Economic Shifts Critical for North Korea Sanctions

By Marcus Noland and Stephan Haggard

Note: This commentary is excerpted from the East-West Center Working Paper The Political Economy of North Korea: Implications for Denuclearization and Proliferation.

HONOLULU (June 12) -- Most analyses of North Korea's nuclear ambitions have viewed them through the lens of high politics. Recent statements, for example, suggest that North Korea may be trying to "break out": to secure a deterrent and gain de facto recognition as a nuclear weapons state. Alternatively, North Korea may still be engaged in a protracted negotiation in which nuclear provocations are used to extract some military or diplomatic benefit, such as normalization of relations with the United States or a security guarantee.

However, North Korea's nuclear ambitions also have an economic component, since nuclear weapons development and proliferation activities can be "traded" not only for military or diplomatic gains, but for economic ones as well. This point has been made by both "hawks" and "doves."

Hawks argue that North Korea is engaged in a blackmail game, in which provocations are used to extract material benefits. Making economic concessions therefore only encourages bad behavior, so aid and other economic concessions should be tightly conditioned on North Korean actions. The Lee Myung-bak administration has adopted this position, offering very generous economic benefits to the North, but only after it sends decisive and irreversible signals of its intent to denuclearize.

Meanwhile, the doves who favor engagement with North Korea have also emphasized the role of expanded trade, investment and aid. On the one hand, they believe that economic inducements can still serve as a useful instrument for convincing the North to abandon its nuclear ambitions. And they also argue that expanded trade and investment will gradually moderate the regime's behavior by promoting economic reform and gradually loosening the reins of central control. This long-run strategy was pivotal to the concept of engagement advanced by the both the Kim Dae-jung and Roh Moo-hyun administrations.

Quite obviously, arguments in favor of engagement have been dealt a severe, if not fatal, blow by the recent missile and nuclear tests. However, the reasons are complicated and also have implications for those arguing for more robust sanctions.

First, there is strong evidence that the leadership has become increasingly wary of economic reform. The domestic origins of this shift are opaque, but the behavioral evidence is unmistakable: the leadership has reverted to a more control-oriented—even Stalinist—approach to economic policy.

General economic inducements, such as lifting of sanctions, entry into international financial institutions like the World Bank, or more formalized regional cooperation, have probably never been as significant economic carrots for North Korea as outsiders believe. The regime has always favored very targeted transfers that can be controlled and used directly by the leadership to sustain control, such as food aid, fuel shipments or—even better—straight cash payments such as those secured from the 2000 North-South summit and the Kaesong and Mt. Kumgang projects. But if anything, the appeal of general economic inducements is even lower now than it has historically been, because of the North's shift away from reform.

A second, and apparently contradictory, observation is that despite the recent anti-reformist turn and the constraints of the second nuclear crisis, North Korea has in fact become more economically open. However the political geography of North Korea's trade has shifted quite fundamentally. Trade with Japan has virtually collapsed as Tokyo moved toward a virtual embargo. Trade with Europe stagnated following the onset of the nuclear crisis, and trade, investment and particularly aid from South Korea fell sharply following the inauguration of Lee Myung-bak.

At the same time, the North's dependence on China for trade has grown dramatically, far outstripping trade with other partners. In addition, North Korea has also sought out other partners who do not pose sanction risks, or with whom North Korea's nuclear and missile interests are aligned ‑ most notably Iran, Syria, and potentially Egypt.

What implications does this economic story have for the development of sanctions in response to North Korea's nuclear activities? The first relates to the question of the regime's intentions.  It is virtually impossible for outsiders to be confident that they understand the inner workings of North Korean decision-making, but it is nonetheless important to ask whether military and diplomatic signals are aligned with other developments in the North Korean political economy. If the North Korean leadership had been pursuing a reformist path since the onset of the crisis ‑ however gradually ‑ it would have constituted an important signal that the country was open to economic inducements.

However, the evidence on this score is not comforting. The North Korean economy is indeed becoming more open, but the leadership remains highly ambivalent about this development, and, as a result, has shown little interest in economic carrots. To the contrary, the willingness to terminate the U.S. food aid program, the government's behavior with respect to Kaesong and the ongoing meddling in the border trade shows a regime that is either indifferent, or actively hostile, towards economic engagement.

Another implication has to do with the political geography of North Korea's external economic relations. An unintended consequence of the crisis has been to push North Korea into a closer economic relationship with China and other trading partners that show little interest in political quid-pro-quos, let alone sanctions. Put differently, North Korea appears to have rearranged its external economic relations to reduce the risk that traditional sanctions would work.

As a result, however, China has become even more central to any effective sanctions effort. The North's very high level of dependence on China raises little doubt that Beijing could exercise influence on Pyongyang if it chose to do so. But as the North Korean leadership understands very well, the Chinese leadership faces its own risks in pushing North Korea to the edge, including further escalatory moves on North Korea's part or the prospect that, if pressed too hard, the North could collapse into a failed state located right at China's doorstep.

This does not mean that the U.S. and its allies are without economic options. First, it is not beyond the realm of possibility that China has in fact reached the limits of its tolerance and that some coordinated or even unilateral action on its part might be forthcoming.

Even in the absence of such coordination, the U.S. can still exercise leverage if it can identify how and where North Korea finances its international trade, and goes aggressively after financial intermediaries. This particular form of sanction does not require multilateral coordination, since foreign banking institutions that conduct significant business in the United States have a strong interest in avoiding institutions that the U.S. Treasury has identified as money-laundering or proliferation concerns.

A third implication has to do with North Korea's incentives for nuclear proliferation. There is some evidence that the North moderated its missile proliferation activities during periods when rapprochement with the United States, and to a lesser extent Japan, was a priority. However, in the absence of such an interest, the incentives increase for the North to engage in arms trading. Indeed, they arguably become greater because of the declining prospects for trade, investment and assistance from the U.S., Japan, South Korea and Western Europe.

Given that the United States has even less leverage over potential customers such as Iran and Syria than it does over China, the only policy options for dealing with this particular form of trade expansion are much more direct, including sanctions on North Korea's Middle Eastern trading partners or a risky test of direct interdiction at sea. 

It is important to underscore that the more transformative conception of engagement that undergirded the Kim Dae-jung and Roh Moo-hyun approaches to North Korea was not an irrational one. If North Korea had embarked on a more robust reformist path, the proposed mechanisms of long-run transformation through engagement might have well taken place. Increased trade, investment and aid would have contributed not only to a deeper engagement in the world economy but been part and parcel of an internal transformation as well.

However, the North Korean economy is structured in such a way that outside economic ties are still largely monopolized by state-owned enterprises and other gatekeepers, such as the military in the case of Kaesong. Under such circumstances, direct transfers to the regime obviously will not have the same transformative effects as private investment and trade. Even nominally commercial relations can be exploited if the North Korean side believes that they are ultimately political in nature and thus vulnerable to blackmail tactics. Again, Kaesong is an important example.

Under these circumstances, those choosing to trade and invest with North Korea do so at their own risk, and North Korea will bear the economic costs if it chooses to renege on commitments or fails to provide a welcoming policy environment.

Finally, it must be emphasized that the international community still faces what might be called a "latent" humanitarian problem with respect to food supply in North Korea. These concerns were muted by a somewhat better-than-expected harvest this year, and probably by commercial purchases of food in the winter and early spring. Even if North Korea does muddle through this crop cycle and the termination of the food aid program, there is little indication that the country is capable of feeding itself. As a result, the prospect of recurrent food shortages is high.

As in the past, the peculiar difficulty of dealing with North Korea stems in part from the humanitarian dilemma the country poses to the international community. It is difficult to turn away from the substantial suffering that the regime imposes on its own population, but increasingly unproductive to extend economic assistance in the face of entrenched resistance to broader reforms.

These shifts in trade patterns make it much more difficult, although not impossible, to pursue an effective sanctions strategy. In the absence of robust cooperation from China, policy would have to shift from trade sanctions to more targeted efforts aimed at North Korea's international financial ties or even direct interdiction of seaborne trade, which is perhaps justified by concerns over weapons proliferation.

Marcus Noland is a Senior Fellow at both the East-West Center and the Peterson Institute for International Economics. Stephan Haggard is a professor at UC San Diego's Graduate School of International Relations and Pacific Studies.


The EAST-WEST CENTER is an education and research organization established by the U.S. Congress in 1960 to strengthen relations and understanding among the peoples and nations of Asia, the Pacific, and the United States. The Center contributes to a peaceful, prosperous and just Asia Pacific community by serving as a vigorous hub for cooperative research, education and dialogue on critical issues of common concern to the Asia Pacific region and the United States. Funding for the Center comes from the U.S. government, with additional support provided by private agencies, individuals, foundations, corporations and the governments of the region.

Click here for daily news on the Pacific Islands.

Click here for links to all East-West Center media programs, fellowships and services


This is an East-West Wire, copyright East-West Center