and political practices to make theoutcome plausible. In the case of the two Koreas,this would mean generating sufficient reform inNorth Korea’s economic and political systemsto make some degree of integration with theSouth sustainable.

The April 2000 North-South summit an-nouncement stunned the world. The timing—three days before the South Korean national as-sembly elections in which Kim Dae-jung’s partytrailed in the polls—raised questions aboutwhether this rapprochement was genuine, orwhether it might be no more than a tacticalmove on the part of the North Koreans timedto extract maximal concessions out of an elec-torally weak Kim Dae-jung, and to buy someinsurance against a possibly harder-line U.S.administration taking office in January 2001.Skepticism was fed by North Korea’s history ofextorting resources from foreigners to secure itsparticipation in diplomatic activities, and bySouth Korea’s history of “checkbook diploma-cy,” most notably in the process of normalizing

A South Korean K1

army tank shows off

its landmine-clearing

capabilities in a de-

monstration staged

in Paju county, South

Korea, close to the

Demilitarized Zone.

Mines will have to be

removed before North

and South Korea can

re-link a railroad line

and build a road

across the DMZ,

something the two

sides agreed to do

following the June

summit.

7


relations with the Soviet Union. Given the Ber-lin Declaration and Kim Dae-jung’s willingnessto directly underwrite economic rehabilitationof the North, many continue to speculate aboutwhat Kim Dae-jung may have promised theNorth in order to secure the pre-election sum-mit announcement.6

In this light, the first question is whetherthe North Koreans are serious about pursuing,at a minimum, economic reform or whether thediplomatic activity of recent months amountsto an elaborate feint undertaken, in effect, todiversify the nation’s aid donor base.

The evidence on this point is mixed, but oneindication can be adduced from North Koreanstatements. For the past decade the North Ko-reans in general (especially in writings or state-ments attributed to Kim Jong-il) have been ab-solutely scathing in their denunciations of thereforms undertaken in Eastern Europe and theformer Soviet Union, which have been likenedto “germs,” “mosquitoes,” and other vermin tobe kept at bay and as “honey-coated poison.”

In 1994, the North Koreans went so far as tocall the Chinese “traitors to the socialist cause”until their own worsening situation and grow-ing dependence on China made it prudent totone down the rhetoric. During the 1999 visitto Beijing by Supreme People’s Assembly leaderKim Yong-nam, the two countries adopted an“I’m OK, you’re OK” formulation in which theyagreed to pursue socialism according to theirrespective national characteristics.

The language used during Kim Jong-il’s May2000 pre-summit visit to Beijing was very dif-ferent, however. In remarks widely broadcast inChina and reported in the international press,Kim noted the “great achievements of openingup the country” by Chinese reformer DengXiao-peng, and announced that North Korea“supports the reform policy pursued by theChinese side.” These comments suggest notonly a new receptiveness to economic reformon the part of the North Koreans, but also the

possibility of the Chinese assuming their naturalrole as mentors in this regard.

That said, Kim’s remarks have not been re-ported in the North Korean press and, indeed,the week after Kim returned from China, NorthKorean television rebroadcast the “opening” as“a Trojan horse tasked with destabilizing social-ism”v editorial, which some have interpreted asindicating that Kim’s Beijing remarks were in-sincere and/or made under economic duress.This evaluation may be too harsh. It is probablynaive to project onto Kim Jong-il the belief thata firewall can be maintained between statementswidely broadcast in China and elsewhere, andstatements that reach the North Korean elite.Moreover, politically it is hard to imagine thatKim could travel onto foreign soil and then, ineffect, announce that the economic policy under-taken by his deified father over the previous 50years was flawed. Rather, it is more likely thatthe North Koreans are searching for a face-savingway to introduce these ideas into domestic dis-course. Admittedly, however, this is speculation.All we know for sure is that Kim Jong-il trav-eled to Beijing and made a series of statementsat odds with longstanding North Korean posi-tions, and these remarks have not been reportedby the North Korean media.

Another indication of North Korea’s intentcan be adduced from North Korean actions. Themost prominent example of North-South eco-nomic cooperation has been a contract thatHyundai signed with Pyongyang to develop thetourism potential of Mt. Kumgang and to buildan industrial park. Although the Mt. Kumgangtourism project understandably has attractedthe most attention, the provision for Hyundaito construct an industrial park may have moreeconomic significance in the long run. Estab-lishment of the industrial park has been delayedby a dispute over the proposed location. KimJong-il reportedly has expressed a preference forShinuiju over Haeju, despite the latter’s greaterattractiveness as an economic hub. Some haveargued that the choice between Haeju andShinuiju will signal whether economics or pol-itics are driving policy.vi The announcement inAugust 2000 that the facility would be located atKaesong would seem to suggest that economic

North Koreawants a face-saving way tointroduce theidea of reforminto domesticdiscourse

6 South Korea has indeed been generous with assistancesince the summit, providing the North with 500,000 tonsof food aid in October 2000, and reputedly also with cash.

8


rationality is beginning to assert some predomi-nance over political symbolism. The possibilityof a second Hyundai-developed special econom-ic zone, located at Tongchon on the east coastnear Mt. Kumgang, also has been reported.vii TheNorth Koreans also have begun to relax their op-position to Japanese tourists visiting Mt. Kum-gang, which would have obvious implicationsfor Hyundai’s bottom line.7

Challenges of Large-Scale Reform

Only time will tell what the North Koreans’intentions are. It is hard to argue, though, thatrecent developments reduce the likelihood ofconsensual integration.

Assuming that the North Koreans have madethe decision to undertake economic reform, theissue then is whether they are capable of suc-cessfully managing reform. The experiences ofother transitional economies over the past decade

suggest that relative success in making the tran-sition from central planning to a market econo-my is strongly affected by idiosyncratic factors.Among the few systematic determinants of suc-cess and failure in this process are the degree ofmacroeconomic stability when reform is initiat-ed, the existence of a functioning commerciallegal system in the pre-socialist period, and theextent of a labor-intensive agricultural sector.North Korea does not appear to be particularlywell placed with regard to either of the first twocriteria.viii

Spin Meisters Keep Up With the Times

In one of the world’s odder attempts to makefriends and influence people, the Korean CentralNews Agency (KCNA), North Korea’s official newsagency, maintains a website (www.kcna.co.jp) pro-viding English translations of North Korean newspieces, the tone of which might be described as“retro-Maoist.” For example, even as the NorthKoreans solicited investment from the South, KimYoung-sam, the former president of South Korea,was regularly denounced as an “abominable flun-keyist traitor,” “the puppet of imperialists,” and a“dyed-in-the-wool, pro-American stooge,” amongother things.

The December 1997 election of former dissi-dent Kim Dae-jung as president of South Koreacreated a dilemma for the North Korean spin meis-ters. Kim Dae-jung had previously been upheld asa martyr of the South Korean “fascist regime,” soit would have been difficult for them to vilify himin the same way they had his predecessors. TheNorth Korean press went largely silent on the newSouth Korean president, instead focusing on otherlongtime nemeses. Japan on multiple occasionswas accused of preparing a military invasion ofNorth Korea. A trilateral meeting among U.S.,Japanese, and South Korean defense officials was

described as a “confab” between “Japanese mili-tarists” and “crazy war maniac” U.S. Defense Sec-retary William Cohen at the “imperial governor’sresidence,” a.k.a. the U.S. embassy in Seoul.

Northern propagandists, however, have not beenthe only ones thrown off balance by events on thepeninsula. In the South, criticism of the North hasbecome dramatically muted in the wake of the June2000 summit, with the exception of the right-wingdaily newspaper Chosun Ilbo, which the NorthKoreans threatened to “blow up” in July 2000 forits “impudent” editorials. The editorial shift in theSouth Korean press may reflect a genuine reappraisalof Kim Jong-il and the situation in the North, butthere are other possibilities as well. Much of theSouth Korean mass media is financially connectedto the chaebol, which are interested in developingbusinesses in the North, and the firewall betweenthe business and editorial sides of the media maynot be as strong in South Korea as in some othercountries. As Scott Snyder, the Asia Foundationrepresentative in Seoul put it, “Old habits die hard.It was little more than a decade ago that the govern-ment was telling the [newspapers] which picturesto run. Everybody knows who is in charge, and thepeople are aware of how instruments of state powerare available for use in certain contexts.”

7 North Korea and Hyundai have a continuing disagree-ment over Hyundai’s desire to increase the flow of tour-ists to Mt. Kumgang. The vast majority of tourists havebeen and likely will continue to be South Korean, buttheir numbers are insufficient. Though the Japanese ap-pear ready to visit, until recently they have been singledout for exclusion, the result of North Korea’s lingeringhostility over the colonial and wartime experiences.

9


The last indicator is particularly salient. InAsia, one all too often hears the following syl-logism. There are two ways of reforming cen-trally planned economies: the unsuccessfulEuropean big-bang approach, and the successfulAsian gradual approach. North Korea is an Asiancountry, ergo it will adopt the successful Asiangradual approach and begin growing 10 percentannually upon commencement of reforms. Thisview is gravely mistaken, conflating the issuesof speed and initial conditions.

Two large Asian countries have experiencedrelatively successful transitions from centralplanning to market economies, namely Chinaand Vietnam. Both had more than 70 percentof their labor forces in the agricultural sectorwhen they began reforms (see Table 1), and therelative success of their reforms was stronglyaffected by the existence of this large pool ofextremely low-productivity labor in the agricul-tural sector. The authorities could liberalize ag-riculture, generating a relatively rapid supplyresponse, and then release surplus labor fromthe agriculture sector into the nascent non-state-owned light manufacturing sector. In theory onecould then tax the light-manufacturing sector togenerate financial resources with which to re-structure the old state-owned heavy industrysector.

This agriculture-led reform process simplymay not be available to North Korea due to itsvery different initial conditions. Economically,

North Korea more closely resembles some coun-tries of Eastern Europe or the former SovietUnion than it does China or Vietnam. Vexingissues such as the restructuring of state-ownedindustrial enterprises, which no country hashandled very well, may play a much more cen-tral role in North Korea’s transition than theyhave in the experience of China or Vietnam.

Another obstacle is political. Again, considerthe cases of Vietnam and China. In the case ofVietnam, North Vietnam and its Viet Cong al-lies defeated South Vietnam in a civil war andunified the country. The government in Hanoibecame the sole arbiter of what it meant to beVietnamese. When the reform policy of doi moi8

was undertaken in the late 1980s, the ideologuesin Hanoi could come up with justifications forwhy the new policy was really what Ho ChiMinh had in mind. Similarly, while China con-fronts the rump of Taiwan, perhaps until therecent defeat of the Kuomintang candidate forthe presidency no one seriously believed thatthe government in Taipei presented an ideologi-cal threat to Beijing. When Deng spearheadedthe Chinese reforms in the late 1970s, the ideo-logues in Beijing were free to come up with slo-gans rationalizing the new policy.

The agriculturalreform thatworked forChina andVietnam maynot be availableto North Korea

Table 1. Percentage distribution of labor force at time of reform

SectorCountry Year Agriculture Industry Service

Czech Republic 1989 11 39 50Slovakia 1989 15 34 51Poland 1989 7 37 56Hungary 1990 15 36 49Soviet Union 1990 19 38 43Ukraine 1990 20 40 40Belarus 1990 20 42 38Romania 1990 28 38 34Bulgaria 1989 19 47 34North Korea 1993 33 37 30China 1979 71 15 14Vietnam 1989 71 12 17

Source: Noland (2000), Table 3.7.

8 The overall policy of economic renovation set forth atVietnam’s Communist Party Congress in 1986.

10


The divided nature of the Korean peninsulapresents prospective North Korean reformerswith a very different ideological challenge. Re-forms that bring North Korean society closerto South Korea could undermine the whole ide-ological justification for the regime: Why be athird-rate South Korean when one can headsouth and become the real thing? The dynasticnature of the North Korean regime makes thispolitical task even harder, as the son will, ineffect, have to disavow the policies of the father.However, this dynastic aspect also could conveycertain short-term advantages; presumably KimJong-il will claim that in private conversations,Kim Il-sung expressed one view or another thatconveniently will support the policy that Kimfils wishes to pursue.

Balanced against these challenges is one greatadvantage that other transitional economies havenot had—namely the existence of a benefactorin the form of South Korea.

W H AT I S T H E S TAT E O F N O R T H KO R E A’ S E C O N O M Y ?

Considerable uncertainty exists regarding thecondition of the North Korean economy. There

is universal agreement that North Korea has ex-perienced a decline in output since the collapseof the Soviet Union and the breakup of the East-ern Bloc, but precise estimates vary enormous-ly.ix There also is agreement that North Koreahas experienced a famine, though disagreementremains as to the timing of the famine and itsdeath toll.x Thus there is no consensus to thecurrent condition of the North Korean economy.

The most widely cited figures in public dis-cussions are those produced by the South Ko-rean central bank, or Bank of Korea (BOK); theBOK is given this task because it would be re-sponsible for monetary policy in a Korea unitedunder Seoul. The annual BOK estimate of NorthKorean national income is constructed by apply-ing South Korean value-added weights to physi-cal estimates of North Korean output obtainedthrough classified methods. Ergo, this estimatemay differ significantly from the true underly-ing figure due to the inadequacy of the calcula-tion method; also, it is not subject to any verifi-cation by outside analysts. The BOK figure isthen subject to interagency discussion, and oncea consensus is reached, the figure is transmittedto the Ministry of National Unification, whichannounces it to the public.

A woman pulls a

cart on the road

between Wonsang

and Pyongyang. Re-

ports out of North

Korea in recent years

have often been about

famine. It is estimat-

ed that two million

people died in 1995–

97, and famine was

reported again in

2000. Despite that,

several relief agencies

have left North

Korea, frustrated by

a lack of access.

11


Normally, this figure is released in the spring.In the spring of 2000, however, the Ministry ofNational Unification did not release a specificfigure, instead adopting the formulation thatNorth Korean national income was approximate-ly unchanged from the previous year. Then inJune, just prior to the North-South summit, fig-ures were released indicating that the North Ko-rean economy had grown by 6.2 percent in 1999(Table 2). This was surprising inasmuch as mul-tiple sources had estimated that the volume ofNorth Korea’s international trade—probably themost accurate externally observable measureof the state of the North Korean economy—de-clined in 1999, with the notable exception ofNorth-South processing on commission trade.The BOK announcement was greeted with uni-versal disbelief by economists working outsidethe South Korean government.xi One explana-tion for the timing of the announcement is thatBOK statisticians had undertaken a rebasing ofbase years, and this contributed to a delay inreleasing their estimate.

At least five possible explanations exist forthe apparent divergence between the expecta-tions of professional observers and the BOK’snumbers. One that was plausible in the spring,before the release of the BOK’s sectoral data inJune, related to the domestic availability offood. Numerous observers reported increasedfood availability in North Korea in 1999, due

to large-scale international assistance and an im-proved domestic harvest made possible by inter-national donations of fertilizer and other inputs,as well as better weather. In technical terms,food aid would contribute to increased consump-tion or availability of food, but would not con-tribute to domestic value-added, and hence na-tional, income. (The fertilizer and improvedweather could contribute to increased yieldsand this could add to national income properlymeasured.) The explanation for no change inoutput since 1999, which could be interpretedas a bottoming out of the decline, could there-fore be rationalized as a misinterpretation ofincreased food availability together with legiti-mately improved circumstances in the agricul-tural sector. Indeed, it is argued that the BOKused high-end estimates of North Korean agri-cultural output to calculate its figures, and if ithad used other existing official estimates, itwould have concluded that there had been nogrowth at all in the North Korean economy in1999.xii

The problem, of course, is that the figures inTable 2 show increased output not only in agri-culture, but throughout the economy. A moresophisticated version of this argument wouldbe that:

■ international assistance acts as implicit balance-of-payments support, permitting importation

Table 2. North Korean growth, 1999

Growth Rate Contribution Share

GDP 6.2 100.0Agriculture, forestry, and fishing 9.2 45.9Mining and quarrying 14.1 14.5Manufacturing 8.5 25.2Electricity, gas, and water 6.8 4.4Construction 24.3 20.7Wholesale and retail trade 11.8 0.7Transport, storage, and communication 7.0 3.1Finance, real estate, and business services 0.6 0.7Government services -4.5 -17.3Others (including Mt. Kumgang) 1037.5 2.1

Memorandum:Light industry 2.4 2.4Heavy and chemical industry 11.6 22.8

Source: Bank of Korea.

The news thatNorth Korea’seconomy hadgrown by 6% in1999 was greet-ed with stunneddisbelief

12


of non-food items with hard currency thatwould otherwise have been used to purchasefood; and

■ observers have confused the increased avail-ability of various products (made possible byaid) with increased domestic production.

The second possible explanation is a varianton this argument. International assistance actsas implicit balance-of-payments support, andthe North Koreans have very wisely spent theirimplicit windfall on critical imported interme-diate inputs that have allowed them to increasecapacity utilization. The issue then becomeswhether this is self-sustaining—that is, if foodaid were cut off, would the apparent recovery of1999 collapse?

A third explanation involves the reputedexistence of a classified North Korean input-output table constructed by economists at theBOK. This secret input-output table presum-ably embodies a different set of input-outputweights than the South Korean input-output ta-ble. Hence, if one took the same physical out-put data and aggregated it using the differentvalue-added weights, one would obtain differingestimates for national income. The reportedjump in North Korean output thus could sim-ply be a statistical artifact created by concate-nating two series produced using two differentsets of value-added weights. If this was the case,one would expect to see a one-time discontinu-ous movement in the series. Put differently, ifthis explanation is correct then, other things be-ing equal, one would expect next year’s growthfigure to fall into the range of figures prior to1999. While this explanation seems plausible,economists at the BOK steadfastly deny thatthis is the case.

The fourth and fifth explanations are the moststraightforward: everyone outside the BOK justgot it wrong, and/or the BOK figure was fabri-cated. Neither of these explanations is entirelyimplausible. Even specialists on the North Ko-rean economy have remarkably little access toconventional economic data, and it could wellbe that the community of North Korea watcherssimply has gotten it wrong, and that the NorthKorean economy is doing far better than ex-

pected. Alternatively, the state of the NorthKorean economy has become a highly sensi-tive political issue in Seoul, and South Koreangovernment statistics are not always abovereproach.xiii

Famine and the Difficulties of Accurate Evaluation

Even the more narrow issue of food availabilityremains subject to dispute. The conventionalwisdom is that North Korea suffered perhaps twomillion deaths due to the famine that peaked in1995–97, though due to lack of access, this fig-ure is little more than a guesstimate.xiv By 1999,the North Koreans were signaling that buildingup energy supplies, not food supplies, was theirtop priority. Nevertheless, during the summerof 2000, official relief agencies were once againreporting that the situation in North Korea wasdeteriorating, and North Korean officials re-quested $250 million in aid through the WorldFood Program (WFP), claiming it would permitthem to attain minimum human-needs self-suf-ficiency by 2002.

Nevertheless, the situation in North Koreain 2000 differed from that in the mid-1990s inthree principal ways. First, even the relief agen-cies accepted that a long-term solution to NorthKorea’s food problem would require strength-ened trade performance that would both facili-tate importation of inputs such as fertilizers andpesticides and allow the North Koreans to coverunexpected shortfalls on commercial terms.xv Asimple cross-national comparison might be in-structive in this regard. At its peak, most ob-servers believe that the North produced about6 million metric tons of grain. This fell by rough-ly half by 1996.xvi In comparison, Morocco alsotypically produces around 6 million metric tons,but bad weather in 1999 knocked domestic pro-duction down to around 1.5 million metric tons,a decline of roughly three-quarters—more thanthe drop experienced by North Korea. However,while times have been hard, there is no faminein Morocco. The Moroccan food shortfall hasbeen closed by importing food on commercialterms.xvii

Second, frustrated by lack of access andNorth Korean dissembling, a number of non-

If food aid werecut off, wouldthe apparenteconomic re-covery collapse?

13


governmental organizations including MedicinsSans Frontieres, World Concern, Oxfam Inter-national, Action Against Hunger, and CARE,have left North Korea. Third, while the U.S.government used the WFP humanitarian ap-peals as diplomatic cover for its political dealswith the North Korean government, this fig leafhas grown increasingly frayed. Of course, thepuzzle remains: If the North Korean economyexperienced sustainable industrial growth ofmore than 6 percent last year, why would theyneed $250 million in grant assistance?

North Korean Coping Strategies

Perhaps the answer to this question lies in thepast behavior of the North Korean governmentand its counterparts. Pyongyang has pursued twostrategies: isolated projects meant to generateforeign exchange, and extortion. The October1998 agreement between Hyundai and Pyongyangis important in this regard. First, payments com-mitted to by Hyundai dwarf anything that NorthKorea could plausibly earn in Rajin-SonbongSpecial Economic Zone (SEZ), and second, theHyundai agreement extends the possibility ofconstruction of a new special economic zone.

Hyundai has guaranteed North Korea $942million over 75 months, with the paymentschedule front-loaded for the first six months.Indeed, the North Koreans used brinkmanshipto extract advance payments before the firsttour visited Mt. Kumgang in November 1998.At $300 per passenger, North Korea stands tomake $450 million per year off the tourismagreement alone, in the admittedly unlikelycase that Hyundai is able to reach its target of1.5 million visitors per year in 2005. To put thisin perspective, this money, if properly deployed,would be enough to permit North Korea to cov-er its food gap on commercial terms. Unfortu-nately, it is believed that the funds are goinginto the Macau bank account of “Bureau 39,”a party organization controlled by Kim Jong-il,to be used for “regime maintenance.” If this ishow the Mt. Kumgang tourism project playsout, it will amount to little more than a regime-preserving hard-currency earner with no realsystemic implications for the organization ofNorth Korea’s economy or society. This con-

trasts with the Rajin-Sonbong SEZ, which alsohas no real systemic implications but has failedto earn much currency.

In this respect, the rest of the Hyundai dealmight be more significant. The agreement alsocalls for development of a second special eco-nomic zone, which apparently will be locatedin Kaesong. This appears to have much betterprospects than Rajin-Sonbong. First, the geo-graphical location is far more auspicious. Second,it has the backing of Hyundai, and presumablythe South Korean government. This is criticalfrom the standpoint that it both provides thenecessary infrastructure, which Rajin-Sonbongsorely lacks, and carries the imprimatur ofHyundai (and by extension the South Koreangovernment). Thus, South Korean small- andmedium-sized enterprises are far more likely tomove light manufacturing operations to Kaesongthan Rajin-Sonbong.

The second coping strategy is extortion, orbrinkmanship, and North Korea has experiencedsome success in extracting resources from theinternational community through this tactic.Numerous times, for example, the U.S. govern-ment has provided North Korea with food aid toinduce its participation in various diplomaticforums.xviii Indeed, some would argue that NorthKorea has shown considerable diplomatic acu-men in parlaying uncertainty about its nuclearprogram into a multibillion-dollar energy assis-tance program. Since 1994 the share of NorthKorean food imports obtained on concessionalterms has risen from nil to more than 80 percent.

Elements and Effects of Economic Reform

Clearly, successful consensual unification wouldrequire a significant reorientation of North Ko-rean policy. Cooperation could be expected toyield economic benefits to North Korea in theform of enhanced trade and investment, assis-tance from multilateral development banks, andsettlement of postcolonial claims against Japan.At the same time, to obtain these benefits, NorthKorea presumably would have to forego its cur-rent revenues from exportation of medium-rangemissiles and other weapons of mass destruction,as well as drug trafficking and counterfeiting.

It is believedthat revenuesfrom Mt.Kumgang’sdevelopmentare going into aMacau bankaccount

14


Furthermore, were it to reenter internationalcapital markets, North Korea would have tosettle private claims arising from past interna-tional loan defaults. Such a deal could involvethe alteration or renegotiation of the 1994Agreed Framework between South Korea andthe United States, upon which much of NorthKorea’s economic interaction with the rest ofthe world is conditioned.

Fundamental reform of the North Koreaneconomy would have two profound effects. First,there would be a significant increase in expo-sure to international trade and investment, muchof this with South Korea and Japan, two coun-tries with which North Korea maintains prob-lematic relations. Second, there could be tre-mendous changes in the composition of output,involving literally millions of workers changing

The Bumpy Road from Juche to an Open Economy

In keeping with its ideology of juche, and its gener-al unease with foreigners, North Korea has empha-sized projects that, literally and figuratively, couldbe fenced off from the rest of its economy. The firstof these was a special economic zone (SEZ) built inthe Rajin-Sonbong area. The second was the openingof Mt. Kumgang to tourism.

Rajin-Sonbong SEZ In 1991, North Korea estab-lished an SEZ in the Tumen River delta in the ex-treme northeast of the country. On paper, the termsfor foreign investors in the SEZ were comparable tothose available to investors in China and Vietnam.In reality, though, government policy in North Ko-rea kept labor costs far higher. This cost disadvan-tage was compounded by inadequate infrastructure,bureaucratic interference in commercial operations,and investors’ unease in dealing with North Ko-rean enterprises due to the North’s history of re-neging on commercial agreements. The practicalresult is that North Korea faces penalty rates whenit trades—export prices are lower and import pricesare higher because trade partners are not sure theywill receive their money. The expected volume ofinvestment has never materialized, and the zone iswidely regarded as a failure—at least as originallyenvisioned.

The greatest potential for the zone now appearsto be as a regional center of transshipment for trade.Already the bulk of activity at the Rajin port istransshipment; examples include South Koreanconstruction materials and electrical goods boundfor China, and North Korean abalone headed forexport. The speed at which this activity grows willdepend further on continued economic vitality inChina’s Jilin Province, as well as on infrastructuralinvestment in Rajin-Sonbong, and competition fromalternative Russian ports.

Geopolitical realities suggest that China (and byextension Hong Kong) will play a dominant role, atleast in the short-term. China is building a four-lanehighway right up to the North Korean border, a de-velopment likely to encourage growth in transship-ment through Rajin-Sonbong. Unfortunately, thiseventuality is hindered at present by the conditionof the roadway in North Korea: it is still a rutteddirt road that becomes impassable much of the year.However, it is possible that the Chinese will solvethis problem by paving the roadway themselves toimprove access to coastal ports.

Mt. Kumgang Tourism Another attempt to earnforeign exchange without fundamentally alteringthe North Korean economy relies on the develop-ment of a North Korean tourist attraction. Mt.Kumgang (Diamond Mountain) is renowned for itsscenic beauty, and since the project’s inaugurationin November 1998, around 250,000 visitors haveboarded Hyundai’s cruise ships to sail north for atightly controlled tour of the mountain. Upon ar-rival in North Korea, tourists are shepherded ontobuses for the trip to the mountain. The road theytake has been walled off to prevent tourists and vil-lagers from seeing each other or interacting and,once at the mountain, all paths are bordered withbarbed wire to discourage “unauthorized exploring.”

North Korea receives not only a fixed paymentfrom Hyundai for the right to operate the tourismconcession, but also a per-passenger payment. Ne-vertheless, Hyundai reportedly has been losinggreat amounts of money on the project, and hasbeen in conflict with North Korean authoritiesover its desire to increase significantly the numberof tourists it brings by including large numbers ofnon-Koreans. In September 2000, the two sidesagreed to permit limited visits by Japanese tourists.

15


employment. Both developments could beexpected to have enormous political implica-tions, and these implications could be thoughtto present significant, perhaps insurmountable,obstacles to reform under the current regime.

Food and Energy It is possible, nevertheless,that with help from abroad North Korea couldattempt a less ambitious reorientation of itseconomic policies and practices. The North Ko-rean economy desperately needs two things tomeet the minimum survival requirements of itspopulation: food and energy.

It may well be that the country obtainsenough income through production or aid toattain its minimum survival requirement, butchooses not to (i.e., the regime has a strongpreference for guns over butter). Taking thesepreferences as a given, how much additionalincome would the country need to attain itsminimum survival requirement? Under currentconditions, North Korea runs a structural fooddeficit of around two million tons. The cost ofclosing this gap through commercial importswould be on the order of several hundred mil-lion dollars, depending on prevailing globalprices. For the past five years, this gap has beenclosed mainly through the provision of interna-tional assistance. This reflects North Koreanpolitical interests-—why pay for something thatcan be obtained for free?—and the political in-terests of Western governments, most promi-nently those of the United States, which facesless domestic resistance to provision of in-kind“humanitarian relief” to North Korea than toprovision of straight aid.

In addition to food, North Korea needs ener-gy. It is reliant on imported oil to generate fuelsand fertilizer for use in transportation and agri-culture. Electricity is generated mainly throughcoal and hydropower. Generation has been ham-pered by difficulties in extracting increasinglyinaccessible and low-quality domestic coal re-serves. Beyond this problem, the power grid(largely underground for security purposes) issaid to suffer from extraordinarily large trans-mission losses.

The 1994 Agreed Framework provides for theconstruction of two light-water reactors and the

provision of oil in the interim. The problem isthat this is essentially a diplomatic agreementcovering North Korea’s nuclear program anddoes not really address the true needs of theNorth Korean economy. From an economicstandpoint, it would be better to renegotiatethe Agreed Framework, scrapping the costlylight-water reactors in favor of building morecost-effective electrical generating systems, re-furbishing the existing electrical grid, and build-ing the infrastructure that would allow NorthKorea to export electricity to South Korea andChina, thereby earning foreign exchange.xix

Nevertheless, if these estimates are correctand the Agreed Framework as negotiated is fullyimplemented, the cost of purchasing the esti-mated shortfalls in grain and energy inputs, aswell as desperately needed supplies of fertiliz-ers, pharmaceuticals, etc., might be less than$1 billion.xx Assuming no more interruptionsin Hyundai’s Mt. Kumgang tours, the contractguarantees North Korea nearly $150 million an-nually over the relevant time period. This is aminimum, as North Korea receives a paymentper visitor, so if Hyundai were to sell out itstours, North Korea would stand to net approx-imately $450 million per year, or enough tocover its grain deficit on commercial terms.Moreover, other South Korean firms have ex-pressed interest in similar tourist ventures. Ifthe North Koreans went through with the otherprojects in the Hyundai agreement, includingthe establishment of a new special economiczone at Haeju, this could generate additionalrevenues.

These figures refer to recurrent flow expen-ditures. In addition, there are one-time needsto rehabilitate the North Korean infrastructure,and a variety of organizations have come upwith estimates of what this might entail. Touse a Seoul metaphor, it depends to a certainextent on whether one takes the black (expen-sive) taxi or the silver (cheap) one. For example,it is estimated that a rural energy rehabilitationprogram would cost between $2 billion and $3billion over five years. The estimated price tagfor a more comprehensive economy-wide pro-gram is $20 billion to $50 billion over 20 years.xxi

The Construction and Economic Research

Food and energyare desperatelyneeded for thesurvival of theNorth Koreanpeople

16


Missiles for Sale

In North Korea, a parallel military economy existsoutside the central plan. This parallel economy hasprivileged access to technology and imports, and95 percent of the North’s weaponry is produced do-mestically. Much of what is produced is exported,and in the 1980s North Korea emerged as a signifi-cant player in the global arms market, with the U.S.Arms Control and Disarmament Agency (ACDA)estimating exports at more than one-half billiondollars a year at times, accounting for more thanone-quarter of all North Korean exports.

The missile program started in the early 1960swith Soviet and Chinese assistance. The North Ko-reans have since entered into technical cooperationprograms with a number of countries includingEgypt, Iran, and possibly Pakistan. The North Ko-reans also allegedly employ foreign scientists andengineers on their programs, including a numberfrom the Ukraine, and allegations of continuingChinese involvement have been a source of frictionbetween China and the United States.

The North Koreans produce a range of missiles.Single-stage missiles include the medium-rangeScud-B, Scud-C, and Scud-D (a.k.a. Rodong-1), whilelong-range multistage missiles include the Taepo-dong-1 (tested in August 1998), the as-yet-untestedTaepodong-2, and the Taepodong-3, which is stillin development. The Rodong-1 missiles have a1000 kg nuclear or chemical warhead and a rangeof 1000 km, putting them within striking range ofboth South Korea and Japan, while the Taepodong-1is thought capable of hitting Guam and parts ofAlaska. The Rodong-1 missiles are thought to haveproblems with their engines and guidance systems,limiting their military usefulness. Nevertheless,the properly armed missiles could present a signifi-cant deterrent to potential adversaries.

On 16 June 1998, the North Koreans admittedwhat the world had long suspected: North Koreaexports missiles. Most observers believe that theseexports began in the 1980s. Over the years, Iran andSyria have been among Pyongyang’s most importantcustomers, though the North Koreans also are al-leged to have had dealings with Iraq, Libya, Nigeria,Pakistan, and Egypt.

Total revenues from missile sales are subject todispute. Robert Einhorn, the chief U.S. negotiatorat the missile talks, reportedly described NorthKorea as the world’s number one exporter of mis-sile equipment and technology (Washington Post,1 April 1999). A highly placed U.S. official indicat-ed that exports have averaged $100 million annual-ly, with around 40 percent of these revenues plowedback into the missile development program. How-ever, a figure of $1 billion a year, attributed to theU.S. Central Intelligence Agency, sometimes ap-pears in press reports (Bill Tarant, Reuters, 1 Sept-ember 1998; Washington Post, 1 September 1998;JoongAng Ilbo, 28 May 1999; and Reuters, 15 Sept-ember 1999; see also Lim (1999)). The truly fantas-tic figure of $5 billion in annual missile exportswas attributed to unnamed South Korean intelli-gence officials in the 28 May 1999 JoongAng Ilbo.This surely is too high: It’s well above both Israel’soffer in its 1992–94 attempt to buy off the NorthKoreans, and the North Koreans’ own contempo-rary demands of the United States. In addition, itwould make North Korea the world’s fifth largestarms exporter after the United States, UnitedKingdom, Russia, and France.

Instead it appears that exports have declinedover time. The following have all depressed themarket for North Korean goods: a lack of Cold Warproxy conflicts, increasingly obsolete designs andinferior products (the Soviets stopped providing newdesigns and technology in 1990), shortages of nec-essary inputs, and fears of default on the part ofshipping companies. The October 1999 moratoriumon long-range missile testing, reached in negotia-tions with the United States, presumably furtherlimits North Korea’s ability to develop and marketthe Taepodong series.

Nevertheless, the fact that the military main-tains its own trading channels outside the centralplan is potentially of enormous policy importance.To the extent that the proceeds from arms sales aregoing directly to the military, the military mayhave a purely pecuniary incentive to continue sell-ing missiles, even if other parts of the governmentwould like to restrict sales for broader foreign policyreasons.

17


Institute of Korea, a think-tank affiliated withthe Ministry of Construction, has estimatedthat North Korea’s infrastructure is comparableto South Korea’s in 1975, and that it would costmore than $6 billion to bring it up to South Ko-rea’s 1990 level. Indeed, it has been estimatedthat transfers on the order of 2–4 percent ofSouth Korean GDP would be needed for an ex-tended period to raise the level of North Korea’sinfrastructure to South Korea’s 1980 level.xxii

Overhauling the North Korean Economy For$2 billion annually, one could undertake a fairlybare-bones reconstruction program in North Ko-rea that would generate rising living standards,possibly reduce discontent, and contribute topolitical stability.9 Around half of this would befor recurrent flow consumption expenditures,and around half would be for industrial and in-frastructural investments that could be self-financed through export revenues. Most of thistrade would be with South Korea and Japan,with China and the United States playing smal-ler roles—even with the United States partiallylifting its embargo against North Korea in June2000. Thus the necessary recurrent externalfinancing needs would be around $1 billion an-nually. This assumes that liberalization in the

North would be on a non-preferential basis. Ithas been shown that the formation of a customsunion between North and South Korea wouldhave a big impact on the North, but only a triv-ial impact on the South.xxiii This union wouldrepresent a major trade liberalization on thepart of the North, while the North’s economywould be too small to have much of an impacton the South’s economy (think of the impact ofNAFTA on the United States, or the accessionof a small central European economy on the EU).This story—big impact on the North, small im-pact on the South—would change considerablyif integration were to come through collapse, asdiscussed in the next section.

Where could the aforementioned $1 billioncome from? There are many possibilities, butthe single biggest potential source of additionalfinancing would be the resolution of North Ko-rea’s postcolonial claims against Japan. Thisissue was raised by former U.S. Defense Secre-tary William Perry during his visit to Pyongyanglast year. The Japanese government paid theSouth Korean government $800 million in com-pensation for colonial and wartime activitieswhen diplomatic relations were normalized in1965; of this, $300 million came in the form ofgrants, $200 million in the form of developmentassistance loans, and $300 million in the formof commercial credits. The North Korean gov-ernment expects similar compensation. Adjust-ing the South Korean payment for differences inpopulation, accrued interest, inflation and ap-preciation of the yen since 1965, one obtains afigure in excess of $20 billion.xxiv

An additional issue raised by North Koreansthat was not included in the South Korean pack-age is compensation for “comfort women” whowere pressed into sexual slavery during WorldWar II.

Reputedly, settlement figures on the orderof $5 billion to $8 billion have been discussedwithin the Japanese government. In comparison,Yi Chong-hyok, vice chairman of the Korea Asia-Pacific Peace Committee, a Korean WorkersParty organization, in remarks before a Washing-ton audience in 1996, indicated that $10 billionwould be the minimum bound for compensa-tion. Japan certainly will argue that its food aid

The North’sinfrastructure issaid to be com-parable to theSouth’s in 1975

9 One should be careful about drawing too simple a causallink between material conditions and political change.There is no theory that reliably correlates deprivationwith political change. Indeed, in his classic study of polit-ical change, Huntington (1968) argues that politicalchange occurs more often in the context of material gainsand rising expectations than it does in the context of stag-nation. In particular, to the extent that political changehas accompanied famine, it has usually occurred afterfamine conditions have sufficiently stabilized for respon-sibility to be assigned and blame to be assessed. Duringfamines, populations typically are too focused on survivalto engage in political activities. However, in the case ofNorth Korea, Gertz (1999) reproduces a secret StateDepartment cable that refers to “extensive evidence of amajor coup attempt by elements of the VI Corps in 1995,which appears to have been crushed only with some diffi-culty” (p. 264). The State Department has not denied theauthenticity of this cable. According to Oberdorfer (1997),after the uprising the Corps, based in the famine-strickennortheastern city of Hamhung, “was disbanded, its lead-ership purged, and its units submerged into others undercircumstances suggesting disarray in the ranks” (p. 375).

18


and its $1 billion contribution to the KoreanPeninsula Energy Development Organizationshould be counted against this charge. Indeed,Japanese negotiators are rumored to be valuingtheir food aid at inflated Japanese prices ratherthan at far lower world prices. Some have spec-ulated that Japan will even try to claim creditfor the costs of recapitalizing bankrupt financialinstitutions controlled by Chochongryun10—inJapan. In any event, such sums properly de-ployed could go a long way toward restoringNorth Korean creditworthiness and financingeconomic modernization.

International Aid If North Korea were to ac-cept the terms of engagement detailed in thePerry review, another carrot that the UnitedStates, Japan, and South Korea could hold outwould be membership in international financialorganizations and the prospect of multilateraleconomic assistance. Pyongyang has periodical-ly expressed interest in joining the InternationalMonetary Fund (IMF), World Bank, and Asian

Development Bank (ADB). However, member-ship talks have never made much progress, forthey have snagged on three issues:

■ North Korea’s unwillingness to permit thekind of access to economic data and informa-tion that is required for membership in theseorganizations;

■ North Korea’s position on the U.S. list ofstates supporting terrorism; and

■ Japanese opposition to North Korea’s admit-tance, resulting from unresolved political is-sues, most notably the alleged kidnapping ofJapanese citizens by North Korea.

Under U.S. law, the U.S. executive directorsat the development banks cannot vote in favorof extending loans to North Korea until it is re-moved from the list of countries engaging instate-sponsored terrorism. At the ADB annualmeeting in May 2000, U.S. Treasury official TedTruman said, “Our position on membership isunchanged. Both because our own legislation re-quires us to do so [and] because North Korea isan international terrorist state…as long as thatsituation prevails and the North Korean regimeis one which is fundamentally incompatiblewith the principles of institutions such as theADB, we would oppose membership.”xxv

Under normal circumstances, if North Koreawere to join these organizations without consid-erable reorientation in domestic economic poli-cies, it would be unlikely that the multilateraldevelopment banks would make significantloans. However, given the political importanceof North Korea to the United States and Japan(both of which are influential shareholders inthe World Bank and the dominant shareholdersin the ADB), one would expect that North Ko-rea might receive favorable treatment. WorldBank President James Wolfensohn already sig-naled as much, writing in a July 2000 letter toSouth Korean President Kim Dae-jung that “We

Park Ok Ryun, a

former “Comfort

Woman,” protests in

front of the Japanese

embassy, Seoul, dur-

ing a demonstration.

North Korea is nego-

tiating with Japan for

compensation for

colonial and wartime

activities, including

the sexual enslave-

ment of many North

Korean women.

10 Chochongryun (chosensoren in Japanese) is an organiza-tion of ethnic Koreans living in Japan who are affiliatedwith Pyongyang.

19


at the World Bank stand ready to support inter-Korean economic cooperation. We hope to assistin the development of North Korea, within ourcapacity and mandate, whenever the North Ko-rean authorities are ready to work with us.” TheNorth Koreans were invited to the September2000 joint World Bank-IMF annual meetings inPrague, but declined to attend.

In any case, technical advice and assistancewould really be more important than directlending activities, which ultimately would onlycomplement the activities of private investors.Working from the case of Vietnam (anotherAsian transitional economy in which the gov-ernment undertook rapid economic reforms)and scaling down the multilateral developmentbanks’ lending program for the smaller size ofthe North Korean population, one obtains alending scale of $150 billion to $250 billion an-nually. Not trivial, but not enough to financeeven a bare-bones recovery program. More mon-ey might be available if the United States, Japan,South Korea, and others set up a special fundfor North Korea at the World Bank or ADB.11

Such a fund might be a particularly useful wayof politically laundering Japanese reparations.

It is possible that under some circumstancesNorth Korea could obtain loans from interna-tional financial institutions even if it were not amember.12 The World Bank, for example, main-tains a special program for peace and sustain-able development in the Middle East throughwhich it makes loans in areas controlled by thePalestinian Authority. It also has adopted a poli-cy that allows it to assist countries emergingfrom crises even though they are not WorldBank members in good standing. This policywas adopted after the bank was precluded fromlending to Cambodia because of a problem withdebt arrearage. The key attributes in these casesappear to have been a cooperative recipient gov-ernment and strong support from major WorldBank shareholders. Bank staff also has expressed

the view privately that an independent, poorNorth Korea would probably be able to accessmore lending than a unified middle-income Ko-rea. Either way, the settlement of postcolonialclaims with Japan would dwarf any assistanceNorth Korea could expect from the multilateraldevelopment banks.

These developments might be thought of asnecessary, though still insufficient conditionsfor consensual unification; even if they were tooccur, they would get the two Koreas only partway down the road. Moreover, these develop-ments do not necessarily imply progress towardconsensual unification. North Korea could adopta minimalist reform program and reject unifica-tion overtures from the South. Indeed, while im-plementing such a program, the North mightfeel compelled to limit discussion of unificationprecisely to prevent system overload and a lossof control.

Collapse is Possible

Of course, although this minimalist reform sce-nario appears relatively attainable, there is noguarantee that such an outcome will occur. Itis possible, though unlikely, that North Koreawill not undertake the policy changes necessaryto ensure its own survival, and instead couldcollapse and be absorbed by South Korea. Sucha development could greatly change the econom-ic calculus on the Korean peninsula. Theoretical-ly, it is also possible that a collapse of the KimJong-il regime would not result in the disappear-ance of North Korea as a state. Yet in reality itis hard to see how a North Korean governmentwithout Kim Il-sung could be much more thana transitional regime witnessing unification onessentially South Korean terms, much as wasthe case for the short-lived East German gov-ernment of Lothar de Maiziére.

In any case, the relatively cheap minimalistreform scenario depends on the stability of theNorth Korean state, and the consequent abilityof all parties to maintain enormously differentlevels of income across the two parts of the Ko-rean peninsula. A collapse would set in motioneconomic and political forces that would makesustained maintenance of such enormous dis-parities difficult, if not impossible.

An independent,poor NorthKorea wouldprobably beable to accessmore lendingthan a unifiedmiddle-incomeKorea

11 The possibilities of a Northeast Asia DevelopmentBank or a Northeast Asia fund have also been mooted.

12 An April 2000 statement to this effect by David T. Coe,the IMF resident representative in Seoul, was immediate-ly denounced by Rep. James Saxton (R-New Jersey).

20


Germany as a Point of Comparison Differencesbetween the German and Korean situationsmay be revealing in this regard. For one thing,North Korea is larger; its population is roughlyhalf that of the South, whereas East Germany’spopulation was roughly a quarter of West Ger-many’s population. Second, income disparitiesare far greater between the two Koreas than be-tween the two Germanys. Although the wholenotion of income is problematic in centrallyplanned economies, pre-unification per capitaincome was probably three to four times greaterin West Germany than in East Germany; in theKorean case, the ratio is more likely to be onthe order of twelve or fifteen to one. Finally, thepopulation of North Korea today is youngerthan the population of East Germany at thetime of unification. The relatively larger, poor-er, and younger population of North Korea allpoints to migration as being a potentially moreimportant issue in the Korean case than in theGerman case.13

Indeed, were Korean unification to occur,the government would face rising expectationsamong the populace of the North, as well as adesire to migrate south in search of better lives.It is possible, though unlikely, that the govern-ment could use the Demilitarized Zone to con-trol population influx for an extended periodwhile conditions in the North slowly improved—but the political imperative would be to im-prove conditions rapidly in the North.

The conventional wisdom is that the Ger-mans made a fundamental mistake in settingthe unification exchange rate, and considerableeconomic distress in East Germany was due tothis avoidable error. However, a more carefulanalysis suggests that it was wage policies, notthe exchange rate, that priced East German

labor out of the market. Moreover, misguidedlabor-market policies were compounded by mis-takes in privatization and restitution policies, aswell as competition (antitrust) policies, all ofwhich combined to greatly reduce the demandfor goods produced in East Germany.xxvi Be thatas it may, even under a relatively optimisticscenario of moderate, controlled, cross-bordermigration, and rapid convergence in North Ko-rea toward South Korean levels of productivity,bringing the level of income in North Korea tohalf that of the South would require a decadeand hundreds of billions of investment dollars—transfers larger in relative terms than in theGerman case.xxvii

Though extensive, this investment wouldnot be pure “cost,” and some in South Koreacould arguably benefit in this scenario. Invest-ment in the North would earn remitted profitsto owners of capital in the South, and the pro-cess could be expected to shift the distributionof income away from labor and toward capital.At the same time, there would be changes inincome distribution among different classes oflabor, with the distribution shifting toward morehighly skilled classes of labor. Another cleavagewould be between sectors producing interna-tionally traded goods such as manufactures, andnon-traded goods such as construction, with thenon-traded-goods sector doing relatively better.The bottom line is that if you were a South Ko-rean construction magnate with savings to in-vest in unification bonds, Korean unificationcould be very good for you; conversely, if youwere a low-skilled manufacturing worker, itcould be a very different story.

P R E PA R I N G F O R R E U N I F I C AT I O N —O R C O L L A P S E

The question then arises: What, if anything, canSouth Korea, the United States, and others do toprepare for such a contingency? South Korea’sneed to prepare for the contingencies of unifica-tion with North Korea coincides with its needto strengthen its financial system in the wakeof its own financial crisis. In the event of unifi-cation, there would be absolutely no reason tofinance the construction of infrastructure out

13 See Noland, Robinson, and Liu (1999) and Noland,Robinson, and Wang (2000c) for modeling of cross-borderfactor flows in the Korean case. The latter paper findsthat North Korea would be virtually depopulated beforewage rates converged sufficiently to choke off the incen-tives for mass migration. The authors conclude thatcross-border migration would have to be limited, or thatopening of the border would have to be combined withhundreds of billions of investment dollars in the North.

North Korea’slarge, poor, andyoung popula-tion will wantto move southin the event ofunification

21


of current tax receipts; instead, the governmentwould want to use both taxes and bonds to fi-nance unification expenditures. Hence, it shouldbe a priority to develop a robust governmentbond market prior to unification.

A second priority would be the rejuvenationof South Korea’s flagging privatization program:There is no reason why the privatization agendain the North should be more aggressive than theone that now exists in the South.xxviii Finally,once the current crisis in South Korea is sur-mounted, the nation will want to return to apolicy of fiscal rectitude, and salt away somereserves for this potential rainy day. A stronggovernment financial position would allow itscope for immediate expenditures in the event,and would facilitate the issuance of “unificationbonds.”

Fiscal, Military, and Social Considerations

At the moment of collapse in this scenario,there will be a critical need for close coordina-tion among the militaries of the United States,South Korea, and China, since presumably theywill be central to maintaining order, handlingrefugee flows, etc. This cannot be overempha-sized, though further discussion is really beyondthe scope of this paper. Once the situation onthe ground has stabilized, longer-run politicaland economic policies come to the fore. As indi-cated earlier, there is extensive literature on thelessons for Korea from German unification, andthe South Korean government has devoted con-siderable resources to studying this topic.

At the time of unification, the South Koreangovernment will have multiple (and potentiallyconflicting) policy objectives. On the one hand,maintenance of market-consistent economicactivity in the North will be the top priority.At the same time, the government should seekto effect a one-time-only wealth transfer to theNorth Korean people since they will have toadjust to market institutions with virtually nohousehold wealth. One can imagine a multi-pronged approach:

■ adopt dual-rate monetary conversion, aimingfor slight undervaluation of the North Koreanwon to maintain competitiveness (making

North Korea an attractive location for invest-ment), and converting personal savings at anovervalued rate (effecting a wealth transfer);

■ deed land to farmers and housing to occu-pants, contingent on continued use for somespecified period of time; and

■ maintain some kind of temporary, emergency,nonmarket social safety net in the North.

Having given the land to farmers, one mustconfront the issue of property rights claimed bypast owners or their descendants, and the moregeneral issue of assignment of property rightsto commercial or industrial entities. Lessonslearned from the experience of Germany, andother former centrally planned economies, wouldbe instructive in this regard:

■ avoid the policy of restitution for seized as-sets—monetary compensation for seized assetsmight be considered, though even some SouthKorean analysts have argued that this wouldbe a mistake;

■ privatize quickly and avoid the cash-on-the-barrelhead model;

■ abolish inter-enterprise debts;

■ emphasize investment transfers, not consump-tion transfers; and

■ accept assistance from foreigners, includingthe Japanese.

Privatization, Chaebol, and Reparations

With respect to privatization, the experience ofEast Germany and other centrally planned econ-omies suggests that it would be best to movequickly and avoid the cash-in-advance model,since it would severely restrict potential buyers.Attempts to restructure these enterprises beforeprivatization should also be avoided; this wouldbe better left to the market. Inter-firm debts,which are a legacy of irrational policies underthe centrally planned regime, should be writtenoff. Debt-equity swaps could be used to pay offexternal debt and at the same time create astake for South Korean or foreign firms in theviability of North Korean enterprises.

Unification willbe good for theSouth Koreanconstructionmagnate; not sogood for thelow-skilledworker

22


Given these considerations, there appears tobe one institution in South Korea ideally suitedfor the task of making North Korea competitive:the chaebol. Unfortunately, one policy goal (toget the North Korean economy functioning asrapidly as possible) will conflict with anotherpolicy goal (to clean up business-government re-lations in South Korea). It goes without sayingwhich would receive the greater weight. Thechaebol are probably ideally suited for refur-bishing the North Korean economy; however,saddling them with unproductive North Koreanenterprises would have an economic price (interms of reducing chaebol competitiveness in-ternationally, and possibly encouraging anti-competitive behavior domestically), as well as apolitical price (in the form of the quid pro quothat the chaebol would be expected to extract.

With respect to the other actors, many of thepolicies that one would want to see in place inthe event of collapse (for example, those regard-ing North Korean involvement with interna-

tional financial institutions) really are not con-tingent on collapse. Indeed, if a collapse is tooccur, it would make sense for the multilateraldevelopment banks already to have been in-volved, so they would possess some country-specific knowledge and expertise prior to theevent.

The big-money issue would be how to re-solve postcolonial claims against Japan if thishad not already been done; if this issue is notresolved prior to collapse, it would be essentialthat Japan and the North Korean governmentquickly reach an accord so that resources couldbegin flowing into Korea. In the case of the Unit-ed States, its role probably would be to providepolitical leadership (like that of the Korean Pe-ninsula Energy Development Organization) rath-er than direct financial assistance. One couldimagine, for example, the United States leadinga multilateral effort to provide additional finan-cial assistance, possibly through a special windowat one of the multilateral development banks.

One joyful celebrant

at a reunification

rally at Han Yang

University in Seoul

gets to be President

Kim Dae-jung in a

depiction of Kim and

North Korean Pres-

ident Kim Jong-il.

23


N O R T H KO R E A N I N T E R E S T S A N D I N T E N T I O N S

How this all plays out, and indeed whether uni-fication via any of the modalities examined inthis paper is likely in the near future depends,at least in part, on the intentions of the NorthKorean elite. A necessary condition for consen-sual unification would be willingness on thepart of this elite to countenance reform of cur-rent practices. It could be that members of theKim Jong-il regime have calculated that the bestway to preserve their own power and perquisiteswithin the North Korean system is to construc-tively engage South Korea and the rest of theworld, and that moving down the path of eco-nomic reform, though risky, presents them withthe highest likelihood of success in preservingthemselves within the system.

It also could be that North Korea intends, es-sentially, to adopt the techniques of economicreform without adhering either to the ethos of

market economics or to the dominant values ofthe international system. In this case, the Unit-ed States and South Korea could be confrontedwith a strengthened adversary on the Koreanpeninsula.

Difficulties of Prediction

How can we predict? In spite of the reportedstabilization of the economy (or even its revivalif the BOK is to be believed), and enhanced rev-enues from the Hyundai deal, North Korea hasincreased its reliance on international food as-sistance. The share of food imported into NorthKorea has risen from nil in 1994 to more than80 percent today. In other words, concessionalassistance has almost completely crowded outimports on commercial terms. Food is fungible,and food aid acts as an implicit balance-of-pay-ments support—funds that would otherwisehave been expended on food can be spent onother items. The issue then is the preferencesof the regime, and in the case of North Korea in

North Korean leader

Kim Jong-il, left, and

South Korean Pres-

ident Kim Dae-jung,

right, shake hands as

Kim Dae-jung arrives

June 13, 2000 at the

Sunan International

Airport in Pyongyang,

North Korea. Kim

Dae-jung won the

Nobel Peace Prize

October 13, 2000 for

his work towards

peace and reconcilia-

tion with North

Korea.

24


the past year, there is reason for unease.According to the South Korean National De-

fense White Paper (1999), North Korea has in-creased its reserves of chemical weapons, boost-ed manpower in the Korean People’s Army (KPA)by 10,000 troops, created a missile division, andadded 10 submarines to its fleet. In August 1999it was revealed that North Korea had purchasedroughly 40 aging MiG-21 fighters and eight mil-itary helicopters from Kazakhstan. It was sub-sequently reported that North Korea was alsotrying to obtain the more advanced MiG-29 andSU-30 fighters.

In September 1999, a classified U.S. Air Forcereport was leaked to the press; the report allegedcontinued work on the Taepodong missile byNorth Korea. In October, Gen. Thomas Schwartz,the newly appointed commander-designate ofU.S. Forces Korea, said in testimony before theU.S. Senate Armed Services Committee thatNorth Korea had accelerated its arms buildupand was forward-deploying artillery and rocket-launchers in underground facilities. In March2000, Adm. Dennis Blair, commander-in-chiefof U.S. Pacific Forces, indicated that North Ko-rean military exercises during the winter of1999–2000 had been the most extensive in re-cent years. Other U.S. military sources indicatethat the 2000 summer exercise cycle also wasthe most extensive in years.

One might regard the analysis of the SouthKorean and U.S. militaries with a certain degreeof skepticism—they do not have any incentiveto underestimate the North Korean threat. Nordoes the purchase of additional armaments bythe North Koreans necessarily signal any ag-gressive intent. Instead, it could be a simplebureaucratic outcome in which the KPA spendsits export revenues on items that it desires, or itcould be that increased military spending is asop thrown to the KPA by Kim Jong-il’s govern-ment in anticipation of future reforms to whichthe military will object. We simply do not know.

Policy Implications

So what are the policy implications? From thestandpoint of South Korea, Kim Dae-jung isfundamentally correct that the focus of policyshould be supporting constructive transforma-

tion of the North. Militarily, North Koreaalready holds Seoul hostage with its forward-deployed artillery. The South Koreans might aswell engage North Korea in an attempt to re-duce tensions and achieve reconciliation andunification, because the marginal increase inNorth Korea’s threat capability that might beachieved through economic reform is relativelysmall. The South Koreans are over that Rubiconalready.

Therefore, the goal of the South Koreansshould be to domesticate North Korea, pursuinga two-track strategy of trying to defang it mili-tarily while rehabilitating its economy. Theproblem from the standpoint of South Koreais the impact that increased integration withNorth Korea could have on its economy. TheSouth Korean financial crisis has at least tem-porarily 20 years of diminishing direct stateinvolvement in its economy.

As a consequence of its increased presencein the financial sector and other, more indirectlevers on power, the South Korean governmenthas a bigger influence on strategic decisions bythe chaebol then it did in 1996 on the eve of thecrisis. The difficulty is that, despite the good in-tentions of the South Korean government, poli-tics and economics are inseparable in the North,even in theory. Any significant interchangewith the North will be highly politicized, andSouth Korea inevitably will be tempted to di-rectly intervene in the economy to promote itsforeign policy goals.

A good example of this would be Hyundai’sMt. Kumgang tourism project which, accordingto South Korean press reports, is losing morethan $100 million annually. The fear, of course,is that the South Korean government will betempted to reward Hyundai or other firms withpreferential treatment for doing its bidding inthe North. For example, there was some appre-hension that the government would be temptedto steer Daewoo Motors to Hyundai (effectivelygiving Hyundai a monopoly on the South Ko-rean passenger car market) as a kind of rewardfor its activities in the North. It is a good signthat this appears unlikely to occur. Other formsof compensation could take the form of bailoutsfor troubled subsidiaries or regulatory forbearance

South Korea’sgoal should beto domesticatethe North,defanging themilitary andrebuilding theeconomy

25


with respect to questionable or illegal intra-group financial transactions.

Imperatives for South Korea

In this light, South Korea should promote twogoals in its dealings with the North: transparen-cy and the transformation of the North Koreansystem. With regard to the first goal, economicintegration between the North and South mayconvey positive externalities to South Korea,and the social rate of return on South Koreaninvestment in the North may exceed the privaterate of return. As a consequence, there is a pub-lic policy justification for encouraging invest-ment in the North. It would be better, though,to introduce broad tax incentives for investmentin the North than to use state influence overthe financial system to encourage investmenton an ad hoc basis. The notion behind a tax-based policy would be to divorce the overarch-ing societal goal of investment in the Northfrom state influence on particular investmentdecisions. The advantage of this approach isthat it would preserve the microeconomic effi-ciency of private firms selecting investmentprojects on the basis of expected rates of return,while taking into account the broader socialimperative to encourage such investment.xxix

It should be noted that Kim Dae-jung hasexpressed the opposite concern (namely that a“gold rush” mentality might generate excessiveinvestment in the North) and has floated theidea of government coordination. Althoughthere is little evidence that any such gold rushwould occur, such a coordination mechanismcould facilitate state meddling in the SouthKorean economy.

With respect to the second goal, of systemictransformation, one can imagine a hierarchy ofmodalities of engagement. The worst would beprojects such as the Mt. Kumgang project, whichliterally and figuratively can be fenced off fromthe rest of the North Korean economy and so-ciety, offering little prospect for structural trans-formation. Given the historical enmity and dis-trust between the North and the South, the Mt.Kumgang project may have been a necessaryfirst step to build confidence and trust. But hav-ing successfully made that step, future projects

should be evaluated with a more critical eye.Marginally preferable to the Mt. Kumgang

project would be mining concessions or specialeconomic zones in remote areas such as Rajin-Sonbong. These are classic enclave economieswith little prospect for spillover into the broad-er society.

Industrial parks, bonded warehouses, andother preferential urban investment zoneswould be preferable, and free investment bySouth Korean firms throughout the countrywould be best of all. The latter would not onlymaximize contact between North and SouthKoreans and promote educational spilloverabout operation of a market economy, it wouldcreate competition between local authorities toattract investment.

The bottom line is that South Korea has beentraumatized by its financial crisis. Although theeconomy is experiencing a cyclical recovery fromthe depths of 1998, continuing labor unrest andthe travails of Hyundai are reminders that thecountry has not put its financial crisis com-pletely behind it. Hopefully, the crisis has dealtonly a temporary setback to the process of con-structive disengagement of the state from theeconomy. The continuation of disengagementand structural reform is a difficult process forany country under any circumstance, but theexistence of the North adds a tremendous addi-tional layer of complexity to the challenge thatSouth Korea faces.

C O N C LU S I O N

North Korea faces a fundamentally supportiveinternational environment; South Korea, Japan,China, even the United States want to see a lessbelligerent North Korea survive until reconcilia-tion and unification can take place on the Ko-rean peninsula. The three questions are whetherNorth Korea is willing to change, whether it iscapable of successfully managing change, and towhat purpose it would apply the fruits of change?

I am hopeful on the first question, skepticalon the second, and wary about the third. I believethat the most likely outcome is a kind of mud-dling through, in which the North Korean re-gime makes a series of ad hoc adjustments while

It is good public policy to encourageinvestment inthe North

26


supported by external powers that would rathersee a struggling, less antagonistic regime thaninstability or collapse.xxx The outcome couldwell be what I have described elsewhere as“apparatchik capitalism” in which the politicalelite would use their control over state power tochannel to themselves the lion’s share of rentsgenerated by a partially marketized and non-transparent economy.xxxi

E N D N O T E S

i On North Korean brinkmanship, see Snyder(1999) and Noerper (1998). An alternative inter-pretation of North Korean behavior is providedby Kim (1999) who argues that North Koreanmilitary expenditures are a rational response tothe threat from the United States and SouthKorea.

ii These events are described in greater detail inNoland (2000).

iii For details of this proposal, Han and Choe(1995) and Yu (1997). For highly informative in-terpretations of North Korea’s unification policy,Park (1993) and Eberstadt (1998).

iv See Steinberg (1998) for some thoughtful reflec-tions on issues of regionalism and central con-trol in the context of the political integration ofthe two Koreas.

v See Noland (2000) for specific references tothese formulations.

vi Moon (2000).

vii Analyses of the industrial park and railwayprojects by the Center for Reunification Eco-nomics (2000).

viii See Noland (2000) Chapter 7 for a more ex-tensive treatment of this issue, and citations torelevant literature.

ix See Noland (2000) Chapter 3 for a discussion ofthe hazards of estimating North Korean nationalincome and a summary of alternative estimates.

x See Noland (2000) Chapter 5 for a discussionof the famine.

xi For example, Oxford Analytica, 9 May 2000and Eberstadt (2000).

xii Eberstadt (2000).

xiii Eberstadt (1995).

xiv See Noland (2000) Chapter 5 for an extensiveanalysis of food availability and an assessmentof alternative estimates of mortality associatedwith the famine.

xv See FAO (2000) for its statement on NorthKorea; and Noland, Robinson, and Wang (2000b)for a more complete analysis of famine recoverystrategies.

xvi Noland (2000) Table 5.1.

xvii See Kim, Lee, and Sumner (1998), Smith(1998), and Smith and Huang (2000), for furtheranalyses of the North Korean food situation.

xviii Noland (2000) Table 5.3.

xix Von Hippel and Hayes (1998).

xx Michell (1998).

xxi Williams, Hayes, and Von Hippel (1999).

xxii Hong (2000).

xxiii Noland, Robinson, and Liu (1999) andNoland, Robinson, and Wang (2000c).

xxiv See Manyin (2000) for alternative estimatesand additional discussion of compensationissues.

xxv Agence France Press, 7 May 2000.

xxvi See Sinn and Sinn (1996), Noland (1997),Watrin (1998), Wolf (1998), Noland (2000), andreferences therein for more extensive discus-sions of the German “lessons” for Korea.

xxvii See Noland, Robinson, and Wang (2000c) fora detailed assessment.

xxviii See Bae (1996) for recommendations on howto improve tax collection; Bae also raises thepossibility of privatizing South Korean govern-ment assets as a means to finance unification.

xxix See Cheong and Lee (1996) for such a proposal.

Among thosewho want tosee a less bel-ligerent NorthKorea surviveare South Korea,Japan, China,and the U.S.

27


xxx See Kim (2000) for a similar conception of a“limited reform strategy.”

xxxi See Noland (2000) Chapter 9 for further elab-oration on this theme, and a comparison to theRomanian case.

R E F E R E N C E S

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A U T H O R I N F O R M AT I O N

Marcus Noland is a senior fellow at the Insti-tute for International Economics and an associ-ate of the International Food Policy ResearchInstitute. He was a senior economist at theCouncil of Economic Advisers in the ExecutiveOffice of the President of the United States, andhas held research, teaching, or fellowship posi-tions at the Johns Hopkins University, the Uni-versity of Southern California, Tokyo University,Saitama University, the University of Ghana,the Korea Development Institute, and the East-West Center (where he was a POSCO fellow).His previous works include three published bythe Institute for International Economics:Avoiding The Apocalypse: The Future of theTwo Koreas (2000), Economic Integration of theKorean Peninsula, ed. (1998), and Global Effectsof the Asian Currency Devaluations, with Liuet al. (1998).

Contact address: 11 Dupont Circle, NWWashington, DC 20036 U.S.A.Telephone: (202) 328-9000Fax: (202) 328-5432Email: [email protected]

Photography credits: p. 3, Liaison Agency; p. 6,Chung Sung-Jun/Liaison Agency; p. 10, Gamma/Liaison Agency; p. 18, Stephen Wunrow; p. 22,Stephen Wunrow; p. 23, Newsmakers/LiaisonAgency.

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Elisa W. Johnston, Publications Manager

Telephone: (808) 944-7145Fax: (808) 944-7376Email: [email protected]: www.EastWestCenter.org

E A S T-W E S T C E N T E R S P E C I A L R E P O R T S

East-West Center Special Reports present athoughtful synthesis of knowledge on issues ofimportance to the Asia Pacific region and theUnited States. Special Reports are authored byscholars, journalists, and other commentators.They are intended for those who make or influ-ence policy decisions in the United States, Asia,and the Pacific, including educators, scholars,journalists, business people, and individualswith a broad interest in Asia or the Pacific.

To order additional copies of this SpecialReport or past issues, contact the East-WestCenter Publication Sales Office at:

[email protected]

or see previous section for other contact infor-mation.

The Development Crisis in Vietnam’s Moun-tains, by Neil L. Jamieson, Le Trong Cuc, and A.Terry Rambo. No. 6. November 1998. 32 pp.$7.00.

The mountain areas of Vietnam, which arehome to one-third of the nation’s people, are ina state of deepening environmental and socialcrisis. Future decades may well see the uplandssuffer widespread environmental disaster andmassive human tragedy. Only by recognizingthe complex dynamics that drive development,and by fundamentally rethinking developmentstrategy can the risk of calamity be minimized.

Environmental Problems in China: Estimates ofEconomic Costs, by Vaclav Smil. No. 5. April1996. 62 pp. $7.00.

How sustainable is a country’s economic growthwhen the costs of accompanying environmentaldamage are factored in? For China, faced withsome of the worst pollution and environmentaldegradation in the world, the question is espe-cially urgent. A first step is to evaluate the hid-den costs of its extraordinarily rapid economicgrowth.

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The Asia-Pacific Airline Industry: EconomicBoom and Political Conflict, by Sumner J. LaCroix and David Jonathan Wolff. No. 4. October1995. 37 pp. $7.00.

The rapid growth of air traffic and related indus-tries servicing Asia is straining existing facili-ties as well as threatening the framework ofbilateral agreements that have governed Asia-Pacific aviation since the end of World War II.A U.S. call for free international trade in airlineservices is getting a wary reception from manyAsian governments.

Democratic Transition in Asia: The Role of theInternational Community, by Muthiah Alagappa.No. 3. October 1994. 36 pp. $7.00.

Many in the West are heralding a worldwidetrend toward democracy—and governments arepromoting it as a goal of their foreign policies.But many Asian leaders contest the universalityof the democratic system of governance and areresisting Western pressure; some see democracyas a threat, especially to economic development.How will these conflicting perceptions combineto foster or inhibit democratic transition in Eastand Southeast Asia?

Porpoises Among the Whales: Small Navies inAsia and the Pacific, by Joseph R. Morgan. No.2. March 1994. 48 pp. $7.00.

Two factors—affordable missile technology andincreasing nationalism—are producing a drama-tic increase in the capabilities of small navies inAsia and the Pacific. The United States mustweigh these developments as it considers whatwill best preserve peace and stability and detera naval arms race in the region.

Intruding on the Hermit: Glimpses of NorthKorea, by Bradley K. Martin. No. 1. July 1993.31 pp. $7.00.

Based on three visits to North Korea by an Amer-ican journalist between 1979 and 1992, this re-port highlights changes from the 1970s, whenthe North had much to boast about in its com-

parative level of economic development, to the1990s when communism’s failures at home andabroad have placed the regime in desperatestraits.

C O N T E M P O R A R Y I S S U E S I N A S I A A N D T H E PA C I F I C

This East-West Center book series is publishedby Stanford University Press. (Information onsubmitting manuscripts and ordering booksappears at the end of the list).

Population Change and Economic Developmentin East AsiaChallenges Met, Opportunities SeizedAndrew Mason, ed.Forthcoming 2001, 450 pp. est.0-8047-4303-7 cloth $65.000-8047-4322-3 paper $29.95

What role did population change play in EastAsia’s rapid economic development? Existingstudies have neglected the fundamental waysin which demographic forces have influencedeconomic growth and regional economic inte-gration. Consequently, the significance of EastAsia’s remarkable decline in childbearing, thediminished rates of population growth, and theaccompanying changes in age structure are notfully appreciated among individuals chargedwith framing and implementing programs de-signed to improve living standards throughoutthe world. This book provides a comprehensiveanswer to this question.

Capital, Coercion, and CrimeBossism in the PhilippinesJohn T. Sidel1999, 316 pp., illus.0-8047-3745-2 cloth $55.000-8047-3746-0 paper $18.95

Local bossism exists when local power brokersachieve monopolistic control over an area’s co-ercive and economic resources. The entrenchedprovincial warlords and political clans of thePhilippines have long made it a striking case ofthis phenomenon. John T. Sidel’s insightful com-

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parative historical analysis argues that the rootsof bossism in the Philippines lie in the inaugu-ration of formal democratic institutions at a rel-atively early stage of capitalist development.

“A superb piece of scholarship . . . . Probing beneath

the superficialities of election rituals, Sidel discovers

the dynamics of a political-economic process of sys-

temic coercion and corruption that may trouble the

democratic transition in many newer nations and re-

gimes for decades to come. These conclusions should

command wide attention from the many scholars and

policy specialists concerned with the recent wave of

democratization across the globe.”

—Alfred W. McCoy,

University of Wisconsin–Madison

Making MajoritiesConstituting the Nation in Japan, Korea, China,Malaysia, Fiji, Turkey, and the United StatesDru C. Gladney, ed.1998, 350 pp.0-8047-3047-4 cloth $55.000-8047-3048-2 paper $19.95

Majorities are made, not born. This book arguesthat there are no pure majorities in the AsiaPacific region, broadly defined, or in the West,challenging the thesis that civilizations arecomposed of more or less homogenous cultures.Analyzing discourses of majority and minority,the fourteen contributors argue that emphasison minority/majority rights is based on un-critically accepted views of purity, numericalsuperiority, and social consensus.

“Contains a wealth of empirical and historical materi-

als, as well as analytic insights, about the dynamics of

ethnicity and cultural identity and their historical

evolution in this vast region of the world…. It should

be valuable to political analysts, cultural theorists,

scholars, as well as educated readers who are general-

ly interested in the social and political dynamics of

the region.”

—Journal of Asian Studies

Chiefs TodayTraditional Pacific Leadership and the Post-colonial StateGeoffrey M. White and Lamont Lindstrom, eds.1997, 343 pp.0-847-2849-6 cloth $49.500-847-2851-8 paper $18.95

The chiefs who operate within modern Pacificstates figure significantly in attempts to fashionnational identities and manage the direction ofpolitical and economic development. The con-tributors to this important volume present de-tailed analyses of the accommodations betweenchiefs and states in Pacific societies—the Fed-erated States of Micronesia, Fiji, Marshall Is-lands, Rotuma, Solomon Islands, Tana Toraja(Indonesia), Tonga, Vanuatu, Western Samoa,and New Zealand—providing a window into thecourse of social and political transformation inpostcolonial states today. The chief is a focusfor cultural struggle in the border zones of local,national, and transnational politics.

“This is a valuable book, with much to offer to schol-

ars of comparative social sciences focusing on the

Pacific Islands.”

—Journal of Pacific History

Political Legitimacy in Southeast Asia The Quest for Moral AuthorityMuthiah Alagappa, ed.1995, 446 pp. (second printing, 1998)0-8047-2504-7 cloth $60.000-8047-2560-8 paper $19.95

The right to rule affects all political activitiesand is crucial to an understanding of the poli-tics of any country. This significant compara-tive study analyzes political legitimacy in sevenSoutheast Asian countries—Malaysia, Singapore,Philippines, Burma, Thailand, Indonesia, andVietnam—addressing questions about the mean-ing and nature of legitimacy; the bases on whichit is claimed, acknowledged, and resisted; thereasons why legitimation projects succeed orfail; and the relevance of conclusions drawnfrom these countries for the study of politicallegitimation elsewhere.

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“An important contribution to reflection on legitimacy

and democratization as well as the study of Southeast

Asian politics.”

—Journal of Democracy

“A highly satisfying blend of empiricism and theory, a

work that commends itself to a wide audience of stu-

dents and policy makers.”

—Journal of Contemporary Asia

Submissions

This series addresses contemporary issues ofpolicy and scholarly concern in Asia and thePacific. It is focused on political, social, eco-nomic, cultural, demographic, environmental,and technological change and the problemsrelated to such change.

Preference is given to comparative or region-al studies that are conceptual in orientation andemphasize underlying processes and to workson a single country that address issues in acomparative or regional context.

Please address inquiries and proposals to:

Sharon F. YamamotoSenior EditorEast-West Center1601 East-West RoadHonolulu, HI 96848-1601

Email: [email protected]: (808) 944-7502

Ordering Information

To request a review copy or for information onexamination copies, please contact StanfordUniversity Press at www.sup.org or by tele-phone at (650) 723-9434.

Stanford University Press books are distrib-uted by Cambridge University Press. To placean order, use any of the following methods.

Online: www.sup.orgTelephone: (800) 872-7423Fax: (914) 937-4712Mail: Cambridge University Press

Distribution Center110 Midland AvenuePort Chester, NY 10573-4930

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