Engagement, Not Sanctions, Deserves a Second Chance

I am grateful for the opportunity to respond to Bill Brown’s comments in “Can Sanctions Get a Mulligan” on my recent piece about North Korean trade, especially since he chose to not mention two of my main points: the fact that North Korea existed comfortably with less than half of the trade volume of 2016 only ten years ago, and that sanctions are suffocating the North Korean market economy.

To start with the data question: As an economist, I know how easy it is to manipulate data even if these numbers are reliable. Trustworthy numbers are a rare species in general, and even more so if they are from or about North Korea. The only good news is that a bias in the interpretation of data is neither a new problem nor one limited to a specific country, so there are techniques to deal with that issue. Among the simpler ones is the use of long-term time series data, thus avoiding the trap of interpreting too much into one-time events or of too enthusiastically extrapolating short-term developments into the future. Outliers can be identified and time series can be Winsorized. None of this is rocket science. Another strategy is to look at changes within data originating from the same source, assuming that a possible bias—be it deliberate or not—is more or less constant.

The Utility and Relevance of KOTRA Data

This is why I find the Korea Trade Investment Promotion Agency’s (KOTRA) data on North Korean trade useful. They show year-on-year changes, and they reach back to the time after the collapse of the politically motivated trade relationship with the socialist bloc almost three decades ago.

I have difficulty understanding how it is possible to call data on the trade of the year 2016 “well out of date” in a piece written in October 2017, as Brown does. At least over here in Europe, the year 2017 is not over yet, so data on 2016 are as fresh as they can be for someone who is looking for yearly figures. Brown suggests using monthly Chinese trade data as an alternative. Since being polemic seems to be de rigueur these days, let me give it a try: This is like measuring the sunlight from 8 a.m. until 4 p.m. and then concluding that the total amount of sunlight emitted during the day is three times that amount. Well possibly, but a day has 24 hours and a year has 12 months. I am not ready to draw any conclusions unless we have data for all of the current year. And even that would be risky, because 2017 could in hindsight turn out to be exceptional. This is why I have not written anything on North Korean trade last year; I wanted to see whether the reduction, as observed by KOTRA for 2015, would be the beginning of a new trend. I was right to wait because it was not. (See the rebound of the curve in graphs 2 and 3.)

So let’s wait for more solid information before we declare, with far-reaching consequences, victory and believe that sanctions are finally working. And don’t forget that sanctions are a long-term business; their effects take time to surface, which makes me even less enthusiastic about jumping to premature conclusions based on short-term changes and on what the Chinese chose to tell us.

And things get even better. A source that Brown quotes to make his point on the superior value of Chinese data has this to say: “Beginning in January 2014, China has reported zero crude oil exports to North Korea each month in its formal customs data, even though by all indications this flow has continued.”

On a more general level, I find it disturbing that an American seems to trust data from adversary China more than numbers from ally South Korea, although the latter are to a certain degree based on what the Chinese reported. This would be as if an American president would allow himself to be lectured about Korean history by a Chinese leader. Oh, wait…

The Utility and Relevance of North Korea’s Budget Data

Brown then challenges my use of the North Korean budget reports. Such a skeptical view is more than justified: the data is from North Korea, which renders them more than questionable, and since 2002, no absolute numbers have been provided, only year-on-year percentage changes. My point is that, after taking all these flaws into consideration, the budget reports are still worth being read and analyzed.

To begin with, they are the only annually published and publicly available official North Korean data on their economy. More importantly, they always come from the same source, so I think it is fair to assume as a working hypothesis that the bias is more or less stable.

I agree that claiming “a 4% increase in the budget equals a 4% GDP growth” would be a very long shot. This is why I never did so. To quote myself from a piece I wrote in 2012 here at 38 North: “I would discourage you from taking them [budget report growth rates] as exact GDP growth rates, or in any other way as a reflection of reality”.

Rather, I interpret the budget growth rate(s) as the official North Korean evaluation of their economic performance, and I argue that there is a correlation with the actual growth rates. I have compared the time series of North Korean official budget growth rates with the GDP growth estimates of the Bank of Korea, and found that the values are very different, but the correlation between the two data sets is remarkably strong. To quote myself again: “the correlation coefficient for this South Korean estimate and North Korea’s officially announced achieved revenue… from 2005 to 2011 is relatively high with r=0.65.”

If we look at the official North Korean budget data over the years, we do find remarkable variations. This is counter-intuitive: Our stereotypical image of a system like North Korea would assume the continuous reporting of bombastic successes but this is not the case if you look at graph 1. The official budget growth rates have become much more modest since 2006 and again since 2013—both years during which North Korea conducted nuclear tests which resulted in more sanctions. So the figures even show what one would expect, and please note that I never said sanctions are having no impact. Of course their effects are being heavily felt in North Korea. My point is that the last thing sanctions will accomplish is stopping North Korea’s nuclear weapons program.

North Korean Cash Reserves

Concerning the number of $2 billion (in US dollars) in North Korean reserves that Brown brought into question, Witness to Transformation’s Stephan Haggard actually wondered about that figure too in one of his latest posts. So let me clarify the source for what Brown curiously called “Frank’s $2 billion.” It is from a report in the Asahi Shimbun quoting a South Korean analyst from the Industrial Bank of Korea who claims that “North Korean leader Kim Jong Un has a $3 billion to $5 billion fund… stashed in bank accounts under false names in Switzerland and other countries.” Such data is questionable, but I have found this number being quoted rather widely and assume it has become part of the general perception about North Korea. Being a careful person, I took the average of the estimate ($4 billion) and reduced it by 50 percent, arriving at $2 billion. To indicate that this number was highly speculative, I wrote “cash reserves of, for example, 2 billion USD” without even quoting Asahi. The point I wanted to make was this: Assuming North Korea does have large cash reserves, whatever their size, we need to be aware of the fact that even a reduction of North Korea’s hard currency income to zero will take quite a while before it has any effects on those imports that Pyongyang regards as strategic, such as oil and oil products (import value $372 million in 2016).

Exchange Rate in North Korea

Brown asked, “At what rate does he think the government is converting its so-called surplus?” This can be answered quickly and simply: They use the only exchange rate there is, i.e. the market rate of, at the moment, roughly 1 USD:8000 KPW. In fact, when I was shopping at North Korean markets, the currency in use was Inminbi (that’s how it is called in North Korea; we know it as Renminbi or Chinese Yuan), so that the whole question seems to miss the point. And since we don’t know any absolute numbers for the North Korean budget, we cannot calculate how much is left over in terms of hard currency. But we do see the trade deficit which must be covered somehow because the North Koreans do pay their bills. So this is all I wanted to say: they might be using domestic revenue to cover parts of their spending on imports. I know this does not correspond with the “illicit activities keep the evil state of North Korea afloat” line, but I thought our propaganda is meant for the other side, not for ourselves. If the North Korean government creates a surplus in North Korean Won, and if it wants to spend that surplus on imports, it will of course have to convert that amount into whatever currency it needs at a rate that the counterpart accepts. The 1:100 “exchange” rate is merely an accounting tool or a ratio of equivalence to simplify shopping at international hotels, and to cheat foreigners such as ORASCOM. Nobody in his right mind in North Korea takes that rate seriously.

 Sanctions Suffocate the Forces of Change in North Korea

By way of conclusion, and since this issue has been largely ignored in the response to my article, let me repeat my main point.

I hope it is not necessary to remind everyone how the West won the Cold War. It managed to convince socialist countries to play the game of the market and of consumerism. That was a game they were not fit to play, and so they either reformed like China and Vietnam, or went down like the Soviet Union or East Germany. I witnessed the latter as an insider.

North Korea has for a long time refused to play that game. When I first went to Pyongyang in 1991, I found an almost completely demonetized society, as Nick Eberstadt called it in The North Korean Economy. Many in the West are unable to appreciate the change that has happened in North Korea ever since, because we regard a monetized society as normal.

Perhaps this is the reason why we so stubbornly refuse to support the trends of monetization and marketization there, unlike what the West did in 1978’s China. Rather than making North Korea a stakeholder of good relations with the international community, we keep isolating them. Rather than providing the North Korean consumer more cash so that he can increase demand on the markets and thus create incentives for more trading and more production, we do all we can to minimize trade with North Korea, to intercept all financial transactions, and to stop even the export of consumer goods to North Korea.

I agree with those who argue that this will result in frustration of the new middle class over an end to their dreams of a rosy economic future. I do not believe, however, that we are correctly predicting their reaction. A “Pyongyang Spring” and a color revolution on Kim Il Sung Square will not happen, no matter how much some people seem to wish for it. As far as my decades of studying North Korea make me believe, nationalism there will trump greed. And in the few cases where it does not, there is always the repressive state apparatus.

Unless we are willing to risk a major catastrophe, our only hope to one day sit down with a responsible North Korean government that is willing to negotiate about freezing, inspecting and at some much later point dismantling its nuclear program is to help them reform their own country at their own pace and with full sovereignty, like the Chinese and the Vietnamese could. Along the way, the livelihood of the people and even the human rights situation will improve dramatically, as we have again learned from the case of China. Sanctions have the opposite effect. They suffocate the forces of reform and drive people back into the arms of the North Korean state. The 20th century has clearly shown that central planning has failed; so why now in the 21st century trying central planning of change in North Korea?

Sanctions have not only been applied once or twice, but more or less continuously over more than two decades. If there is any policy that deserves a mulligan, it would be engagement which has not been given a serious, sustained effort since the end of the Agreed Framework and perhaps not even before.

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