Why is North Korea growing?

October 20, 2015 6:00 AM

Last week I visited the University of Hawaii to deliver the 2015 Seiji Naya Lecture. (Unfortunately I do not believe the event was videotaped, otherwise I would include a link.) During the Q&A, Rob York of NK News invited me to comment on the Bank of Korea’s estimate that the North Korean economy grew at a 1 percent rate last year, and the positive spin put on North Korean economic conditions in a recent CRS report. Given the anecdotal accounts of growing prosperity in Pyongyang and some other cities, the skepticism about the BOK’s estimate is understandable and indeed, I suspect that properly assessed the North Korean economy is growing faster—possibly much faster—than the BOK allows.

One can think of two general explanations for why the eyewitness accounts of Pyongyang (and some other cities) and the BOK growth estimate would seem to diverge. One is that the BOK is underestimating growth—their number is just too low.  This explanation is not implausible: estimating North Korean growth from the outside is actually quite a devilish task beset with “sketchy data, questionable methods, politicization etc.

The other explanation centers on distribution: resources are increasingly concentrated in Pyongyang and eyewitnesses mistake the growing affluence of the capital city for general prosperity.  Steph Haggard has termed this “Pyongyang illusion” and this explanation comports with the description of aid workers and others who report stagnant or declining conditions in the hinterlands.

But this begs the question, what it driving North Korean growth? I would put forward two basic explanations, one emphasizing internal conditions, the other external relations.

With regard to the former, we know from basic microeconomic theory that the gain from relaxing a quota is the greatest during the initial stages of relaxation when the constraint is most binding.  If one thinks about the North Korean economy as a system subject to pervasive quotas, considerable pure efficiency gains can be achieved simply by relaxing existing constraints—or in everyday language, just letting people make money. Moreover, much of this new activity is in the service sector, which is relatively less amenable to being counted using the BOK’s methods, a characteristic which might help explain why their calculations do not seem to line up with the anecdotes.

For better or worse, Kim Jong-un seems more comfortable with rich people, or at least the notion of rich people, than his forebears.  There is even a word for this rising entrepreneurial class, donju. So just easing up on economic repression can generate real productivity gains in the economy, even with no additional resources.

But the resource pool may be growing as well.  During the commodity boom, exports to China—consisting in significant part of coal and minerals—grew, propelled by both by both rising volumes and rising prices.  The mines represent classic “point source” resources.  Not only do they generate revenues, those revenues are relatively easy for the state to capture and invest in centrally orchestrated projects be they ski resorts, amusement parks or ICBMs.

These two drivers: pure efficiency gains associated with the decriminalization of economic activity, and growing external demand, could explain why the North Korean economy has seemed to be doing relatively well in recent years, and the political economy of the mining sector lends itself to acting as a source of finance for state-supported prestige projects as well.

But there are questions about the durability of both of these drivers. The slowdown in China and the consequent fall in global commodity prices mean that the external sector may be imposing a growing drag on the economy, as recent data from KOTRA and COMTRADE would seem to suggest.  (There is a sizable difference in the KOTRA and COMTRADE figures for 2014 China-North Korea trade.  KOTRA reports roughly $500 million more in North Korean imports from China than COMTRADE and a similar number on the export side; one possibility that might explain at least part of the discrepancy is that KOTRA is double counting processing-on-commission trade which appears to be growing.  But both sources point to an expanding trade deficit.)

On the internal side, the catch is that as far as I know the laws that make much of this emerging market activity illegal are still on the books.  That is to say that while the regime is currently acquiescing to this activity, at some point the state may decide it has had enough, reverse field, and begin enforcing the law (as it has in the past).  This very uncertainty suggests that a genuine regularization of this activity would generate an additional boost to productivity, as the risk premium on investment fell, and more complex transactional forms became viable.

Indeed, because the marketization we have observed for the last 25 years has been fundamentally a bottom-up process driven by state failure and not any intentional top-down reform, the state maintains an ambivalent stance toward the market, and has failed to develop institutions capable of supporting a well-functioning modern market economy. That’s the bad news. The good news is that if the state were to embrace the market, this could set off another round of pure efficiency gains.

https://www.youtube.com/watch?v=cYXSTMK8MU8

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