KEI Communications Director Jenna Gibson, host of Korean Kontext, recently interviewed Dr. Stephan Haggard of the University of California-San Diego on the North Korean economy, the role of black markets, and the potential impacts of new UN sanctions. The following is a partial transcript of that conversation. The rest of the conversation can be found at http://keia.podbean.com/.

Jenna Gibson: To start off, I’d like to get a broad view and then we’ll get a little more specific. So can you start off by giving us a broad picture of the economic situation in North Korea. I’m especially curious about the emergence of the black market over the last decade or so. Now experts estimate that North Korea’s economy is 40-60% black market. How exactly is the economy operating?

Stephan Haggard: That’s a very good question. The origins of the black market actually go all the way back to the famine of the mid-90s and it was in the wake of the famine that households and work-units had to essentially survive by pursuing economic activities, selling assets, engaging in trade and so forth. The economy bottomed out in the late-90s and we think that this marketization process from below probably contributed to the subsequent gradual recovery of the economy over the course of the 2000s and into this decade. There were several bumps along that process though, it remains an economy which is vulnerable to food shortages and particularly in the 2010, 2012 period, there was a recurrence of distress, obviously not on famine levels. But if we’re talking simply about what is going on in the North Korean economy currently, it’s probably recovered somewhat in the last two or three years, partly on the back of this marketization process, private investment, and trade, particularly with China.

Jenna Gibson: In terms of the black market, this is obviously something that local people are doing to survive. How much has the government been involved though? Is the government getting a piece, getting a slice of this black market economy?

Stephan Haggard: The black market probably began at what we might think of as the retail level in the sense that households were involved in this sort of trade. But what’s happened over the last four or five years, and again we have no accurate way of measuring the extent of this, is that we’ve seen evidence of what might be called larger scale activities operating in the market. For example, we know that there is a real estate market in North Korea, which means that either people have accumulated adequate savings to make these relatively large purchases or that there’s also an underground financial market which is operating and allows people to borrow. In combination, things like real estate, construction, housing, plus finance, suggests that the black market has scaled up to include actors that are really like capitalists. These are not just petty traders but these are people who probably have significant assets.

Jenna Gibson: There has been for a long time this perception that North Korea is dependent on China, and there’s a lot of rhetoric going around and especially in the political sphere that if we can make China do something, then we can make North Korea do something. But recently, North Korea been making some efforts to diversify their trading partners – one thing that we were talking about today at out panel is Russia and Japan’s perspective. Could you tell us a little bit more about the DPRK’s economic relations with other countries?

Stephan Haggard: Well again, this is great question because we don’t really fully know how much they’ve diversified. The problem that North Korea faces is that it’s really been very dependent on just two trading partners – first China which could be as much as 70% of North Korea’s total trade, but also, until the closure of Kaesong following the recent nuclear test, South Korea. And Kaesong alone probably accounted for roughly 25-30% of North Korea’s total trade. That gives you some sense of the scale of the North Korean economy, that a single export processing zone with 50 mid-sized South Korean companies could account for 20 or 25% of the country’s trade. This is clearly a very small economy. With respect to the rest of the world, there’s small bits of evidence of trade in other places but in the end, I just don’t see it as significant enough to really be substantial or politically significant for North Korea because the bulk still resides with these two trading partners, now whittled down to one as a result of the closure of Kaesong.

Jenna Gibson: We’ve talked about the black market, we’ve talked about some of the trade going on, it seems as if there’s this “official North Korea” and then there’s this “unofficial North Korea”. And sanctions can only really target one for the most part. Will this black market economy be directly affected by sanctions and, if not, then how effective can the sanctions really be?

Stephan Haggard: Well this actually really goes back in a way to a question you asked earlier, which is the relationship between this emerging private sector and the state. And particularly as we move into these larger scale activities like housing and finance, it’s very doubtful that the state is not involved in those activities. The organizational capacity of the North Korean regime and its ability to surveil is obviously very strong indeed but it extends all the way down to the neighborhood level, and certainly the activities of someone who owns a restaurant or is trading in real estate would be visible to someone. I think one of the questions which we just honestly don’t have answers to is whether this trade is protected by the state and these actors are effectively private, or whether we’ve moved into a stage where we’re looking at a kind of hybrid economy where state-owned enterprises are nominally state-owned but they include managers who are working with private sector actors on this increased scale.

With respect to the effect that sanctions on trade, there are a lot of ways in which sanctions can influence what North Korea imports and exports but the one point that I want to emphasize is that not all of them are obvious, they don’t simply come through bans on exports or bans on imports. They can also come through the exchange rate. If you look at the sanctions resolution, a plain reading of it suggests that North Korea should be substantially affected by these resolutions because they go after financial transactions, they go after a large share of trade, particularly in respect to coal. They potentially go after exports of labor. They go after a wide variety of sources of foreign exchange, and we know from a wide experience with other countries that have experienced these kinds of foreign exchange shortages that they can induce financial crises or balance-of-payments crises that have a predictable path. And one of them that we saw quite clearly, in the Iranian case for example, is the sharp depreciation of the exchange rate – when foreign exchange is scarce, the effect of that is to up its price in these markets. So I think that one of the things we should be watching is the movements in the exchange rate. Right now those who watch this haven’t seen movements yet but I can’t believe that if China is actually enforcing these sanctions, then they wouldn’t be these effects on the exchange rate and those effects would take the form of depreciation of the won and a corresponding increase in the won prices of all imported goods.

Jenna Gibson: To follow up on that, China and some others have emphasized the need to not hurt the average North Korean while still carrying out sanctions and trying to squeeze the elites. But is that really possible in a country like North Korea?

Stephan Haggard: First of all just to talk about the [Security Council] resolution itself, it was written with Chinese input to be extraordinarily cautious, and that caution took two forms. One was some vaguely worded humanitarian exemptions about the livelihood about the North Koreans, and the other was – do these activities actually contribute to the North Korean’s weapons of mass destruction and missile programs. Under both of those, my interpretation is that what China has allowed itself is some discretion in how these sanctions will be enforced, and one thing that we may be seeing is some exercise of that discretion. So the Chinese officials say repeatedly, “We’re going to execute these sanctions, we’re going to prosecute these sanctions to the letter,” but the letter is ambiguous and so China could exercise discretion in how they’re implemented. I suspect that what they’re doing is implementing measures which they think will have adverse effects, seeing whether and if there’s a diplomatic reaction from North Korea, going back and exercising discretion again because their objective is ultimately diplomatic, it’s to put pressure back on the United States to engage in the Six Party Talks and as long as the North Koreans are showing absolutely no interest in doing so the diplomatic ball is in China’s court, not in the US court.

Jenna Gibson: People are speculating a lot about what is going to come out of the Worker’s Party Congress that’s meeting this spring. Are there any things that you would say people should be looking out for or that you think might come out of that meeting?

Stephan Haggard: This is just a big topic because the significance of the Party Congress and actually reconvening a Party Congress has been widely, underestimated and really not examined as closely as it needs to be. As I mentioned in the presentation today, there were two Party conferences which are ad-hoc bodies that were convened during the course of the succession, that were connected with trying to gather the politic tribes, so to speak, around Kim Jong-un and make sure that the Party was rallying behind the new leadership. But the convening of a Party Congress could signal at least an attempt to maybe rationalize and institutionalize the entire political system, which as you know has this extraordinarily personalist element…It’s a system in which personal ties with particular officials and the personal secretary of Kim Jong-un plays a very substantial role, so if this is what we expect it to be, one implication would be an attempt to kind of regularize or institutionalize Kim Jong-un’s rule in a way which would make it more stable after a period in which there has been a lot of turnover, purges, obviously Jang Seong-thaek the most obvious, but of high-ranking officials in the military and in the state apparatus and Party as well. But the other thing that we’re looking for, of course, is whether this Party Congress will roll out any strategic direction for the country more broadly. What I’m worried about is that that step has already been taken in 2013 with the so called Byung-jin Line of pursuing both nuclear weapons and economic development. So if that gets reiterated at the Party Congress, then we’re in for a stage of prolonged confrontation not just between the United States and North Korea, but also potentially between China and North Korea because China can’t achieve any of its strategic objectives without restarting talks, and if the North Koreans basically say, “we’re uninterested in giving up our nuclear weapons,” then in some ways, the game changes quite fundamentally because then the purpose of talks becomes completely unclear.

Jenna Gibson: Is there anything else that you think our listeners should be keeping an eye out for, or is there anything else that you think they need to understand about North Korea and the North Korean economy.

Stephan Haggard: Well obviously, there are humanitarian issues that we always have to be concerned about. As we move into these sanctions regime, we have to be cautious that basic medicines and things that we really think are necessary to get to North Korea don’t face constraints. But I think that the larger strategic issues right now have to do with the card that the United States has as a result of the passage of so-called secondary sanctions. There was legislation passed earlier in the year, in February, and then in March the issue of an executive order which provides the United States quite sweeping discretionary authority on the part of the President to undertake secondary sanctions which would in principle would probably be aimed primarily at Chinese firms but could be aimed at virtually any firm anywhere where North Korea is trying to diversify its trade. So one issue that I think everyone is going to be watching is, if Chinese implementation of 2270 appears to lag, does the United States step in and exercise some of the discretion it has under the executive order, to push the Chinese. If there’s a fifth [nuclear] test, or the missile march continues, you can see impatience rising to the level that the President would try to send some shots across the bow of other people who are still trading and investing in North Korea, and using the access to the American financial market, in effect, is a way of deterring that kind of activity. That instrument is new, we haven’t used that before, and an interesting thing to watch is whether we will.

Photo from Uri Tours’ photostream on flickr Creative Commons.

Transcribed by Thomas Lee, an intern at the Korea Economic Institute of America and a graduate of American University.