author_book_wMarcus Noland:
The North Korean Economy & Its Impact on South Korea

with Marcus Noland, author of Avoiding the Apocalypse: The Future of the Two Koreas.

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Full Transcript of Interview

Tom Tucker:Hello and thanks for joining us today at KoreaBusinessCentral.com. My name is Tom Tucker. I’m the host for our podcast interview series and today our topic is the North Korean economy and its impact on South Korea.

Our guest today is Marcus Noland. Mr. Noland is the deputy director and senior fellow with the Peterson Institute for International Economics. He has devoted much serious scholarly effort to the problems in North Korea and the prospects for Korean unification.

Marcus is also the author of the critically acclaimed book Avoiding the Apocalypse: The Future of the Two Koreas. Marcus, it’s great to have you with us today. Thanks for joining us.

Marcus Noland:My pleasure.

Tom Tucker:If you would, start for us by describing the current state of the North Korean economy.

Marcus Noland:Well, the current state of the North Korean economy is really quite bad. North Korea was a sort of satellite of the Soviet Union. It adopted classic central planning. That system began to fall apart in the 1980s and the country began to marketize under duress – essentially, a function of state failure.

That process got an enormous boost in the 1990s with a famine that killed, I estimate 600,000 to a million people or about 3-5% of the precrisis population making it one of the 20thcentury’s worst.

Over the last 15 years or so, the economy has essentially marketized, but marketized really beyond state control. And as a consequence, the state has never been comfortable with this process. And economic policy has had a kind of two steps forward, one step back character.

Since about 2005, the general trend has been negative and the country today is characterized by increasing degrees of inequality, increasing amounts of corruption, a chronic foodproblem. They really haven’t fully abated since the famine period of the 90s.

It is an economy for which, for a small number of people, works fairly well. But, for a much larger number of people, really is quite grim.

Tom Tucker:Yeah, it certainly is. As I’m sure you know, the per capita GDP – or per capita incomerather – the average Korean has about $1800 a year. And in fact, as I’m sure you know as well, it’s one of the poorest nations in East Asia.

Marcus Noland:Yes, I know. It is a very sad kind of social science experiment on the Korean Peninsula. You have the same people. It’s the same group of Koreans, but they have adopted two radically different systems; South Korea embracing market capitalism, and in the last 20 years or so, political democracy as well, North Korea clinging to the central plan which has now really deteriorated into really a very highly distorted market economy.

And in the political sphere, maintaining what is probably the strangest political KO””>systemon Earth; a mixture of really a kind of dynastic Stalinism centered around the Kim family and characterized by terrible human rights abuses which have an economic component as well.

Tom Tucker:That leads me to my next question. How and why is North Korea one of the most isolated countries on Earth?

Marcus Noland: It’s a terrible thing. North Korea is in a very good neighborhood. North Korea oughtto be a wealthy country. It ought to be growing at a reasonable rate. It borders China and it should be being sucked along KO””>in China’s slip stream.

It borders South Korea which is, arguably, the premier development success story of the post-war period and it’s only a short ocean transport distance away from Japan – the world’s secondlargest economy or third, depending on how you count.

It’s in a very good neighborhood. This isolation is self-imposed and it is self-imposed because the political system believes that this political regime probably could not survive a greateramount of openness and a greater amount of personal freedom that openness would entail.

Tom Tucker:The government recently established a state development bank. Talk about that a little bit, and what that means and what it means interms of potential impact.

Marcus Noland:Well, as I indicated earlier, really what we’ve observed for about the last 15 years is akind of tug of war in which the state has tried to reassert the control it lost in the early 1990s over the economy which marketized, as I said, really as a function of state failure.

What we’ve seen over the last several years are a number of moves including the establishment of this development bank. But even more importantly, the currency reform – confiscatory currency reform – that was undertaken in December of 2009; an attempt by the state to, basically, reconstitute socialism, to clamp down on the market and reestablish the preeminence of the state economic life.

So, what the state is doing is it’s had this currency reform which has basically been an attack on the market attempting to wipe out the working capital of entrepreneurs. And now, it isestablishing or trying to reinvigorate state institutions to channel what economic activity occurs through those institutions.

So, the state development bank can be seen as a way of trying to channel capital flows that may be occurring in North Korea or may occur in the future through an institution that is underdirect state control, not through more decentralized organizations than institutions.

Tom Tucker:Talk a little bit more about this currency devaluation. Elaborate a little bit more on whythe government did that and what is that going to mean for the average North Korean.

Marcus Noland:Well, what the North Koreans have done, really twice now in the last ten years, isundertake radical macroeconomic moves that could be explained in a number of different days. But, probably the single best explanation is that these are moves aimed at undercutting the market.

The market poses a challenge to this political regime because it offers the possibility of wealth, prestige and, ultimately, power that is not directly connected to the state. The statefinds the threat.

In the most recent go around, they did a confiscatory currency reform. Now, currency reforms themselves are not necessarily a bad thing. Oftentimes, governments after a period of highinflation that’s finally been broken, the government wants to establish that the battle days are gone and kind of do something to really put up an exclamation point on that achievement and demonstrate to the public that we’re a in a new, better economic world.

So in recent years, for example, countries like Ghana, and West Africa, Romania, Turkey have all done currency reforms. And typically what happens is they knock off some number of zeroes offthe currency to establish a new, smaller number – so, $100 becomes $1 – oftentimes, linking their exchange rate to the dollar, or to the euro or some other well-known currency as a kind of pre-commitment mechanism.

And when they do that, they normally give people extensive advanced notice. In Ghana, for example, there was a seven month campaign explaining what they were going to do to the peoplebefore the currency reform was enacted.

You have to change accounting rules, you have to literally change software on cash registers. You have to do a lot of things.

And then, they give people a period of time – in Ghana, it was six months – in which both the old currency and the new currency circulate in parallel and then the old currency ceases tobe legal tender and is worthless at the end of that period.

What the North Koreans did, they announced it on November 30thand it really went into effect the first week of December was something radically different than that. They sprungthis on the people. They did not give them seven months prior warning.

They simply sprung it on them that a new currency was being issued that would have two zeroes less than the old currency. They gave them one week, not six months, to convert thecurrencies. And then most important, they put very severe limits on the amount of currency that could be converted.

There are different ways of trying to measure how much. It was equivalent to, really, about a 50 kilo bag of rice. That amount of money in cash could be converted into the new currency.

Well, the country with a financial system as underdeveloped as North Korea’s is, most people’s lives operate in cash. Most businesses are operated in cash.

And so, those limits that the government put on the conversion had the effect of destroying many people’s savings and it destroyed the working capital of these private entrepreneursthat had sprung up over the last 15 or 20 years.

There’s been a lot of back and forth since then as you can well imagine with the government making this move. People rushed and tried to get into foreigncurrencies trying to convert their holdings into US dollars or Chinese yuan. Then, the government followed up with a ban on foreign currencies.

I’m skeptical that they will be able to make that ban stick. But as you can see, it’s basically a set of moves that are aimed at restricting the role of the market. They’re quite explicit in their announcements about this and possibly, essentially, gain resources for state use.

2012 will be the centenary of Kim Il Sung, the Founder of the country. They’re building lots of kind of prestige projects. And so, there’s a sense that the state needed some money and so confiscating the excess cash from the people might be a way of raising revenue to pursue these monumental edifices that they’re trying to build.

Tom Tucker:Let’s change gears a little bit and talk about China. China is being real aggressive in pursuing a strategy of economic engagement with North Korea. What are your thoughts on that?

Marcus Noland:From a Chinese standpoint, North Korea is a small province. Jilin province that borders North Korea has a population that’s roughly three times that of North Korea. North Korea is not very big in Chinese terms.

But, China sees some advantages of North Korea continuing to exist as a fraternally alive socialist state. And as a consequence, China has emerged as the North Korean’s regime’s ultimate guarantorboth in economic and political respects.

China has only reluctantly gone along with UN sanctions undertaken over the last year in response to North Korea missile and nuclear tests. There’s very little, if any, evidence that those sanctions have actually been forced by the Chinese who have emerged as North Korea’s largest partner for trade and investment.

The positive spin you could put on this is China is essentially trying to do what Kim Dae Jung, the South Korean President, did a decade ago which is operate a sunshine policy that willencourage the North Koreans to adopt less belligerent behavior towards the outside world and a lesser oppressive behavior internally.

But thus far, there is little evidence that the Chinese initiative has had any real positive impact on North Korean behavior.

Tom Tucker:The model for economic development in China is one that appears, at least, to be serving China well. Is that an economic model that leadership in North Korea would consider? Are they considering China’s approach to economic development? And why would they not take a look at that model and say, hey we need to go that route too?

Marcus Noland:That’s a very good question. There have been two countries in Asia that’s two formallycentrally planned economies which have reformed and done really well – China and then Vietnam.

Those two countries differ from North Korea in really some very important respects that make it questionable whether their models would really be effective in the North Korean context.

For one thing, both China and Vietnam when they started their reforms had more than 70% of their labor force in the agricultural sector. They were really agrarian economies.

This is important because with a large labor intensive agricultural sector, the sort of incentive changes that the Chinese and Vietnamese did in agriculture were able to generate very rapidand positive supply responses that made a lot of other things in terms of restructuring the old manufacturing sector possible.

North Korea, in terms of economic composition, really looks more like Romania or parts of the Soviet Union; much more industrialized. And as a consequence, that sort of Chinese or Vietnamese path of reform is probably less likely to deliver the same sorts of benefits.

It’s also different in political terms. Vietnam is the obvious case to compare it with. Vietnam had a civil war, and one side won and one side became the monopolistic definers of what it meant to be Vietnamese.

And then, when they initiated their reforms in the late 1980s, ideologues in Hanoi could come up with justifications for why what they were doing was really what Uncle Ho had in mind.

North Korea is the junior partner both in size and accomplishment on a divided peninsula. And the problem for the North Korean regime is as they begin to adopt market oriented reforms, they start to look more and more like a third rate South Korea.

And the question will inevitably rise in their populist’s minds, why be a third rate South Korea when you can just be the real thing?

So, neither the economic model has the same dynamics and the political situation is very difficult. This has made it difficult for the North Koreans to go forward with reform. And indeed, what they’ve been doing recently quite literally turns the Chinese model on its head.

Rather than, essentially, freezing the old state economy in place and allowing development to occur at the margin according to market dictates, the North Koreans are trying to reverse that, to actually squelch the market and made growth occur according to state dictates.

It’s very interesting when Kim Jung Il visited Shanghai. He visited Pudong and saw the giant skyscrapers there. And he turned to his Generals and he said, “This is what I want for North Korea.”

The problem is it wasn’t clear when Kim Jun Il said that whether he meant he wanted a modern center of financial intermediation for North Korea or whether he wanted big, tall buildings. And unfortunately, it appears that it may have been the second interpretation which is the relevant one.

Tom Tucker:What about prospects of South Korea’s economic involvement and engagement with the North? And what would be the best approach for the South’s taken this regard?

Marcus Noland: Well, from a South Korean perspective, engagement makes sense. North Korea, effectively, holds the city of Seoul hostagewith 11,400 deployed artillery tubes.

And so, some economic growth that gives the North Korean’s a bit more money and allows them to install the 12,000thtube are really as not a major increase in its threat to South Korea.

So, from a South Korean standpoint, you might as well engage with the North, hope that you can encourage the kind of constructive change and reform in the North which will ultimately form a basis for national reconciliation and, ultimately, unification.

So, from a South Korean standpoint, engagement makes sense. The problem is that North Koreans understand very well the political threat to them that engagement with South Korea poses.

So, they have been quite restrictive in terms of what they allow South Korea to do. South Korean involvement with the North is basically bottled up in two enclaves. One is the Mount Kumgang tourism project which is currently suspended following the killing of South Korean tourists there and the other is the Kaesong Industrial Complex.

Ultimately, if there was enough political rapprochementbetween Seoul and Pyongyang, one could hope to see an expansion of South Korea’s economic engagement with the North; something more like, frankly, what the Chinese have where you have Chinese businesses running all over North Korea trying to trade, and to a more limited extent, actually investing.

But, this is something that will really only move as quickly as the North Korean regime will allow it to move. And ultimately, that is bound up in their insecurity about their relative poor performance and the cognitive dissonance that contact with a wealthy, healthy and large South Koreans could have in the North Korean population.

They can take away the South Korean cell phones when they enter the country to go Kaesong. But, the literal, physical differences in the two populations as well as the way the South Koreans just look; how much healthier, better dressed they are is obvious to any observers.

Tom Tucker:Where do you see North Korea heading? Where will the country be, say, 10-20 years from now?

Marcus Noland:It’s hard for me to imagine that 10-20 years from now North Korea will have the same political regime it has now. There will be a transition either gradual or abrupt. This regime is simply so anachronistic, I don’t see how it can survive.

Though I have to say, many people have gone broke betting on the collapse of North Korea. But, I think the political regime will be very different.

I think, really, the question is do those political changes within North Korea lead to a North Korea that is more tightly integrated with China or South Korea? And I think this is something the South Koreans are very concerned that despite all the protestations, or self-protestations, about self-reliance and Juche, the trajectory that North Korea is on could well end up reverting back to status of a tributary state to China.

Tom Tucker:Will unification ever happen and what would need for that to fall in place in order for that to happen?

Marcus Noland:Well, both governments have stated plans for unification which are gradual in the extreme with time horizons on the order of 50 years. Really, what has to happen is enough political evolution in North Korea to make kind of reconciliation and confederation with the South plausible.

And there are really only two ways you can get that. One is through an abrupt collapse of the state, like we saw in the case of the Germanys, or one might get some radical but gradual change in the political regime that allows it to be plausible for the two states to establish a confederal relationship and, eventually, unify.

The alternative is that the Korean Peninsula could potentially be in a situation similar to what Latin America was, say, in the late 19thcentury or with Germany and Austria that they end up being permanent, separate, independent states with common cultural aniseeds, but through an accident of history, end up being permanently independent. I think that would be a sad thing if that were to happen, but I think it is a distinct possibility.

Tom Tucker:What are your thoughts on the nuclear issue?

Marcus Noland:Well, I think that what we have to do is convince North Korea that there are ways of achieving their goals that do not require nuclear weapons and that nuclear weapons ultimately are a greater hindrance to North Korea than they are an asset.

The problem is that it is very difficult to force North Korea into a stark choice between retaining their nuclear weapons capability, but remaining relatively isolated in the world versus giving up the nuclear program and integrating into the global economy in a much more prosperous way.

The problem is the North Koreans, of course, want to have their cake and eat it too. They want to integrate with the rest of the world on their own terms which include maintenance of their nuclear deterrent.

And when the United States, and Japan and, at times, South Korea, have attempted to deal with North Korea in a relatively forceful way, China and at other times, South Korea, have acted to undercut that pressure, ultimately, by their revealed behavior.

China certainly and, potentially, South Korea fear instability in North Korea more than they fear a nuclear armed North Korea.

So, the United States and its allies are never really able to push North Korea to the wall so that it would have to make that stark choice. Either keep the nukes and remain cold and dark or give up the nukes and join the world in a better way.

And as a consequence, we sort of muddle along in a situation in which the North Koreans can maintain some nuclear capability, but that nuclear capability creates an enormous impediment to its normalization of economic and diplomatic relations with the rest of the world.

Tom Tucker:How would you rate the leading powers response to North Korea’s nuclear weapons program and how should it change? What would you recommend in terms of the best way to handle this issue with North Korea?

Marcus Noland:Well, I think that, unfortunately, we probably are – we’re at where we’re at. We’re in a situation where the North Koreans have some nuclear capability. They have one nuclear program based on plutonium, which has essentially been moth balled, but could be restarted.

And then, they have a second – or allegedly – have a second program based on highly enriched uranium that is of still unknown size and capability.

The problem we face is that we probably cannot provide – what the North Koreans want from us is something that we probably can’t provide and that is a guarantee of the sustainability of their political regime.

Not only can we not guarantee it, the sorts of the things that we might be able to do in terms of diplomatic and economic benefits, it is simply inconceivable that our United States political system could generate those kinds of benefits with the North Korea that maintains the political character does in nuclear weapons.

So, it’s almost impossible to envision a deal that is grand enough that would convince the North Koreans to give up their nuclear weapons.

So, we’re in a situation where the North Koreans have these nuclear weapons. If somehow, we could hermetically seal them on the Korean Peninsula, that would not be a good situation, but it’s a situation we could live with.

As I mentioned earlier, the North Koreans have essentially held sole hostage for a long time with their superior conventional military capability. The nukes really don’t add much to that and that deterrence has existed on the Korean Peninsula for more than 50 years. And there’s no reason to imagine it couldn’t continue to exist even with a nuclear armed North Korea.

The problem is we can’t keep the nuclear problem confined to the peninsula for two reasons. First of all, just the example of North Korea, a country that resigned or suspended its participation in the Non-Proliferation Treaty and essentially broke out and developed nuclear weapons is an example for other countries to emulate.

And more importantly, the North Koreans as we know cooperate with various governments around the world both in the nuclear field as well as in areas like missile technology, most prominently with countries in the Middle East such as Iran.

And it’s that capacity to proliferate both expertise, and equipment and materials that is a great threat to American interest globally.

And so, if we could somehow just keep the nuclear issue on the peninsula, I think everyone could learn to live with it. The problem is there’s no way for the North Koreans to guarantee to us that that’s what’s going to happen. And indeed, they have this established track record of engaging in proliferation activities elsewhere in the world.

And so, we are really stuck in a situation of managing the problem, trying to impede those proliferation activities as best we can while we try to, we hope for and try to encourage a political evolution in North Korea that would make the regime less threatening to its neighbors, to the United States and to US global interest. It ultimately is a political problem, not a technological problem.

Tom Tucker:In closing, for our listeners, what would be the most important point to take away today regarding North Korea at its future?

Marcus Noland:I think this has been a fairly depressing interview. I’m sad to say it, Tom.

Tom Tucker:I agree. That’s been my sentiment throughout this conversation.

Marcus Noland:North Korea is a terrible tragedy. At the time of the division of the peninsula in 1945, North Korea was the richer part of the peninsula. North Korea had higher levels of education than the South.

And if you simply compare the trajectories of the North and South over the intervening, now more than 60 years, you have one country which is the premier success story of that period, both in economic and political terms, and you have another country that is mired famine, and horrendous human rights abuses and a dysfunctional economy.

And I think that what we can only hope for is that with enough careful diplomacy and encouragement that, through one path or another, North Korea will evolve in a way that allows it to get out of the hole that it’s in because it is a life that is, as I said, if you simply compare the two parts of the peninsula, the costs of the paths the North Koreans have chosen to follow is manifestly evident.

Tom Tucker:Well, we can only hope and watch for the best. Certainly, that’s the case. Our guest today has been Marcus Noland. Mr. Noland is the deputy director and senior fellow with The Peterson Institute for International Economics. Marcus, it’s been a real pleasure to have you visiting with us and I truly appreciate it. I look forward to visiting with you again in the future.

Marcus Noland:It was my pleasure.

Tom Tucker: Thanks for joining us today at KoreaBusinessCentral.com. My name is Tom Tucker. I’m the host and will look forward to having a conversation with you next time. Thanks for joining us today.