Once Again, Sanctions Enforcement

July 5, 2016 7:00 AM

In an earlier post, I talked about the qualitative evidence that North Korea is starting to experience distress, and noted that the ultimate fate of the North Korean economy hinges more than ever on what China chooses to do. At a recent meeting in Washington, I had the pleasure of catching up with Prof. Byung-yeon Kim (Seoul National University), one of the leading South Korean economists working on the North Korean economy. We had a lively discussion with a Chinese colleague about the ongoing issue of sanctions enforcement, and it prompted a closer look at exactly how exemptions are being managed. On the one hand, enforcement appears lax, and not just by China; there is anecdotal evidence of lax enforcement of South Korean sub-contracting chains that end up in North Korea as well. On the other, there may be political economy factors in the Northeast that make the coal and iron bans more credible and as noted in my earlier post, China is clearly cracking down on some illicit activities.

Outside of the shipping and financial provisions, the most binding constraint contained in 2270 is the ban on coal, iron and iron ore exports; the exact language of the relevant sections of 2270 are attached below, along with the separate restriction on more lightly-traded gold and some other ores. Coal alone accounts for about 40% of North Korea’s exports (excluding the Russian coal business).  

At the end of the notice announcing the restrictions, three documents are linked: the list of sanctioned items (Annex 1); a statement that the import is not of North Korean origin (Annex 3) and Annex 2, which reflects the WMD and livelihood exemption status. The form reads as follows:

“My company is importing _________from North Korea. My company attests that this transaction is: solely for the people's livelihood, and that does not involve the nuclear program or the ballistic missile program of the DPRK or any other profit-generating activities prohibited in the Resolutions 1718 (2006), 1874(2009), 2087(2013), 2094 (2013) or 2270 (2016) of the UN Security Council.” 

When placed against April trade data reports, the form itself raises a number of important questions. Overall, North Korean coal exports in April 2016 were 20.5% below exports in April 2015, but with the bulk of that decline attributable to the fall in commodity prices.

On the one hand, the language of 2270 could not be more clear: China successfully insisted that the two exemptions—linking the trade and the livelihood exemption—be included in the resolution. China is therefore fully within its rights to enforce the resolution as written.

Yet the language raises a number of quite obvious questions about what the written text means and implies. The first problem is that firms appear to self-declare. In the absence of independent investigative oversight by Chinese authorities, those with an interest in such trade will be tempted to misrepresent the issue or plead ignorance. But the problem is deeper. Money is fungible, and particularly so in a highly-centralized political economy in which foreign exchange earnings are effectively pooled and deployed as the regime sees fit. It is highly unlikely that any revenue generated by the production of coal, iron or iron ore is going to be accompanied by a “dedicated to the WMD program” certificate. Second—and similarly—virtually all economic activities contribute to the livelihoods of those involved in them, whether owners, managers or workers. On what grounds should we—as a legitimate humanitarian concern—exempt some activity from inclusion in the sanctions?

Such exemptions cannot generate the result that no or little trade is affected; the negotiation of 2270 would in that case have been a completely disingenuous exercise. The approach to solving this problem could be to think in terms of either criteria or targets that lend some objectivity to the process and allow for outside monitoring of enforcement. A “criteria approach” would establish ex-ante standards for the livelihood exemption. Such exemptions could be claimed for transactions undertaken by small exporters or importers (note the ambiguity that the livelihood exemption could be claimed on the basis of either the exporter or importer). A target approach would say “sanctions are being enforced when we see a 50 or 70 or 90 percent drop in coal export volumes; in the absence of such changes, the presumption should be that sanctions are not being enforced.” Such a targets approach could even consider measures such as prices; as I have argued in previous posts, if there are no effects from sanctions on either the exchange rate or domestic prices, it would appear prima facie evidence that North Korea’s external sector—now almost entirely dependent on China—is not being constrained.

The alternative is to rely on Chinese discretion and seek to cooperate on the issue; the objective is not sanctions enforcement per se but to provide incentives for a return to negotiations. In this regard, my colleague Jason Kuo located some interesting evidence on why at least some firms in the Northeast may support a ban. Around the time the UNSC resolution was passed, Anshan Steel posted an announcement that Liaoning provincial government formed a leading group to deal with the oversupply of coal and steel. That announcement, in turn, referred to an announcement from the State Council made in Feb 1, 2016 expressing concern about the decline of the coal and steel industry and the need for structural adjustment. The upshot: the State Council prohibited SOEs in the coal and steel industries from launching any new production projects and all levels of government were prohibited from assisting a new production project for coal and mine production; the Liaoning and central government announcements can be found here and here. In this case, sanctions enforcement may in fact be incentive compatible.

A second enforcement issue pertains to South Korean companies, not Chinese ones. It is an open secret that a number of medium-sized Korean apparel and trading firms sub-contract to Chinese firms in the Northeast, which in turn subcontract to North Korea. An informant reported to us seeing with his own eyes large-scale warehouses in which “made in China” labels were affixed to North Korean apparel; in some cases, the labels are provided to North Korean subcontractors directly. This trade would appear to violate the May 24 post-Cheonan embargo, but as with the Chinese sanctions enforcement to date appears lax. Responsibility for sanctions enforcement appears scattered in South Korea, but regulatory oversight and putting South Korean firms on notice that they are liable would be first steps.  

 

From UN Security Council Resolution 2270 (2016)

29. Decides that the DPRK shall not supply, sell or transfer, directly or indirectly, from its territory or by its nationals or using its flag vessels or aircraft, coal, iron, and iron ore, and that all States shall prohibit the procurement of such material from the DPRK by their nationals, or using their flag vessels or aircraft, and whether or not originating in the territory of the DPRK, and decides that this provision shall not apply with respect to:

(a) Coal that the procuring State confirms on the basis of credible information has originated outside the DPRK and was transported through the DPRK solely for export from the Port of Rajin (Rason), provided that the State notifies the Committee in advance and such transactions are unrelated to generating revenue for the DPRK’s nuclear or ballistic missile programs or other activities prohibited by resolutions 1718 (2006), 1874 (2009), 2087 (2013), 2094 (2013) or this resolution; and,

(b) Transactions that are determined to be exclusively for livelihood purposes and unrelated to generating revenue for the DPRK’s nuclear or ballistic missile programs or other activities prohibited by resolutions 1718 (2006), 1874 (2009), 2087 (2013), 2094 (2013) or this resolution;

30. Decides that the DPRK shall not supply, sell or transfer, directly or indirectly, from its territory or by its nationals or using its flag vessels or aircraft, gold, titanium ore, vanadium ore, and rare earth minerals, and that all States shall prohibit the procurement of such material from the DPRK by their nationals, or using their flag vessels or aircraft, and whether or not originating in the territory of the DPRK…

 

 

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