Rethinking Economic Engagement with North Korea

Now is a good time to rethink strategies for economic engagement with North Korea. Recent requests for food aid from the North and the report from a U.S. NGO Needs Assessment Team paint a picture of deteriorating food security due to harsh weather conditions and continued systemic failures. The UN humanitarian appeal for 2011 is being updated by a special assessment now underway. These developments raise for fresh debate the merits of renewing humanitarian aid following a vacuum of international response to the convulsions of internal economic changes inside North Korea over the past year, with China standing out as the glaring exception. The failure of Pyongyang’s policies to dampen the role of markets and reassert socialist management system practices, and its inability to temper inflationary forces in the economy, stand in contrast to the proclamations of improving the lives of ordinary people and becoming a “strong and prosperous country” by 2012. Recent announcements of Cabinet changes made to better plan and manage economic development projects and foreign investment and trade initiatives signal openness to new ideas and relationships. But there is no evidence that the North Korean leadership is ready to embrace markets and pursue the economic policy reforms that will be needed to nurture a growing role for markets.

Economic and political disengagement from North Korea by the United States and South Korea embody the doctrines of “strategic patience” and “reciprocity” adopted by these two administrations and has been amplified by increased military hostilities between the two Koreas during the past year. In a departure from previous governments in both countries, the Obama and Lee administrations have resisted requests for humanitarian assistance of any significant scale. Although widespread concern for the plight of ordinary North Koreans is genuine, some actors believe it is paramount to respond to demonstrated humanitarian needs, while others also recognize that political factors need to be taken into account when calibrating a response. Concerns about whether the North Korean government appeal is motivated by domestic priorities to shore up stocks to meet expectations created for 2012, and whether monitoring protocols will be honored after previous experiences, contribute to the hesitation to respond robustly. Also, provision of humanitarian assistance has implications for the perceived role of foreigners by the recipient groups and the effectiveness of the government’s own systems and capacity for providing food for the people. Any claims that food aid is fully “independent” of other considerations are not credible for those concerned with the wider political dynamics of engagement with North Korea. This means that food aid should be understood to have significance as a political tool and also should be synchronized with an overall economic engagement policy that is shaped by political and not solely humanitarian objectives.

While the international community has been giving greater attention to better integration of “relief” and “development” strategies,[1] this has not been true in the case of North Korea thus far. Recognizing the need for a more coherent approach would allow for a nuanced discussion of the merits of providing food directly through UN or NGO channels to particularly vulnerable groups, along with the importance of encouraging North Korea to improve domestic capacity to manage its food security challenges without relying on free handouts indefinitely. This includes: 1) expanding sustainable domestic food production; 2) embracing market mechanisms for more efficient distribution; 3) focusing the public distribution system not on the general population, but on targeted vulnerable population groups; and 4) using trade more aggressively to acquire the food and fertilizer necessary to close the structural food supply gap that averages about one million tons of rice equivalent a year. The political objective should be to improve incentives for North Korea to follow a rational economic development and social protection policy that recognizes the essential role for markets and foreign trade, not one governed by isolation and bargaining for aid.

The implication of pursuing such an objective is that large-scale government-to-government transfers of food aid should be avoided. Also, any transfers targeting acutely vulnerable groups should be carefully monitored and accompanied by parallel efforts to support expansion of the role of markets in meeting the food needs of non-targeted populations, such as providing resources for building community gardens, microcredit to boost small-scale production, and investments that lower the cost of transport to market.  Incentives to trade for food rather than seek food aid should also be factored into engagement policies. This is already the case for China, which emphasizes the role of commercial transactions and limits government assistance. South Korean food aid policy, by contrast, has tended to emphasize the role of government-to-government transfers rather than commercial trade for food. This approach, however, instead of stimulating the role of markets, served to prop up the public distribution system.

Contradictions between what North Korea wants and what it needs pose a fundamental challenge for economic engagement. Beyond the issue of food security, transformation of the North Korean economy is hampered by a regressive mindset that seeks to maintain a state-directed system that emphasizes self-reliance and import substitution. But this system also requires foreign exchange and trade to meet critical requirements not just for food, but for the imported energy and investment capital needed to stimulate economic growth. Past negotiations over North Korea’s nuclear program and expanded relations under South Korea’s “Sunshine Policy” tended to give North Korea financial and economic inducements that corresponded to what North Korea wanted to satisfy its internal political perceptions of valuable rewards. However, these had little to do with benefitting the economy as a whole, modernizing the economic system, or meeting North Korea’s own longer-term interests in economic viability.

In negotiations on North Korea’s nuclear program, the economic incentives that were accepted under the Agreed Framework—light water reactors and heavy fuel oil—did nothing to advance the transformation of the North Korean economic system and, in fact, diverted resources from more beneficial investments.[2] The economic incentives adopted under phase two of the Six Party Talks process were only a slight improvement, providing the equipment needed to begin rehabilitation of conventional power plants and continuing shipments of heavy fuel oil. But there was no technical collaboration, no impact on the energy system as a whole, and no improvement in North Korea’s ability to purchase the imports necessary for its own energy security. This approach to economic incentives for denuclearization was not a successful recipe for improving the economy in any meaningful way.

It is hard to believe that North Korea would willingly give up its nuclear deterrent without confidence in its economic as well as security future. Any negotiations related to the nuclear program should be approached with the objective of increasing the economic rationality of incentives offered for progress on denuclearization, while reinforcing the motivation and capacity to pursue economic policies that are consistent with building up the role of market mechanisms and an outward-oriented economic development strategy. Energy assistance is a reasonable area for continued priority attention, especially in demonstrating how partnerships in planning and implementing economically-sound projects can be done successfully. Rehabilitation of conventional power production capacity, phased upgrading of the grid, and attention to energy efficiency would all fit within this paradigm. The future of nuclear power in North Korea should be determined by economic and technical considerations linked to an overall energy sector development plan, and not treated as a political given.

Part of the future agenda should also be to encourage North Korea to develop a transparent, rules-based financial system and to realign sanctions to give positive incentives for North Korea to do business in the right way. Recent changes within the North make such a strategy more feasible than earlier rounds of negotiations. The push back by the North Korean people to the policy of repressing markets has put the government in a new situation where public expectations about the value of markets and their unwillingness to accept at least some policy directives cannot be ignored. Cabinet changes meant to streamline economic development planning and approval of foreign investment projects also signal a new openness to more businesslike practices in dealing with foreigners. While expanded trade and investment from China is already reinforcing this trend, it is not in North Korea’s interest to rely solely on China for its future economic security.

The South Korean economic policies towards the North that underpinned the “Sunshine Policy” era also erred on the side of giving North Korea what it wanted, not what it needed. Cash for concessions served to fill the coffers of the North Korean leadership and reinforced the status quo system rather than facilitating systemic reform. Wage payments for workers in the Kaesong industrial zone and payments under the processing-on-commission trade also served to prop up the existing system, channeling payments through intermediaries rather than directly to employees and contracted suppliers. While South Korean economic engagement has produced jobs and income for North Korea, it has not helped stimulate the market economy; instead, it continues to feed the centralized money management system.

There needs to be a renegotiation of business practices in the inter-Korean relationship. If the Chinese can establish joint ventures in North Korea and engage in direct enterprise-to-enterprise commercial relations, then why should we assume that South Korea cannot do the same? It is also noteworthy that the UNDP recently renegotiated arrangements for hiring and paying North Korean local staff, under which, direct payments are made to such employees. This sets an important precedent. Thus, as the two Koreas seek to repair their bruised relations following the events of 2010, one area for attention should be adopting more normal business practices in enterprise relationships across the border. New business models for the Kaesong industrial zone, for example, could include joint ventures and opportunities for North Korean companies to manufacture and trade with South Korea. Also, encouraging manufacturers in the Kaesong industrial zone to procure inputs and services from small and medium-sized North Korean enterprises could help expand opportunities for local businesses and stimulate the adoption of commercial practices.

Unfortunately, U.S., South Korean, and Chinese economic engagement policies with North Korea have been guided by very different national interests and objectives. Taken together they produce conflicting dynamics that distort incentives for managed change in the economic system. Giveaways, sanctions, and commerce are all in this mix, with results that are not satisfying for any of the countries involved and are no doubt confusing for the North Koreans. Dealing with North Korea’s nuclear program with its global implications for nonproliferation, and dealing with North Korea’s economic and political future in Northeast Asia, are two very different sets of challenges that must be addressed at the same time. A more coherent policy of economic engagement that can be pursued both bilaterally and multilaterally is necessary, and must be based on a shared vision for the future of the North Korean economy and requirements for political stability. Debating what that shared vision should be and aligning economic engagement policies should be given much higher priority for the multilateral diplomacy now underway.

Increased informal contact and exchanges among economic experts would help improve the environment for discussing economic issues in a more rational way. Efforts by the Nautilus Institute to pursue such engagement in the energy sector are a good example. There are also signs of increased North Korean openness to expanding opportunities for knowledge sharing in economic management, not only with China, but also with other countries as well, including the United States. Another step could be commissioning the IMF, World Bank, and UNDP to undertake a comprehensive and independent economic assessment that can serve as the foundation for a different kind of discussion of issues related to North Korea’s economic future than has been possible up until now. Also, if multilateral negotiations are resumed to address North Korea’s nuclear program and other topics, teams assigned to explore economic cooperation possibilities should include economic and financial experts. Now is a good time to rethink strategies for economic engagement to help transform and modernize the North Korean system and to encourage the changes in behavior that are widely seen as essential to making progress on the whole range of issues of concern with North Korea.

[1] In the late 1990s, UNDP and the Government prepared an Agricultural Recovery and Environmental Protection Program (AREP) that attempted to build this bridge. Despite a good discussion with official donors and NGOs in Geneva, funding for the program was not forthcoming. A number of NGO’s have pursued small scale agricultural development projects over the years, but apart from demonstrating good practices, the scale of such endeavors and impact on the agricultural system as a whole have been modest. In recent years, such activities have continued at a much reduced level in a fragmented way and in a vacuum of meaningful policy dialogue on links to markets and other important system management challenges.

[2] Not only was the LWR project economically irrational in nearly every respect, but the heavy fuel oil, while providing short-term relief for electricity production, shortened the economic life of the existing power plants due to corrosion of boilers by the high sulfur content of the oil.

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