Another Round of Disappointment

North Korea’s special investigation on the Japanese abductees ended on October 29, 2014, with no meaningful achievements, leaving only a sour aftertaste for the Japanese. Expectations had been rather high in Japan, as Pyongyang announced with great fanfare that the mission would be carried out by the State Security Department, the infamous and veiled ideology-policing agency. But the outcome showed that the Japanese people’s naive belief in the goodness of human nature had been betrayed again.

This episode makes us ponder the essential nature of the political community called North Korea. How can we cope with the fact that the basic common sense of the human race is not applicable when it comes to explaining and predicting things North Korean?

An Unheard-Of National Financial System

In this essay, I propose a new approach to understanding North Korea—an approach based on money flows. I had this conception when I was teaching at the People’s Bank of China as a visiting professor in 2000. At the time, a team of bankers from North Korea’s central bank were stationed at the PBC for training. That exposure led me to have some grasp of the North Korean financial system.

At that juncture, I envisioned that the North Korean financial system would evolve into something similar to the “mono-banking” system that is found today in Cuba. Far from matching my expectation, however, the North Korean financial system ended up becoming something that is unheard of in human civilization. Understanding the form and nature of this system, I believe, can pave the way to a grasp of the operating principles and even the future destiny of the North Korean regime.

The mass media often project the image of children beggars roaming in the black markets of North Korea. We then hear about party cadre members purchasing high-rise apartments costing as much as $100,000, and their wives insisting on using cosmetics made in South Korea or Japan. How can we reconcile these contrasting images and messages from North Korea?

One answer can be found by breaking down the seemingly coherent Democratic People’s Republic of Korea into several “bundles” for purposes of analysis. The term “republic” refers to a political system in which the national leader is elected by vote of the people, who hold sovereignty. If that is the case, North Korea, where the supreme power has been passed from father to son within the Kim clan over three generations, can hardly be called a democratic republic. It is a monarchy instituted and operating in the digital era. This monarchy can be conceived as consisting of three economic tiers and four money-flow spheres.

Three Economic Tiers on the Ladder of Power

One defining element of the modern state is the national economy. The national economy stands on the two pillars of a monetary system managed by the central bank and a system of national finances based on taxation. Yet North Korea does not have a national economy that conforms to this definition. Even though the regime issues the currency, won, it does not function as a national currency is supposed to. Furthermore, the regime’s planned economy is malfunctioning, and there is no private ownership to support people’s livelihoods. The only logical alternative—the national rationing system—does not work either. Alongside these failures, there have arisen three economic tiers, as indicated in the diagram above.

(1) The Winning Coalition

Scholars who characterize North Korea as a dynasty argue, as a corollary, that North Korea has a “court economy.” While this notion serves to express disappointment and frustration, it lacks in explanatory power. I find an effective alternative in the notion of the “winning coalition.” This notion was introduced by a group of political scientists headed by Bruce Bueno de Mesquita. Simply speaking, the winning coalition refers to a group of people who install political leadership and then garner vested rights stemming from that success. As for North Korea, this theory would posit that the winning coalition there shares its fate with its chosen leader, Kim Jong-un. In view of this nature of the winning coalition, it is not hard to understand why there are no such textbook traits as the presence of national leaders who promote national interests or of a bureaucracy in pursuit of institutional rationality.

How many belong to the North Korean winning coalition? Some South Korean specialists who follow North Korean affairs casually refer to “one ten-thousandth” of North Korea’s population of some 25 million—in other words, approximately 2,500 people. As a matter of fact, though, the annual publication entitled Information on the Key Figures of North Korea(*1) released by the South Korean Ministry of Unification has 315 entries in the 2014 issue. If we leave out those who are out of active service due to senility or other reasons, we end up with some 250 people.

The cream of the crop that constitutes this winning coalition has particular backgrounds. Some 10% of its members belong to the Kim family or have privileged ties through marriages. Others have such outstanding pedigrees as the offspring of the revolutionary families or aristocratic credentials such as attendance at the Mangyongdae Revolutionary School. Those who do not have these backgrounds boast outstanding qualifications such as education at elite schools including Kim Il-sung University and Kim Il-sung Military University.

Those who belong to the winning coalition must devote everything to the cause of sustaining the ruling machine. In exchange for that suffocating job of sharing the fate with the one single leader, they can enjoy power and affluence. Their blindly loyal service puts them in a unique position that allows the conversion of the national economy into parcels of private business. In running this national business, the members of the winning coalition reap monetary gains, which are then preserved using preferred currencies such as the US dollar, the euro, the Japanese yen, and the Chinese yuan.

(2) The “Pyongyang Republic”

Below this top-tier economy lies the “Pyongyang Republic.” Those aspects and scenes that allow North Korea to look like an ordinary country stem from this narrowly defined, particular segment of North Korea. A modern state consists of territory, people, and government. The Pyongyang Republic serves to create the image that the two components of people and government are in place.

The Pyongyang Republic here refers to the rank-and-file personnel of the North Korean ruling machine and their family members, amounting to around 1.8 million people. Not all of them reside in the greater Pyongyang area; they are in charge of routine operation of the North Korean political and military machines around the country. Most of them have college-level educations and work experience of 10 years or more in their own fields. In short, the Pyongyang Republic is the functional base of the winning coalition.

The members of the Pyongyang Republic perform the jobs of running the country’s social institutions and infrastructure, such as the party, cabinet, the military, local governments, factories, enterprises, and schools. In exchange for that service, they have priority entitlement to the national rationing system. In addition to this, they may have the luck of reaping extra income from the black markets. For instance, medical doctors may smuggle medication to the black markets for personal sales. And soldiers guarding the China border may pocket cash bribes from individuals escaping from North Korea.

(3) Deserted people

The ordinary people who account for 90% of the North Korean populace exist below the above two tiers. The people of the nation (Staatsvolk in German) as a component of a country are supposed to maintain political loyalty to their country. If we judge them by that criterion, the ordinary North Korean people who try to seize the opportunity to escape from their country cannot be called national citizens. Some North Korea specialists in South Korea even mention the scenario of 10% of North Koreans fleeing their country.

These ordinary North Koreans neither pay taxes nor receive benefits from their country. They just stay in the land where they happened to be born, without the foggiest notion of “the right to the pursuit of happiness.” Simply speaking, they are deserted people who have to join the struggle of all against all for survival.

The Four Money-Flow Spheres

The three-tier economy presented above can be classified into four spheres in terms of money flows.

Sphere Court/party Military Cabinet Underground Beneficiaries (1) Kim clan and (2) members of the winning coalition (1) and (2) (3) members of the Pyongyang Republic (1), (2), (3), and

(4) deserted people Functions (1) securing secret funds for exclusive uses (1), (2) autarky of military units, and (3) permitting corruption to prevent revolts and coups (1), (2), (3), and

(4) macro finance of the “pseudo-government” (1)–(4) and

(5) survival of the deserted people Forms of

intermediaries specialized banks, joint-stock banks specialized banks, joint-stock banks national banks black markets Key examples Chosun Daesung Bank, Kumkang Bank, Koryo Bank Chosun Changgwang Credit Bank, First Trust Bank, Kumsung Bank Bank of Chosun, Chosun Trade Bank money traders

(1) The Cabinet Sphere

In an ordinary country, the flow of money in the national economy is managed by the central bank. The cabinet then manages the national economy based on that money flow. This basic system, however, is missing from North Korea. There do exist a cabinet and a central bank. Officially speaking, North Korea has a “mono banking” system, in which the central bank, the Bank of Chosun, monopolizes all financial functions. The BOC provides all the services that are performed by the central as well as commercial banks in other countries. As an exception, the Chosun Trade Bank is in charge of foreign currency transactions and settlements.

This pubic financial sector, however, is said to account for no more than 20% of the entire added value that is created in reality. If this is true, the remaining 80% of the added value must be sanctioned and transacted through other financial intermediaries. These other intermediaries belong in the court/party and military spheres.

(2) The Court/Party Sphere

A key to the understanding of the economic and financial affairs of North Korea resides in the money flow of the court/party sphere. The primary institutions of this money flow system are the “special purpose” banks. There are several specialized banks that function as money management intermediaries for pockets or organs of the vested rights of the winning coalition. Those pockets of the vested rights have their own missions and operating logic, which lead to the different names, locales, and functions of their respective banks. Nevertheless, all the specialized banks are tightly controlled by the uppermost party secretaries on behalf of the supreme leader, Kim Jong-un.

The way these specialized banks exist and work is reminiscent of the “prisoner’s dilemma” in game theory. They do not talk to or work with each other. It is only the group of top-tier party secretaries who know and dictate how the banks work in dealing with money in and outside of North Korea. This is a prime example of the divide-and-rule principle.

It is no wonder that many of these specialized banks are on the sanction list of the Financial Crimes Enforcement Network (FinCEN ) of the US Treasury Department. These banks were created against the background of North Korea’s foreign currency procurement campaign in the mid-1970s. The campaign was conceived as a way to prove the loyalty to Kim Jong-il of his winning coalition members. Then, entering the “March of Perseverance” period in the 1990s, the campaign took another course of evolution. The new mission was now to safeguard the very existence of the Kim Jong-il regime, not to mention the winning coalition.

The bizarre and widely discussed practice called waku came to be widely adopted in this phase. Waku has now become a buzzword among professionals who follow the North Korean economy. But nobody mentions the origin of this vocabulary item, which is neither Korean nor Western; it is quite certain that the word is a North Korean borrowing of the Japanese term waku (枠), which means quota or distribution framework.

In sum, waku refers to the special permission by the supreme leader that allows specified privileged business activities. With the given waku, competing groups of the winning coalition can venture into any kind of economic activity, such as manufacturing, trade, mining, construction, or even services. Monetary gains from these activities are converted to preferred currencies such as the US dollar, the euro, the Japanese yen, and the Chinese yuan. The funds are supposed to be drawn on and centrally managed by the supreme leader’s secretaries. The resulting pool of money is called the “revolutionary fund,” yet in reality it amounts to a “fund for co-survival” of the winning coalition.

The mysterious Bureau 39 and Bureau 38 of the Workers’ Party of North Korea are widely cited as entities that run waku businesses. But the practice is widespread and involves organizations that are critical for the sustainability of the North Korean regime. They include the Second Economic Commission of the People’s Army, which specializes in arms production.

One well-known example of a specialized bank is Daesung Bank. This bank belongs to the Daesung Industrial Group, which is operated and sanctioned by Bureau 39 of the Central Committee of the Workers’ Party. The bank’s mission is indeed “specialized,” as its job is to procure and manage secret funds for free use by the supreme leader. Some specialized banks have even set up foreign branches. For instance, Gold Star Bank maintained a branch in Vienna, Austria, for a considerable period of time. Chosun Kumkang Bank, for another instance, was created in 1978 to provide foreign settlement services for Bonghwa Trading and Pyongyang Trading, the two trading companies operating under the auspices of the Economic Policy Inspection Department of the Workers’ Party.

(3) The Military Sphere

Given that there is no notion of separation of powers and hence that the supreme leader controls all forms of coercion, it would be futile and meaningless to distinguish between the court/party economy and the military economy. The two sectors are both partners and competitors in the business of keeping the winning coalition afloat. If we have to make some distinction, however, a good case in point is Chosun Changgwang Credit Bank, established in 1986. The bank was created to deal with foreign currency settlements for Ryongaksan General Trading Company, which is run by the Second Economic Commission in charge of arms production and trading. The military sector also set up First Trust Bank in 1992 and Gold Star Bank (later renamed Ilshim International Bank) for foreign currency transactions on behalf of the enterprises under its sway.

(4) The Underground Sphere

One of the most important and striking aspects of the North Korean economy is the ever-expanding underground sector. While the North Korean regime tries hard to project the image that it is running a tight ship, it is not capable of controlling or managing the marketplaces that have mushroomed around the country. This unsanctioned market mechanism arose in the 1950s from the natural phenomenon of farmers swapping their surplus produce. There were several important developments that served to switch this mechanism into high gear, such as the trading of Japanese goods and money brought in by Koreans who repatriated from Japan. The mechanism then took a great leap forward during the “March of Perseverance” period in the 1990s. As the socialist state came to fail to provide its very basic service of universal rationing of food and survival goods, there had to be some alternatives. The black markets were now the market of the paralyzed socialist regime, putting an end to the planned economy.

The financial transactions in the underground economy are handled by private money dealers, called donchangsa, who trade US dollars, euros, Japanese yen, Chinese yuan, and even counterfeit dollars. What warrants attention here is that even ordinary North Koreans have come to be interested in the Chinese yuan as a “safe asset.” This new phenomenon came to be visible after many North Koreans lost their life’s savings in the 2009 currency reform just by following the orders of the regime. This new development implies, among other things, that North Korea’s dependence on China is getting deeper at the grassroots level. It is an ironical contrast that the “deserted” ordinary North Koreans prefer the Chinese yuan, while the members of the winning coalition are preoccupied with the US dollar as their “safe asset.”

The North Koreans as “Economic Animals”

The integration of the global economy is progressing to the point where people are using terms like “global village.” Far from this current, one single country called North Korea stays alone like a real-life example of the impermeable billiard ball envisioned in classic textbooks of international politics. Nevertheless, North Korea is no exception to the rule that an economy needs a circulatory system, with money serving as its blood. If we approach North Korea in terms of which people make and own the money and how they do so, we may well reach the finding that this opaque and seemingly incomprehensible political community also consists of “economic animals.” And the future of North Korea may depend, at least in part, on how these economic animals calculate and behave.

(A Japanese version of this article was published on December 9, 2014; this English version was also provided by the author. Banner photo: A scene of seemingly normal life in Pyongyang, North Korea’s capital. Courtesy of Barcroft Media/Aflo.)