North Korea's Economy, Once Freed, Will Need Shock Therapy
by Junki Kim

The Democratic People’s Republic of Korea, or DPRK, has experienced severe contraction in its economy in recent years. Industrial production has fallen precipitously over the past seven years and a food shortage has worsened economic problems. There are no signs that the country is abandoning its bureaucratic centralized economic planning structure or pursuit of its socialist goals. But debate among economists is heating up about the depth and scope of the reform needed to move North Korea toward a market-based economy. The experiences of Eastern Europe, countries of the FSU, and China can be useful in this respect.

China’s dual track approach—continuing state control and heavy subsidization of the state-owned enterprise (SOE) sector while allowing the private sector to develop—cannot be adopted in North Korea. The country’s economic structure and social welfare system are quire different. Whereas in China 70 percent of the work force is engaged in agriculture, in the DPRK the figure is only 25 percent. When China’s agricultural sector was liberalized, it had room for growth, largely unhindered by problems in the relatively small state sector. The rapidly expanding non-state sector was able to employ the vast rural labor pool. North Korea’s economic structure, in contrast, resembles the structures in Eastern Europe and the FSU, where the state plays a more extensive role.

Indeed, in comparison with the former socialist economies, the DPRK is by far the most heavily industrialized country: its stateowned manufacturing industries employ more than 56 percent of the work force, as against Russia’s 46 and Poland’s 37 percent in the late 1980s. Although the exact amount of government subsidies to SOEs and state farms in North Korea is not known, it is likely to be closer to Russia’s 20 percent of GDP registered in 1992, than the 8 percent allocated in China in 1991. Tackling the state sector’s difficulties will thus be crucial to economic transition.

Extensive social welfare programs in North Korea absorb about 14 percent of GNP, adding inefficiencies to the labor market. Universal social welfare coverage and an equitable income distribution system ensure that the income levels of the urban and rural populations are much closer than in China. Labor mobility is thus quite restricted. A Chinese-style agricultural reform, by itself, would not be sufficient to stimulate the flow of labor and capital into the more productive nonstate sector. The large, heavily subsidized state enterprise sector and the inefficient labor market, taken together, would make development of the private sector difficult. If reform is to succeed in the DPRK, the SOE sector must be reduced, subsidies cut, and social welfare programs kept to a minimum.

The halfhearted attempt in the 1980s to reform the state-owned sector—in which managerial incentives were improved and enterprises were “depoliticized”—not only failed, they backfired. To counter severe information asymmetry problems, the authorities decided to strengthen centralization of the information flow and resource allocation. Steps taken to grant greater autonomy to SOEs did not also credibly harden their budget constraints and only led to hoarding of material resources and labor. The authorities shied away from a real hardening of budget constraints, which would have required SOEs to undergo bankruptcy procedures and give up most of their state subsidies.

Unlike command economies that allowed private ownership on a selective basis and provided some material incentives for workers, the Democratic People’s Republic of Korea has relied mainly on its SOE sector and non-pecuniary incentive schemes. The state’s role in the economy is pervasive, as evidenced by the ratio of government expenditure to GNP, which reached 71.9 percent in 1990 compared with 34 percent in pr-reform China in 1979. The DPRK leadership’s hardline ideological stance against private ownership has all but decimated the private sector. When conditions allow for reform, the country’s economy will require a comprehensive, radical structural adjustment, rather than applications of the tools of a gradual development, Chinese-style.

Evaluating the course that reform policy will take in North Korea is critical at this juncture. South Korean officials seem to favor a partial, gradual reform approach similar to that followed in China. When they look at the apparent success of the Chinese reform and compare it with the high, short-term costs of comprehensive reforms in Eastern Europe and countries of the FSU, which incorporated macro-stabilization, liberalization, and privatization, these policymakers opt for a gradual reform strategy in the North. Such a policy choice is understandable, as South Korea traditionally has promoted economic development through state control over resource (credit) allocation and through various industrial policies. Korea’s Development Institute (KDI), a government think tank, takes the stance that “the shock therapy is to swift to be efficiently digested by a previously command economy.” It argues further that the relative effectiveness of the two approaches is clear-cut “if the economic performance of East Asian transitional economies is compared with that in Eastern Europe.”

This view ignores the experience of many East European and FSU countries that have pursued comprehensive reforms, achieved macroeconomic stability, and are on track for stable economic growth. Gradualists, on the other hand, have sometimes fared worse, suffering falls in production and living standards that have, in turn, intensified political difficulties, as seen in Bulgaria and Russia.

Although the Chinese reform is thought of as gradual, sectors that have recorded great success have in fact undergone a shock therapy: for instance, in the agricultural sector, farms were de-collectivized and prices liberalized. Those sectors that moved quickly toward a market economy, have reaped the greater benefits. Analysts have found that the main sources of growth were the non-state industries—small to medium-size firms in rural areas and private manufacturing firms and joint ventures in urban areas. North Korea should look to these lessons learned in China. But without a thorough reform of the SOE sector and fundamental changes in the role of the state, there is little chance that North Korea will recover from the current economic crisis.

The author is Assistant Professor, Graduate School of Public Administration, Seoul National University, Email: Jkkim@Plaza.Snu.Ac.Kr