What Lies Ahead for North Korea?

This article appeared in the Deseret News on December 27th.

Kim Jung-il, the ruler of North Korea, died last week, reportedly of a massive stroke.  Other than a few deluded souls who might have been sincerely crying their eyes out on North Korean television, he will be missed by no one.

His death does, however, open up the possibility of changes in that reclusive country's policies, both domestically and internationally.  In terms of politics and policy, North Korea is probably the hardest country in the world to reliably understand.  We can observe the final results of whatever process determines policy, but very few people outside North Korea have any clue how that process actually proceeds.  So it is entirely possible that nothing will change in practical terms as a result of Kim Jung-il's death.  Still, if you are a bit of a gambler, the odds are higher now than they have been in a long time.

North Korea by almost any economic standard is a real basket case today.  This wasn't always the case.  Korea was occupied by Japan from 1910 until the end of World War II.  By agreement of the allied powers at the Yalta conference the Russians occupied the peninsula north of the 38th parallel and the U.S. occupied the south.  At that time the south was largely agrarian and what industry the Japanese had allowed to be built was mostly in the north, closer to natural resources from Manchuria, which Japan also occupied.  Up until the 1970's, standards of living in North Korea were actually higher than those in South Korea.

The real slide in standards of living came with the fall of the U.S.S.R.  Up until that time the North Koreans had skillfully played off of the antagonism between it and China.  When the Soviet Union ceased to exist, both China and Russia felt less of a need to compete for North Korean loyalty and the subsidies virtually ceased.

For several years I have been working with my BYU colleague, Scott Bradford, to try and predict what would happen if economic policy in North Korea were to change.  In a recently published paper with a former student, Dan Kim, now at Cambridge University, we examined what would happen if the government there were to open to market reforms, much like China did in the 1970's and 80's.  We found that simply implementing a market pricing mechanism is insufficient to bring North Korea out of a downward spiral.

North Korea has two major economic problems that need to be corrected.  First, it needs to more efficiently allocate the goods it produced across various industries.  Second, it needs to use a much greater proportion of its GDP for investment in capital equipment.  Partial reforms which are more likely to be enacted by a government intent on gradual change could solve the first problem, but leave the second in place.  For example, suppose the government continued to mandate the amount of production at state-run firms, but let those firms compete in a market with each other to purchase materials and equipment.  This would go a long way toward reducing inefficiency, but would still leave the country as a whole woefully short of capital.

Increasing investment in capital and infrastructure would correct the second problem, but is very difficult to do if North Korea is intent on remaining isolated from the rest of the world.  If they do not open up to trade, then the only way to allocate more toward capital goods is to either lower government spending on the military (unlikely) or lower consumption by households (difficult given chronic problems with starvation).

The best solution would be to import capital from other countries.  China, South Korea, Japan, and many other countries have capital available and firms that would be ecstatic to invest in North Korea under the right circumstances.

Meaningful reform in North Korea, if it happens, must involve changing the way they view outsiders.  Right now South Koreans enjoy a standard of living that is well over ten times higher than their North Korean neighbors.  This difference is due almost entirely to economic policy; the South is open to the world with free flows of capital, goods, and even workers.  The North is closed to even its closest ally, China, and exports little (almost all of its imports are in the form of humanitarian aid).

North Korea has a long, long road ahead if it is ever to catch up with South Korea and the path looks daunting.  However, remember that fifty years ago the same things were said about South Korea.  It may take time, but recovery is possible.