North Korea: Economic Leverage and Policy Analysis
Released: 2010-01-22T00:00:00

Major Points and Recent Developments

The Issue, Interests, and Policy

This report examines the economic side of U.S. leverage with North Korea and reviews U.S. policy and legislation. The security side of U.S.-DPRK relations is addressed in other CRS reports. Here we examine the economy of North Korea in the context of U.S. confrontation with that country over its nuclear weapon and missile programs. This report provides an overview of the North Korean economy, surveys its economic relationships with major trading partners, and examines various U.S. policy options.

The issue with respect to the economy of the Democratic People's Republic of Korea and its economic relations deals with what actions the United States could take that would lead to a verifiable halt to the DPRK's nuclear weapons program; the lessening of tensions between the DPRK and South Korea, Japan, and the United States; the prevention of proliferation of nuclear weapons and missile material by North Korea; and the betterment of human rights and the standard of living of North Korean non-elites.

The year 2009 may turn out to be the tipping point in the quest by the DPRK to become a de facto nuclear-armed state, although its ability to deliver a nuclear weapon remains problematic. In 2009, the DPRK embarked on a course that included a major shift in power toward the military, emphasis on ideological purity, rising criticism of the United States, an attempt to restart its nuclear plant at Yongbyon, the test of a potential long-range ballistic missile in spite of sanctions and objections from much of the rest of the world, the sentencing of two American news reporters, the capture of a South Korean worker from the joint Kaesong Industrial Complex, and the test of its second nuclear weapon as well as short-range missiles. North Korea also has indicated that it would not return to the Six-Party Talks on denuclearization.

Then suddenly in late 2009, the DPRK entered into the second phase of what appears to be a policy cycle of: (1) threats and aggressive actions; (2) diplomacy and a "charm offensive" with promises made by the DPRK and negotiating partners; (3) deliveries of economic and humanitarian assistance to the DPRK; and (4) another cycle of broken promises, threats, and aggressive actions. The current "charm offensive" by the DPRK has included the release of the two American reporters to former President William Clinton; the release of the South Korean worker captured from the Kaesong Industrial Complex, a visit to South Korea by a high-level North Korean delegation to honor former South Korean President Kim Dae-jung; a resumption of activity at the Kaesong Industrial Complex; bilateral talks between U.S. Special Envoy Stephen Bosworth and Pyongyang officials under the rubric of the Six Party Talks; high-level exchanges between China and the DPRK; attempts by the DPRK to attract more foreign investment; and other diplomatic events. Meanwhile, North Korea's military has been somewhat subdued, although it periodically reminds the world of its presence with a provocative action, such as attempting to ship 35 tons of weapons (reportedly including explosives, rocket-propelled grenades, and components for surface-to-air missiles on a manifest that stated the cargo was oil drilling machinery) using a Georgian Ilyushin cargo plane that was intercepted when it made an emergency landing to refuel in Thailand.

For some time in 2008 and 2009, DPRK leader Kim Jong-il was not seen in public and speculation was rampant about a possible successor. Following an apparent stroke (and possible cancer), in August 2008, the country appeared to be preparing for succession at the same time it also was preparing for the 100 th anniversary in 2012 of the birth of Kim Il-sung, the nation's founder. In jockeying for position, the military and its activities related to national security took policy priority over the civilian side of government and over issues related to economics, international trade, and society at large. In addition, Pyongyang's leaders seemed to be leaning more toward nationalism, purity of thought, and loyalty both to the Communist party and to the party's ideals. The result was a policy shift in which North Korea's domestic issues were taking priority over foreign considerations, leading to increased isolation from the rest of the world. It appears that Kim Jong-il has designated his youngest son, Kim Jong-un, as his heir apparent. This, however, is not confirmed. As Kim Jong-il faced possible death, one prominent theory was that he was indulging hard-line elements in the armed forces in order to secure military backing for his chosen successor. Another possibility was that the military was preparing to name its own leader to succeed Kim Jong-il. As Leader Kim has recovered, official preparation for succession seems to have abated.

Since Kim Jong-un is in his mid-20s, if he becomes the successor to Kim Jong-il, he likely will undergo a period of grooming before actually assuming power. According to news reports, Kim Jong-il's brother-in-law, Jang Seong-taek, ran many of the day-to-day affairs of the DPRK on behalf of the ailing Kim Jong-il. If Kim Jong-un succeeds his father, Jang Seong-taek may run the country through his membership on the National Defense Commission until Kim Jong-un is properly trained to take over leadership. The Commission currently is headed by Kim Jong-il. Kim Jong-un reportedly is being given some responsibilities to groom him for future leadership. It is not clear whether the DPRK military and society will accept this "three generation succession" once the Dear Leader is out of the picture. For a while, North Korean diplomats reportedly were been told to "pay homage to Kim Jong-un;" some schoolchildren had been including his name in their songs; and the military reportedly was referring to him as "Brilliant Comrade." Little is know about Kim Jong-un except that he might have attended the International School of Berne (Switzerland) under an alias or a German-speaking school in Koniz. He graduated from Pyongyang's Kim Il-sung Military University.

On December 8-10, 2009, U.S. Special Envoy to North Korea Stephen Bosworth visited Pyongyang for bilateral talks conducted in the context of the Six Party Talks (6PT), although the DPRK did not agree with that characterization of the talks. From the U.S. side, the meetings were considered exploratory on how to restart the 6PT and provided an opportunity for each side to articulate their positions. Bosworth did not meet with Kim Jong-il, nor did he request such, so there was little propaganda value in the meetings for Pyongyang. Ambassador Bosworth carried a letter from President Obama to the North Korean leader.

Figure 1 illustrates what appears to be North Korea's policy cycle. It is apparent that the DPRK's foreign relations and Pyongyang's actions to become a recognized nuclear power have alternated between what appears to be movement toward denuclearization and a warming of foreign relations and actions that move toward nuclearization and a cooling of foreign relations. The one constant in this cycle is the DPRK's drive to develop nuclear weapons and a delivery system for them.

Goals and Means

These developments in the DPRK hold significant implications for U.S. interests and goals in Asia. U.S. goals with respect to the DPRK have included (1) verifiable elimination of North Korea's nuclear weapons program; (2) the halt to DPRK nuclear or ballistic missile proliferation activities (particularly with Syria and Iran); (3) the reduction of tensions on the Korean Peninsula and between the DPRK and Japan, (4) the halt to DPRK-sponsored illicit activities (including counterfeiting of dollars and of products such as American-brand cigarettes), and (5) better human rights and treatment of returned refugees in North Korea.

The Six-Party Agreement (United States, China, Russia, Japan, South Korea, and the DPRK) of February 13, 2007, included an economic incentive of heavy fuel oil and humanitarian food aid, as well as the prospect of the normalization of diplomatic relations between the DPRK and the United States and Japan in exchange for North Korea's freezing and allowing inspections of the activity at its Yongbyon nuclear reactor. By early 2009, the Yongbyon plutonium nuclear installation was about 80% dismantled. On June 26, 2008, President George W. Bush had lifted the application of the Trading with the Enemy Act with respect to the DPRK and in October 2008 had removed North Korea from its list of state sponsors of terrorism. The progress that had been made under the Six Party Talks also enabled the United States to resume shipments of humanitarian aid to North Korea. A shipload of food and another of heavy fuel oil arrived in North Korea shortly after the announcement by President Bush of the above actions. These activities, as negotiated under the Six-Party Talks, have been halted since December 2008.

For the DPRK economy, the worst of the crisis reached in the mid-1990s seems to have passed, but the economy is still struggling and heavily dependent on foreign assistance to stave off starvation among a sizable proportion of its people. In a December 2008 report, the U.N. World Food Program (WFP) estimated total food production to be 4.21 million tons for the 2008/2009 marketing year (November 2008-October 2009), leaving the DPRK to face a cereal deficit of 836,000 tons, even with commercial imports (around 500,000 tons). This would have left insufficient food to feed almost 9 million people until the harvest in October 2009. The potential starvation of a sizable part of North Korea's population provides some, but limited, leverage for the United States.

The countries considered to have major influence in North Korea are China and Russia. Both issued strong statements condemning Pyongyang's second nuclear test. China arguably has the most influence, but even though China has not approved of many of North Korea's actions, it fears that instability in the DPRK will create a flood of refugees into its northern provinces. China's fear of a collapse of the regime or the economy is an incentive for it to ensure that the DPRK has sufficient energy and food for some minimal level of existence. Beijing is the host for the Six-Party Talks but faces conflicting goals. China needs stability in East Asia to continue its economic development and views the DPRK as a fellow socialist state. Strategically, China would like to avoid an arms race in Northeast Asia and is leery of a reunified North and South Korea. The last thing China needs is for the alliance relationship between the United States and South Korea to be extended to the Yalu River bordering China. Beijing seems to be more comfortable with an economically poor state with nuclear aspirations as a neighbor than a more independent, unified Korean state (possibly with nuclear weapons) that could go the way of the unified Germany and support the Western alliance. The North Korean nuclear problem, however, works against a major Chinese interest. It ensures that the United States will remain committed to its alliance relationships with Japan and South Korea and provides a rationale for a stronger U.S.-led anti-ballistic missile effort in East Asia. China's strategy also could backfire if a nuclear-armed DPRK compelled Japan or South Korea to develop nuclear weapons of their own.

Pyongyang perceives its nuclear weapon and potential ballistic missile programs as a means to achieve two national goals: to gain stature in the world and to develop a credible deterrent against hostile military action. The DPRK sees itself as surrounded by nuclear powers—either by countries that are nuclear powers themselves (China and Russia) or countries that are under the U.S. nuclear umbrella (South Korea and Japan). Without the DPRK nuclear program, North Korea would be a humanitarian aid "basket case" and a reclusive society that would be hard pressed to draw more world notice than countries such as Laos or Mongolia. Instead, North Korea is high on the world's security agenda. Pyongyang has become adept at using this attention to extract economic assistance and has used actions by other countries (such as sanctions or U.S. military exercises in the region) as propaganda tools to fuel nationalism and strengthen support for its regime. North Korea's leaders seem to be in a policy dilemma. They have pushed to become a nuclear power despite warnings not to do so even from China, their major ally. Yet North Korea's nuclear weapon development has become a rallying point for national pride. However, a January 2008 joint newspaper editorial by the Communist Party, military, and youth militia stated that "at present, no other task is more urgent or more important than solving the people's food problem and eating problem." Pyongyang currently faces the archetypical economic trade-off between "guns and butter," but in their case the question is whether to retain the "guns" (nuclear weapons) or give them up in order to obtain "butter" (food imports). Apparently Pyongyang feels it can accomplish both goals (with the help of China) since it has designated 2012 to both become a nuclear and space power and to join the club of economic tigers of Asia.

North Korea claims that the reasons for its nuclear program are to deter an attack by the United States and to use the bombs if South Korea starts a war or to devastate Japan in order to prevent the United States from participating in such a war. The nuclear program also enables it to gain international prestige, to exercise a degree of hegemony over South Korea, and to extract economic assistance from other countries. Pyongyang is unlikely to abandon this nuclear program without significant changes to the underlying reasons for the program's existence. Its fear of being attacked was exacerbated by its inclusion in the "axis of evil," the Bush doctrine of preemptive strikes, the U.S.-led invasion of Iraq, and the death of Saddam Hussein. They apparently see nuclear weapons as an insurance policy against attempts at regime change by the West. Also, Pyongyang apparently has observed that once a country becomes a recognized nuclear power, the United States becomes more friendly with it. Pakistan, India, and China are cases in point.

U.S. interest in the moribund North Korea economy goes beyond the leverage that economic assistance provides in negotiations over Pyongyang's nuclear weapons. The economy provides the financial and industrial resources for Pyongyang to support its military and nuclear weapons program. It constitutes an important "push factor" for refugees seeking to flee the country. It creates pressure for the country to engage in illicit trade. When the economy is performing poorly, it diverts international food aid that could be used elsewhere and creates instability that raises the risk of desperate action by Pyongyang. However, dismal economic conditions may foster forces of discontent in the DPRK that potentially could turn against the ruling regime of Kim Jong-il—especially if knowledge of the luxurious lifestyle of regime leaders and the higher standard of living in South Korea spreads or if the poor economic performance hurts even Pyongyang's elite. Despite nearly two decades of hardship, though, most dissatisfaction or opposition to the regime seems to be muted.

Conventional Wisdom and Considerations

Conventional wisdom with respect to North Korea includes the following considerations: (1) without stringent monitoring mechanisms, Pyongyang probably will cheat on any agreement; (2) the DPRK will renege on agreements for what seem to be superficial reasons, (3) Pyongyang's first priority seems to be regime survival; (4) North Korea regularly engages in illicit activity and may take actions opposed to normally accepted international law or standards of national behavior; (5) the DPRK likely will sell nuclear technology and missiles to countries not able to obtain them through other channels; (6) economic privation in North Korea mainly affects the population outside of the political and military elite, particularly in the countryside; (7) popular sentiment opposing the current regime, although reportedly on the rise, appears weak or suppressed sufficiently for Kim Jong-il or his successor to remain in power for an indefinite period of time; and (8) Pyongyang feels justified in its actions given what it perceives as "hostility" by the United States and South Korea and "broken promises" to build a light-water nuclear plant for the DPRK and to deliver energy and food aid.

Other factors to be considered include the following: (1) Japan would likely provide a large monetary settlement to Pyongyang in return for its years of occupation should a peace settlement be reached; (2) the border between China and North Korea is porous, particularly in the winter when the rivers are frozen and electricity so scarce that few lights operate at night; (3) centrally planned, communist economies that have been operating for several decades create distortions and consumer dissatisfaction that enable rapid transition to a market economy once those economies are liberalized; (4) economic reform and the opening of trade and investment in North Korea would likely induce large increases in production and economic well-being, but most DPRK production facilities are so lacking in new machinery and equipment that major investments would be needed to raise them to world standards; (5) Pyongyang is addressing inefficiencies in its economy partly by inviting Chinese investment in the northern provinces and South Korean investment in the Kaesong Industrial Complex in the south; and (6) the level of distrust between the United States and the DPRK is deep and long-standing.

Strategy and Tools

The three legs of any grand strategy toward the DPRK include economic, diplomatic, and military means to accomplish U.S. goals and protect U.S. national interests. U.S. strategy may take both short- and long-term paths. A short-term strategy includes some tit-tor-tat—an immediate response to provocations by the DPRK—in order to affect the cost-benefit calculations by leaders in Pyongyang. Such responses would either increase the costs or decrease the benefits to the ruling regime stemming from the action in question, and arguably deter Pyongyang from similar actions in the future. Such sanctions have targeted the North Korean elite (as was done in freezing their bank accounts in Macao's Banco Delta Asia and restricting exports to North Korea of luxury goods) or North Korean companies (those involved in weapons sales, including small arms), and they have attempted to deprive the central government of revenues from illicit activities (particularly the sales of nuclear or missile-related items and from counterfeiting currency, drugs, and cigarettes). This strategy has been manifest in UN Resolution 1874, particularly the interdiction of shipments of arms or other banned cargo from the DPRK.

A long-term strategy would be aimed at accomplishing a three-fold transformation in the DPRK: (1) a transformation in its relations with Western nations (to include the DPRK's perceived need for nuclear weapons to protect itself from hostile action by the United States), (2) a transformation in the basis of legitimacy of the ruling regime (to reduce the need to garner support through Stalinist tactics and by grandiose goals such as becoming a nuclear and space power), and (3) a transformation in the DPRK economy so that it no longer has to "extort" food and energy assistance in order to reduce starvation among its people.

What seems clear in dealings with the DPRK is that Pyongyang is highly skilled in setting the agenda in its relations with the United States and other nations and in obtaining certain narrow results, such as developing nuclear weapons despite opposition from major countries of the world. The DPRK seems able to achieve such goals partly because of the strong role that the military plays in policy and partly because its isolation and drive toward self-sufficiency allows the government to perpetuate misperceptions among its citizens. The feelings of mistrust of other nations and nationalism are so strong that the North Korean people, particularly the non-elite, seem willing to suffer deprivation, the imposition of draconian security measures, and violations of their human rights all in the name of country.

A problem in relations with the DPRK is that the arsenal of diplomatic weapons and incentives has diminished considerably. The United States and Japan have virtually no trade with North Korea, and South Korea's relations with the DPRK often are subject to the political situation of the day. Humanitarian and economic assistance often do not reach the people most in need and reportedly may be diverted to the military and party elites. The United States, however, does have financial clout in the world, and no country, financial institution, or exporter would like to have to choose between its ties with the United States and those with the DPRK.

The tools that can be implemented to influence decision making in Pyongyang include positive and negative inducements, neither of which seem to work very well. Positive inducements consist primarily of economic and humanitarian assistance, diplomatic recognition, and increased economic and trade ties. North Korea also has been pressing for direct bilateral negotiations with the United States. Negative inducements toward North Korea include general economic sanctions, sanctions on particular companies, financial sanctions, diplomatic isolation, actions to prevent sales of nuclear and missile technology and materials abroad, and the threat of military action.

The Six-Party Talks

Engagement with North Korea has been conducted under the Six-Party Talks plus bilateral discussions between Pyongyang and other nations. The talks (now suspended) include the United States, DPRK, China, Japan, South Korea, and Russia. This brings all major players to the table, exposes China and Russia to North Korean obstinacy, enables China and Russia to exert pressure on Pyongyang, and includes Japan and South Korea who have direct interests in a peaceful resolution of the problem and are likely to be the major providers of aid to the DPRK. The talks, however, rely heavily on China, and China has conflicting interests in the actual resolution of DPRK nuclear issue. (For discussion of the talks, see CRS Report RL33590, North Korea's Nuclear Weapons Development and Diplomacy , and CRS Report RL33567, Korea-U.S. Relations: Issues for Congress , both by Larry Niksch.)

Table 1 summarizes the major negotiating priorities and bargaining chips for each side in the Six-Party Talks. Any policy package would have to address at least some of the priorities of each nation.

Policy Options

Major U.S. policy options, given the above interests, goals, assumptions, and strategies with respect to the DPRK, include the following.

Continue current policy with respect to the DPRK of intensified sanctions plus limited engagement. The policy includes: (1) seeking verifiable denuclearization by the DPRK, (2) enforcement of sanctions under U.N. Resolutions 1874 and 1718 (including interdiction of arms shipments), (3) engaging with the DPRK in bilateral talks but keeping them under the framework of the Six Party Talks; (4) non-proliferation efforts, including the Proliferation Security Initiative; (5) keeping North Korea from joining international financial institutions; (6) international efforts to counter trafficking by North Korea in illegal drugs, counterfeit currency, or other contraband; and (7) maintenance of U.S. military forces in South Korea and Japan and continued development of a missile defense system for East Asia. Current U.S. policy accounts for the DPRK's strategy to gain recognition as a nuclear power and marginalize the Six Party Talks by engaging in bilateral talks with the United States. It also recognizes that for China, stability in North Korea takes precedence over denuclearization but that China has a stake in the success of the Six Party Talks. Intensify negative pressures on the DPRK: tighten and provide for closer monitoring of U.N. and U.S. sanctions; (e.g., freeze assets of and sanction certain North Korean companies and individuals; ban certain North Koreans from traveling abroad; tighten a ban on imports of luxury goods into the DPRK, designate the DPRK or additional entities as "primary money laundering concerns"); return the DPRK to the list of sponsors of terrorism (although certain legal conditions would need to be met) induce China to use its extensive influence with and exports to North Korea to punish it for its nuclear test and to bring Pyongyang back to the Six-Party Talks; or stop providing protection for North Korean ships from Somali pirates. Negative pressures also may include weakening the hold by Pyongyang on the daily lives of its citizens and support of Kim Jong-il by fostering alternative centers of power, facilitating the transition to a market economy, and increasing information flows into the country. Negative pressure may include a major campaign of soft power to include admittance of more North Korean refugees into the United States, funding exchanges and visits by North Korean cultural shows and dance groups to the United States, and having the World Food Program provide North Koreans with food that is more identifiable as originating abroad. (South Korea has found a secret weapon that has been a hit with North Koreans: South Korean "Choco Pies," a snack consisting of two large round cookies covered with chocolate with a filling of marshmallow in between much like an Oreo cookie. Choco Pies have been so popular in the lunches provided to Kaesong Industrial Complex workers in North Korea that they were making their way into black markets in the surrounding area and causing alarm among North Korean authorities. ) Offer a "grand bargain" to the DPRK that would include large shipments of economic assistance, normalization, a peace treaty, and a security assurance in exchange for verifiable denuclearization, non-proliferation, a lessening of military tensions along the border with South Korea, and an improvement in human rights in North Korea. This possibly could include an extension of a nuclear umbrella to the DPRK by China that would assist in assuring the security of the DPRK against attack and allow for a gradual de-escalation of military forces along the DMZ. A question, however, is what level of security assurance and economic assistance would the DPRK need in order to induce it to abandon its nuclear weapons and ballistic missiles.

Legislation

In the 111 th Congress, legislation related to the DPRK economy includes:

S.Amdt. 1761 (John Kerry) to S. 1390 agreed to on July 22, 2009. To express the sense of the Senate that the United States should fully enforce existing sanctions, explore additional sanctions, and require a review to determine whether North Korea should be re-listed as a state sponsor of terrorism was agreed to in the Senate. S.Amdt. 1597 (Brownback) to redesignate North Korea as a state sponsor of terrorism was not agreed to. S. 6 (Reid). Restoring America's Power Act of 2009. Sense of Congress that Congress should enact, and the President should sign, legislation to restore and enhance the national security of the United States by (among others) reducing the threat posed by unsecured nuclear materials and other weapons of mass destruction and effectively addressing the security challenges posed by Iran and North Korea. S. 837 (Brownback). North Korea Sanctions Act of 2009. A bill to require that North Korea be listed as a state sponsor of terrorism, to ensure that human rights is a prominent issue in negotiations between the United States and North Korea, and for other purposes. S. 1416 (Brownback). North Korea Accountability Act of 2009. A bill to require the redesignation of North Korea as a state sponsor of terrorism, to impose sanctions with respect to North Korea , to require reports on the status of North Korea's nuclear weapons program and counterproliferation efforts, and for other purposes. S. 1434 (Leahy)/ H.R. 3081 (Lowey). Making appropriations for the Department of State, foreign operations, and related programs for the fiscal year ending September 30, 2010, and for other purposes. July 7, 2009. H.R. 3081 a greed to by the House. H.Res. 309 (Peter King). Expressing the sense of the House of Representatives that North Korea should immediately stop any hostile rhetoric and activity towards the Republic of Korea and engage in mutual dialogue. June 15, 2009, passed by the House. H.R. 485 (Ros-Lehtinen). Security through Termination of Proliferation Act of 2009. States that specified U.S. sanctions with respect to Iran, North Korea, or Syria shall remain in effect until the President certifies to the appropriate congressional committees that such country has verifiably dismantled its weapons of mass destruction programs. H.Res. 604 (Ros-Lehtinen) Recognizing the vital role of the Proliferation Security Initiative in preventing the spread of weapons of mass destruction. H.Res. 705 (Minnick) Condemning hard-labor prison camps in the Democratic People's Republic of Korea as an egregious violation of human rights. H.R. 1105 (Obey). (March 11, 2009 became P.L. 111-8 ) Omnibus Appropriations Act, 2009. Includes a prohibition against funds for assistance or reparations for the government of, North Korea to include direct loans, credits, insurance and guarantees of the Export-Import Bank or its agents. Funds made available under the heading `Migration and Refugee Assistance' in this act shall be made available for assistance for refugees from North Korea. Makes specified funds under the Department of State, Foreign Operations, and Related Programs Appropriations Act, 2008 available for a grant for nuclear security initiatives relating to North Korea. Provided for not less than $8,000,000 for broadcasts into North Korea, and prohibited Economic Support Funds in FY2009 to be made available for energy-related assistance for North Korea unless the Secretary of State determines that North Korea is continuing to fulfill its commitments under the Six Party Talks agreements. H.R. 1980 (Ros-Lehtinen). North Korea Sanctions and Diplomatic Nonrecognition Act of 2009. To continue restrictions against and prohibit diplomatic recognition of the Government of North Korea, and for other purposes. H.R. 2290 (Sherman). International Uranium Extraction and Milling Control Act of 2009. To provide for the application of measures to foreign persons who transfer to Iran, Syria, or North Korea certain goods, services, or technology that could assist Iran, Syria, or North Korea to extract or mill their domestic sources of uranium ore. H.R. 2346 (Obey). Supplemental Appropriations Act, 2009. Among its provisions, it rejects a request for $34.5 million in Department of Energy non-proliferation funds to dismantle nuclear facilities in North Korea and rejects $95 million requested for energy assistance to North Korea in the foreign assistance accounts. House bill provides $18 million for development assistance to North Korea in the Economic Support Fund. On June 24, 2009 became Public Law No: 111-32. H.R. 2845 (Franks). Protect the Homeland from North Korean and Iranian Ballistic Missiles Act. H.R. 3423 (McMahon ).To impose certain sanctions on North Korea as a result of the detonation by that country of a nuclear explosive device on May 25, 2009, and for other purposes.

Overview of the DPRK Economy

The North Korean economy is one of the world's most isolated and bleak, even though it has pockets of modernity (particularly in Pyongyang) and several grandiose, Soviet-style monuments. It was completely bypassed by the Asian "economic miracles" of the past three decades, which brought modern economic growth and industrialization to South Korea, Taiwan, Singapore, and Hong Kong, as well as rapid growth and trade liberalization to China, Thailand, Malaysia and other Asian nations. The "Stalinist " North Korean economy can be characterized by state ownership of means of production; centralized economic planning; the lack of basic freedoms necessary for a market economy (such as freedom of movement and of commerce); political repression; and an emphasis on military development (military-first policy). The economic system is designed to be self-reliant and closed. The irony of the situation is that the longer the economy tries to remain self-sufficient, the poorer its performance and the more dependent the country becomes on the outside world just to survive.

During the 1990s, as many as 2 million people starved to death. Major portions of the North Korean population survived primarily through transfers of food and other economic assistance from abroad. The worst of the food crisis has passed, but shortages still exist, and the country depends on staples from China, and, when allowed, from the U.N. World Food Program, as well as fertilizer from South Korea (when it was being delivered).

In that decade, the inefficiencies of North Korea's centrally planned economy, especially its promotion of state-owned heavy industries, along with high military spending—about 15-25% of GDP—joined with drought and floods to push the economy into crisis. In addition, the collapse of the Soviet bloc meant the loss of Russian aid, export markets, and cheap oil. Trade with the former Soviet Union dropped from as much as $3.58 billion in 1999 and to $111 million in 2008. This has added to disastrous domestic economic conditions in North Korea.

Food in North Korea has been so scarce that youth there are shorter than those in other East Asian nations. Since 1998, the military reportedly has had to lower its minimum height requirement in order to garner sufficient new recruits. Life expectancy has been contracting. With the help of the WFP, which had been feeding more than a quarter of North Korea's 23 million people, chronic malnourishment among children reportedly fell from 62% in 1998 to about 37% in 2004. About one-third of mothers were considered to be both malnourished and anemic. The Food and Agriculture Organization of the United Nations estimated that 7.6 million North Koreans were undernourished in the 2002-2004 period. North Korea refers to this period of hardship as the "arduous march," an apparent comparison to the "long march" in Chinese revolutionary history. In January 2006, Pyongyang ordered the WFP to stop food deliveries to the DPRK, but limited food assistance (about 75,000 tons annually) was resumed after an agreement in May 2006. Over the winter of 2007-2008, the abnormally dry and cold weather, reportedly combined with severe flooding during the summer of 2007, seriously affected the crop growth. In a December 2008 report, the WFP estimated total food production to be 4.21 million tons for the 2008/2009 marketing year (November 2008-October 2009), leaving the DPRK to face a cereal deficit of 836,000 tons, even with commercial imports (around 500,000 tons). Food assistance requirements to feed almost 9 million people were estimated at 800,000 tons until the next harvest in October 2009.

An extensive analysis of the famine in the 1990s concludes that the "ultimate and deepest roots of North Korea's food problems must be found in the very nature of the North Korean economic and political system." Since 2002, Pyongyang has allowed some market-oriented reforms that may ease the economic pressures over the long term. In a sense, these reforms legitimized what was already occurring following the collapse of the centrally planned economy. The Kim regime refuses to call the economic measures "reforms," but prefers to characterize them as "utilitarian socialism." This includes the introduction domestically of market economy elements (called the July 1, 2001, measures) and in the international arena, the pursuit of normalization of relations with countries that have traditionally been hostile toward their country.

The DPRK's gross national product in 2008 in purchasing power parity prices (PPP)—prices adjusted to international levels—has been estimated at $40 billion (CIA estimate) to $54 billion (Global Insight estimate). This amounts to national income of about $1,700 to $2,248 per capita in PPP values or roughly in the range of that of Zimbabwe, Uzbekistan, Bangladesh, or the Sudan. This is considerably lower than that of China ($6,000), Indonesia ($3,900), or Japan ($38,455). It is also dramatically lower than South Korea's $26,000 in PPP values or $18,933 at market prices. According to the Bank of Korea, in market prices, North Korea's GDP in 2008 was an estimated $26.7 billion compared with $971.3 billion for South Korea. Global Insight, an econometric consulting firm, estimated North Korea's GDP in 2008 in market prices at $28.5 billion and $1,223 on a per capita basis. A remarkable fact is that in the post-Korean War and into the mid-1970s, living standards were higher in North Korea than in either South Korea or China. Now, North Korea is far behind its rapidly growing neighbors.

As shown in Figure 3 , growth in estimated real gross domestic product (GDP) in the DPRK dropped into the negative for most of the 1990s before beginning to recover in 1999. In 2004 to 2006, growth has been continuing at about 2%, up slightly from earlier years. In 2006, the economy shrank by 1.1% and continued to decline by 2.3% in 2007. In 2008, the economy weathered the global recession and grew by a surprisingly large 3.7%. According to Global Insight (an economic consulting firm), North Korea's economic growth rates is expected to continue at about 2% per year to 2011.

It should be noted that various scholars and government officials produce a variety of estimates of North Korean growth rates and GDP. Some estimates show gradual recovery since the 1990s, but others argue that real per capita GDP has been stagnant or even declining over the past decade. One problem is that estimates of inflation are difficult to obtain and are inherently unreliable. The reason is that there is no systematic method of collecting data, and even if there were, households in different sectors of the economy often pay different prices for the same commodities—particularly staples that have been distributed through official channels to some but must be purchased in markets by others. Rice, for example, may be sold in an official market for one price, sold in an irregular market for another, or distributed as a ration to certain households basically for free. Another problem is that officials who report data often are under pressure to meet certain targets. Unlike in the West where data may be "sugar coated" to make them more palatable, in the DPRK, the underlying statistics often are "rubberized." They may be stretched or compressed according to official expectations.

Another problem with North Korean data is that there is a huge difference between the official exchange rate and the free market rate. This problem is avoided in PPP estimates that compare purchasing power and adjust for exchange rate differences. In estimates of GDP expressed in dollars, however, the exchange rate is used to convert North Korean won to U.S. dollars. Tourists can exchange dollars to won at about 140 won per dollar, but the black market rate is about 4,300 won per dollar.

What can be said for certain is that a sizable part of the DPRK population lives on the edge of existence. In few countries today does a small decline in GDP or summer flooding cause massive starvation and growth stunting in children as it does in the DPRK. Also, despite the threat of imprisonment for crossing the border into China and being repatriated to North Korea, a large number of refugees still attempt to flee the economic and political conditions in the country.

In this land of scarcity, consumer necessities have been rationed and also used to reward party loyalists. Under Pyongyang's economic reforms, this system appears to be phasing out, but beginning in the fall of 2005, North Korea has backtracked on many of its economic reforms by forbidding private sales of grains and reinstituting a centralized food rationing system. Pyongyang also reportedly closed its food markets but then opened consolidated markets that carried food and other items. The reality in much of the DPRK is that the official food distribution system does not have sufficient supplies to feed the population. The food markets, therefore, are essential for the non-elite in society.

The combination of a weak economy unable to provide basic food and necessities and a ruling regime intent on maintaining its power has created economic divisions within society. North Korea reportedly officially classifies its citizens into three ranks and 51 categories based on their ideological orientation. However, in actuality, the economy has created five classes of people. The official categories are used to allocate rations for daily necessities, jobs, and housing. The de facto categories have resulted from the intrusion of market forces and trading on the official class divisions.

The top class consists of the elite who claim the first rewards from society. They are the party cadres who are leaders in the military and bureaucracy and who enjoy privileges far above the reach of the average household. While starvation haunts the provinces, many of the privileged class live in Pyongyang (where provincial North Koreans cannot enter without special permission); some drive foreign cars, acquire imported home appliances, reside in apartments on a lower floor (so they do not have to climb too many stairs when the electricity is out), and buy imported food, medicines, and toiletries at special hard currency stores. The elite have a strong vested interest in maintaining the current economic system, despite its problems. Their incomes originate from the treasury, from foreign investors (mostly South Korean), remittances from ethnic Koreans in Japan (although these have been curtailed) and South Korea, and the country's shadowy trade in everything from missile technology to fake banknotes and narcotics.

After the elites surrounding Kim Jong-il, the second group comprises business traders with access to foreign capital and international transactions; the third consists of "organized thugs" who make their money through public trading and markets. The fourth class is composed of urbanites and others who scrape by on government rations, while the fifth class is farmers who support their way of life through farming private plots and selling goods in markets.

Despite hushed grumbling about economic deprivation, forced food deliveries to the central government, and new prohibitions on markets, dissent in North Korea remains stifled. Support for the ruling regime appears sufficiently strong—even among the lower classes of people—although this support is often enforced by severe squashing of even the slightest hint of dissent. Even suspicious comments in casual conversations may be reported to the authorities. The country is far from developing a middle class with independent economic means, personal sources of information, and a thirst for more democratic institutions.

In 2007, South Korea's new President Lee Myung-bak stated in his plan, "Vision 3000: Denuclearization and Openness," that if North Korea denuclearizes and opens, his administration will help to make North Korea's national income $3,000 per person within 10 years. The plan, however, does not provide an alternative if North Korea does not denuclearize and has been shelved for now.

Juche Philosophy and the Military

The Pyongyang regime has pursued a policy of self-sufficiency and isolation from the world economy that they call juche or self-reliance. Juche goes beyond economics as the philosophy has been used since the 1950s to perpetuate power by the central government and to build an aura of the supernatural around their supreme leaders Kim—both father and son. Although the regime does not emphasize the connection, the current system of dynastic succession with a paramount father figure also harkens back to Confucianism and the powerful dynastic tradition that united the Korean peninsula for hundreds of years.

The economic practice of juche has minimized international trade relations, discouraged foreign direct investment, and fostered what it considers to be core industries—mostly heavy manufacturing. While promoting such heavy industry, for most of the post-Korean War period, Pyongyang has emphasized the parallel development of military strength.

Current head of state, Kim Jong-il (often referred to as "Dear Leader"), has given highest priority to the military. This military-first policy places the army ahead of the working class for the first time in the history of North Korea's so-called revolutionary movement. Under Kim Il-sung (Kim Jong-il's father), the juche ideology placed equal emphasis on political independence, self-defense, and economic self-support capabilities. Kim Jong-il, however, insists that North Korea can be a "country strong in ideology and economy" only when its military is strong. The country, therefore, has been developing its industries within the context of a military-industrial complex with strong links between heavy industry and munitions production. Some of North Korea's munitions industries (manufacturing dual use products) are virtually indistinguishable from those supplying civilians.

In 1998 at the 10 th Supreme People's Assembly, the military's National Defense Commission arguably eclipsed the Politburo as the supreme national decision making body in North Korea. In the years since, the term "military-first politics" has been used to signify the privileged status the Korean People's Army holds and to stress the ascendant position of the military relative to the power of the Korean Workers' Party, the traditional center of the DPRK's decision making. Of course, the ultimate decision maker in Pyongyang is the Dear Leader, Kim Jong-il, who is Chairman of the National Defense Commission.

North Korea claims to spend about 15% of its GDP on national defense. In 2006, Pyongyang's defense budget was an estimated $2.3 billion to maintain its 1.17 million member military. South Korea estimated the North's military expenditures at $5 billion in 2003. In 2005, North Korea stated that the defense budget was 15.9% of its total annual budget, but others had put the figure at 27.2% in 2003. Even a defense budget of $2.3 billion, however, implies an expenditure of $2,090 per member of the military, a woefully small amount. This implies that the tug of war between "guns and butter" within the North Korean regime must be quite intense given the scarcity of resources throughout the country even though the military does operate businesses that bring in additional revenues.

The heavy weight of the military in Pyongyang's decision making may help explain what to outsiders seem to be inexplicable actions by the North Korean government. For example, almost immediately after negotiators had issued the September 19, 2005, Six-party Statement in which North Korea ostensibly committed itself to abandoning all nuclear weapons and existing nuclear programs, Pyongyang began backtracking and within two months announced a boycott of future Six-Party Talks. It also may help explain North Korea's carrying out its nuclear tests despite being warned not to do so by the United States, China, and other nations. Progress in the Six-Party Talks under which North Korea shut down its Yongbyon nuclear reactor as required in phase I of the February 13, 2007 agreement arguably represented a defeat for the military, but the restart of Yongbyon and nuclear tests in 2009 indicate a strong resurgence by military interests.

When juche is combined with central planning, a command economy, and government ownership of the means of production, economic decisions that in a market economy would be made by private business and farmers have to go through a few elite in Pyongyang. These decisionmakers may or may not understand advances in agronomy or manufacturing and tend to be motivated by non-economic factors, such as maintaining political power or avoiding blame for initiatives gone awry. Farming methods based partly on crop rotation or new varieties of rice, for example, may be viewed as too risky. Foreign investment also is hindered partly because the regime abhors being "exploited" by capitalists who seek to make profits on their business ventures in North Korea and partly because of their deep-seated mistrust of Westerners, Japanese, and South Koreans.

Economic Reforms and Free Trade Zones

As with other isolationist economies in the contemporary world of globalization and interlinked societies, North Korea has been plagued with the negative effects of its attempts at self sufficiency: technological obsolescence, uncompetitive exports, economic privation, and lack of foreign exchange. Much of the reforms, however, have been from the "bottom up" by necessity as the central government faltered on its ability to deliver food and basic necessities through its distribution system. These difficulties, together with advice from China and Russia, have compelled the Pyongyang regime to allow some economic reforms. To the extent possible, they are allowing reforms in the Chinese sequence with economic reforms preceding political reforms while eschewing the Russian model of political reform preceding and concurrent with economic reforms. The DPRK also has been examining the Vietnamese model of development and do moi (reform). Kim Jong-il reportedly prefers the Vietnamese style of gradual economic reform rather than the abrupt Chinese style.

The reforms began in July 2002 when Pyongyang announced a series of measures that some had hoped would mark the beginning of the end of the Stalinist controls over the economy and the onset of more use of the market mechanism to make economic decisions, particularly production and consumer purchases. Although the government has dubbed the reforms an "economic adjustment policy," in the manufacturing sector, in particular, the actions appear to be a desperate attempt to revive the moribund economy. The reforms also dovetail with North Korea's "military-first" policy. As Kim Jong-il has given first priority to the military, the rest of the population has suffered. This, in turn, has raised pressures on Pyongyang to increase the productivity of its economic system.

The adjustments (reforms) featured an end to the rationing system for daily commodities (except for food), a huge increase in prices of essentials and in wages, a major devaluation of the currency (official exchange rate), abolishment of the foreign exchange coupon system, increased autonomy of enterprises, authorization of the establishment of markets and other trading centers, and a limited opening of the economy to foreign investment. Prices still remain under centralized control but at levels closer to those existing in peasant (free) markets. North Korea has not abandoned the socialist planned economy, but it has been compelled to "adjust" certain aspects of it.

Under the initial reforms, overall prices increased by 10 to 20 times. Government prices for many essential items, however, rose by much more. The price for rice rose by 550 times, for corn 471 times, for diesel oil 38 times, and for electricity 60 times. Wages also were raised but not enough to keep pace with skyrocketing consumer prices. Wages rose by 18 times for laborers and 20 times for managers. Even though not all workers received the promised wage increases, the price and wage reforms caused households to face rampant consumer inflation, and many people ended up worse off financially than before the reforms.

In North Korean factories, reforms include greater control over prices, procurement, wages, and some incentives to increase profits in order to distribute them based on individual performance. The regime also is looking to implement reforms in agriculture similar to those implemented in China (along the lines of the rural household contract system). In the mid-1990s, North Korea's agricultural work squads had already been reduced in size. Now they are moving toward family oriented operations with farmers allowed to retain more of any production exceeding official targets.

Although small farmers' markets have long existed in North Korea, Pyongyang did not legalize such farmers' markets until June 2003. This followed the formal recognition of commercial transactions between individuals and the 1998 revision to the constitution that allowed individuals to keep profits earned through legitimate economic activities. Now free markets and shopping centers that use currency, not ration coupons, are spreading. The Pyongyang Central Market, for example, became so crowded that a new, three-story supermarket had to be built. Pyongyang's Tongil market with its lines of covered stalls stocked with items such as fruit, watches, foreign liquor, clothes, Chinese-made television sets, and beer from Singapore also is bustling with sellers and consumers reminiscent of those in other Asian countries. Visitors to Pyongyang in late 2006 indicated that the market was thriving with all types of products and shoppers driving European cars.

The North Korean population is gradually becoming re-accustomed to operating in open markets. This has raised fears by the DPRK regime of encroachment by capitalism into their socialist economic system. On August 26, 2007, Kim Jong-il announced that "markets have become anti-socialist, Western-style markets." This has led to a steady stream of government edicts restricting market activity across the country. At first, authorities prohibited women under the age of 40 from selling goods in Pyongyang markets. Then on December 1 the authorities banned women under the age of 49 from running businesses in Pyongyang. (Since males are officially required to be at their assigned workplaces, women generally run the businesses.) Certain products, such as videos of South Korean dramas, movies, and other so-called non-socialist elements are also banned from central markets.

Enforcement of the new regulations at first was spotty, but in late 2007, it appears to have become more strict. According to news reports, policing is also being conducted by central government security agencies, organizations that normally deal with issues such as intelligence gathering and sedition. The extent of the Kim regime's attempts to control the development of a market economy can be illustrated by the increased difficulty of acquiring travel permits for persons suspected of being wholesale merchants intending to carry goods from one place to another. This crackdown on travel also is affecting normal tourist and family trips. Corruption, however, allows some businesses to continue, as certain officials reportedly are receptive to bribes. Secret peddling on streets and other banned activity also continues out of sight of the authorities (particularly by young and nimble traders).

Currency Reform

In late 2009, the DPRK government carried out a currency reform that actually amounted to a confiscation of wealth by the central government and an attack on Chinese-style markets. Much of the wealth that became worthless had been accumulated by "illegal" merchants and traders through their activity on private markets. Under the currency reform, the government issued new currency denominated in amounts one-hundreth of those on the old currency. Introduced ostensibly to control inflation, the catch was that the amount that households could exchange was limited initially to about $40 (later raised to $200). Hence, the currency exchange effectively became a device to confiscate wealth, much of it earned by buying goods in China and selling them in North Korean markets or by private transactions within the DPRK economy. This currency reform amounted to a rebuke, not only of the North Koreans who had accumulated wealth through private markets but of China who had been encouraging market-oriented reforms similar to those undertaken by Beijing. Pyongyang also banned the use of foreign currency in transactions, particularly dollars, euros, and Chinese yuan, and placed tighter restrictions on travel, border crossings, and on markets. The currency reform also was aimed at controlling inflation, although it appears to have worsened the situation. Commodities were being held off markets and had become even more scarce, and the value of the new currency on in terms of the Chinese yuan declined.

The currency reform, however, coincided with a renewed effort to attract foreign investment into the country. There was an announcement on December 16, 2009, of several new economic laws and regulations affecting commodities, real estate, and import of capital goods. The irony of the reform, however, was that it was the precisely the type of measure that foreign investors fear—the government confiscating wealth and banning transactions in foreign currency.

Foreign Investment

Even though Pyongyang seems highly distrustful of foreigners and market-based production systems, it has allowed for limited entry by foreign companies, particularly from China and South Korea. On December 15, 2009, Kim Jong-il stated during a visit to one free trade zone near the borders with China and Russia that "[We] must actively develop international activities and continuously open up new markets." This followed a statement during the previous month that the DPRK needed to "stimulate investments from other countries" in order to build a strong economy. This official backing from Kim Jong-il may open the door to more entry by foreign firms in North Korea.

Under the Joint-Operation Act of 1984 to 1994, there were 148 cases of foreign investment worth about $200 million into North Korea. Of these 148 cases, 131 were from pro-North Korean residents of Japan. In 1991, Pyongyang opened the Rajin-Sonbong free trade zone (now called Rason Special City or municipality) and established the Foreigner Investment Act. To 1997, some 80 investments totaled $1.4 million.

On October 4, 2009, the sixtieth anniversary of diplomatic relations between China and the DPRK, Chinese Premier Wen Jiabao made a "goodwill trip" to Pyongyang, the first by a Chinese Premier in eighteen years. He was accompanied by a large delegation of high ranking officials. Both countries vowed to support each other and signed several documents including an agreement on economic and technological cooperation. Wen also offered to expand and strengthen economic cooperation and exchange, and the two sides reached a consensus to proceed with construction of a new bridge over the Yalu (Amnok) River between their two countries (estimated to cost over $150 million). In addition, Wen reportedly offered an economic cooperation package worth another $50 million. The two countries have embarked on the development of the Tumen River Cross-Border Economic Cooperation Zone, also called the Tonghua-Dandong Economic Zone, along the North Korean border aimed at boosting trade. This zone is to include the rebuilt bridge, a new port, a duty-free zone, warehouses, and international transit facilities. It is to cover about 350 km or most of the Western half of the Sino-DPRK border.

The DPRK also established the Sinuiju Special Administrative Region (SAR) on the northwestern border with China. Since being established in 2002, the development of the Sinuiju SAR has been stymied partly because of the arrest by Beijing of Chinese businessman Yang Bin, a Chinese-Dutch entrepreneur who was named as its governor, on charges of illegal land use, bribery and fraud. After Kim Jong-il's visit to China in 2006, Sinuiju appears to be receiving new attention. Foreign currency management groups reportedly have moved in, and ordinary citizens are being replaced by residents of Pyongyang and other areas.

Other North Korean areas receiving foreign investment include Nampo, Pyongyang, Kosung-gun, Shimpo, Wonsan, and Mt. Kumkang. Mt. Kumkang has been developed with the cooperation of South Korea's Hyundai corporation into a tourist destination for South Koreans and a venue for reunions of families separated by the DMZ. In 2008, as relations with South Korea soured and a South Korean tourist there was shot, operations at Mt. Kumkang ceased. The Kumgang tour program, run by South Korea's Hyundai Asian Corp., was launched in 1998. More than 1.9 million South Koreans have visited the resort.

A major foreign investment project is the Kaesong Industrial Complex (discussed below). Investment from China is also discussed below.

The DPRK also has been able to attract a limited amount of foreign investment from other nations. For example, in January 2008, Orascom Telecom, the fourth-largest Arab phone operator based in Cairo, Egypt, announced that its subsidiary in North Korea (CHEO Technology—25% owned by the state-owned Korea Post and Telecommunications) had received a license to be the first provider of mobile telephone services throughout the country. The company is to invest up to $400 million in network infrastructure over the first thee years and to provide service to Pyongyang and other major cities within one year.

According to data compiled by the United Nations Conference on Trade and Development (UNCTAD) since 1987, the DPRK had a cumulative $1.38 billion in foreign direct investment (FDI) as of the end of 2007. Annual FDI flows have been sporadic, even negative in some years, but since 2003 (except for 2006), they have been rising. (See Figure 4 .)

Kaesong Industrial Complex86

The most significant effort at creating free-trade zones has been the Kaesong Industrial Complex (KIC), although in 2009 during a period of increased tensions surrounding North Korea's missile and nuclear tests, Pyongyang threatened to shut it down. Since then, operations have resumed. This joint effort between North and South Korea has been developing rapidly, despite fluctuations in political and military relationships between the two governments. The KIC is managed by South Korea's Hyundai Asan and Korea Land Corporation. Located just over the border 43 miles north of Seoul on the route to Pyongyang, this 810-acre complex aims to attract South Korean companies, particularly small and medium sized enterprises, seeking lower labor and other costs for their manufactured products and who may not be able to establish subsidiaries in China or other countries. As of November 2009, 116 factories were operating in Kaesong. They were employing about 40,000 North Korean personnel and 1,000 South Korean personnel. To be completed in three stages, the first stage (2002-2007) had 3.3 million square meters of a total of 66 million square meters being constructed or under construction in 2006. Hyundai Asan and the Korea Land Corporation plan to eventually attract 300 businesses in the first stage, 700 in the second, and 1,000 businesses in the third stage with an estimated total of 300,000 workers. Of the $374 million initial cost for the first stage, $223 million was to be provided by the South Korean government. In December 2006, the Korea Electric Power Corporation connected North and South Korea by a 100,000 kilowatt power-transmission line for use by the companies in the KIC.

In 2006, the KIC produced some $7.5 million worth of goods each month. In September 2007, monthly production had reached $17.1 million. In 2008 yearly production reached about $250 million or about $20.8 million per month, and the production had increased to $27 million in October 2009. The major products include textiles, chemical products, metals and machinery, and electric and electronic products.

Kaesong developed partly from South Korea's sunshine policy of economic engagement with the North. The KIC serves both geopolitical and economic purposes. Geopolitically, it provides a channel for rapprochement between North and South Korea, a bridge for communication, a method of defusing tensions, and a way to expose North Koreans to outside ideas and ways of doing business. Economically, the KIC provides small- and medium-sized South Korean firms with a low-cost supply of labor for manufacturing products, provides jobs for North Korean workers, and provides needed hard currency for Pyongyang. For the South Korean government, the question now is whether to build dormitories for workers from areas beyond the commuting watershed of the KIC. Currently, buses transport workers to and from the nearby Kaesong city. Kaesong City, however, has essentially reached the limit for the workers it can supply for the KIC, and where the workers will come from for the 18 projects currently under construction and the 105 projects that have been allotted land but have not yet begun construction. If workers are imported from beyond the Kaesong City commuting area, they will either have to be housed in the city or on the KIC. The previous Roh Moo-hyn administration agreed to provide dormitories for 15,000 workers. If the dormitories are built, they will constitute a significant additional cost for the South Korean government. Also, Pyongyang may have to decide whether it will risk having workers from other regions interact with South Koreans, experience market-based production methods, and be exposed to non-DPRK products.

A controversial issue has arisen with respect to the KIC and the proposed South Korea-U.S. Free-trade Agreement (FTA). South Korea had requested that products exported from the complex be considered to have originated in South Korea in order to qualify for duty free status under the proposed FTA. Such a provision had been included in other South Korean FTAs.

The language of the proposed Korea-United States FTA (signed but not yet approved by Congress) does not provide for duty-free entry into the United States for products made in Kaesong. Annex 22-B to the proposed FTA, however, provides for a Committee on Outward Processing Zones (OPZ) to be formed and in the future to designate zones, such as the KIC, to receive preferential treatment under the FTA. Such a designation apparently would require legislative approval by both countries.

Other issues raised by the KIC have been the conditions for North Korean workers, whether they are being exploited, as well as the hard currency funds the industrial complex provides for the ruling regime in Pyongyang. South Korean officials, as well as other analysts, point out that average wages and working conditions at Kaesong are far better than those in the rest of North Korea. Before 2009 when the DPRK insisted that wages be increased, the monthly minimum wage was $50 ($57.50 including the cost of social insurance). General workers received $50, team leaders received $52-$55, and heads of companies received $75 per month. After the government took its share of the wages, the workers received about $37 per month. Workers also received overtime pay.

The North Korean government derives hard currency from several sources in the KIC project, including leasing fees and its taxes and fees deducted from the wages of North Korean workers. The wages are first paid in hard currency to a North Korean government agency that takes a certain percentage before paying the North Korean workers in won. The government collects about $20 per month (in social insurance taxes plus its cut of wages) for each of the 10,000 workers now at Kaesong. Its monthly take from wages, therefore, would amount to approximately $200,000 per month or $2,440,000 over a year. One estimate is that Pyongyang earns some $33.52 million a year from the Kaesong Industrial Complex.

Investment From China

China has a direct interest in economic reform and recovery in the DPRK. Chinese business interests with support from Beijing are beginning to invest widely in the North Korean economy. Unlike, South Korean investors, Chinese are allowed to invest in enterprises fully integrated into the DPRK economy. They also have provided machinery and equipment to existing North Korean factories.

The amount and major characteristics of Chinese investment are:

according to the United Nations, China's investment in the DPRK increased from $1.5 million in 2002 to $42 million in 2008, but in January 2008, the Chinese government reported that there were 84 investment cases worth $440 million; much investment is in mineral extraction (particularly coal and iron ore) that includes processing in China; much of it is located in the three northeaster provinces of the DPRK near China; and some investment is going into infrastructure such as ports, bridges, railroads, and electrical transmission lines along the Sino-DPRK border.

Chinese investment in mineral extraction in the DPRK seems to represent an easing of the DPRK constitutional ban against "cultural infiltration (Article 41). This has been interpreted to include international economic integration and globalization. However, Pyongyang seems to be treating investment from China as being "not contaminated" relative to those from South Korea or other nations. South Korean investments are carefully walled off from the average North Korean citizen, whereas China has been able to invest in production facilities in various locations.

International Trade

Despite North Korea's isolation and emphasis on juche , it does trade with other countries. According to trade statistics compiled by the International Monetary Fund, the DPRK had at least some trade with 80 of the 182 countries or customs territories that report their trade data to the Fund. For Pyongyang, the foreign economic sector plays an important role in that it allows the country to import food, technology, and other merchandise that it is unable to produce in sufficient quantities at home. Since North Korea does not export enough to pay for its imports, it generates a deficit in reported merchandise trade that must be financed by other means. Pyongyang has to find sources of foreign exchange—other than from its overtly traded exports—to pay for the imports. Experts point out that the DPRK has used its military threat to "extort" aid and other transfers from the United States, Japan, South Korea, and the humanitarian agencies. This, along with various illicit activities, has helped Pyongyang to finance a surfeit of imports.

Detailed data on the country's external economic relations suffer from reliability problems similar to those associated with the domestic economy. The foreign economic data on actual commercial transactions, however, tend to be more accurate since they also are reported by trading partner countries and are compiled by the International Monetary Fund and United Nations. Individual countries, for example, report on their imports from and exports to North Korea. These mirror statistics, however, differ from North Korea's actual annual numbers because of differences in data gathering methods, coverage, timing, and reporting. Countries also may misreport trade with the Republic of Korea as trade with the Democratic People's Republic of Korea. Detailed and reliable data on trade in military equipment and illegal drugs also are notoriously difficult to obtain and to verify.

South Korea also compiles statistics on trade with North Korea that differ from its data reported to the United Nations. South Korea considers trade with the North as inter-Korean trade, not foreign trade. The trade figures that South Korea reports to the IMF for its commercial transactions with the North are considerably lower than the figures that it reports as inter-Korean trade [usually available from the Korea Trade-Investment Promotion Agency (KOTRA)]. The inter-Korean trade data reported by South Korea also include more detail on non-transactional trade (mostly foreign aid) with North Korea. IMF data also differ somewhat from those reported by data vending companies (such as Global Trade Atlas and Global Insight). This report uses a combination of trade totals (mirror statistics) from the IMF, partner country data from the Global Trade Atlas, intra-Korean trade from South Korea's KOTRA, and references some estimates of total trade from Global Insight.

The DPRK's policy of juche , its suspicion of foreign countries, and the collapse of its industrial production, has resulted in a minimal level of commercial relations with other nations in the world. This trade has been rising in recent years, although much of this increase can be attributed to investments by South Korea and China in DPRK mining and manufacturing. As shown in Table 2 , in 2008 North Korea exported an estimated $2,801 in merchandise (up from $2,535 million in 2007) while importing $4,127 million (up from $3,437 million in 2007). This created an apparent merchandise trade deficit of $1,326 million (up from $901 million in 2007). Imports from China, in particular, rose 46% from $1,393 million in 2007 to $2,033 million in 2008. In recent years, North Korea's exports to and imports from China and South Korea have risen. South Korea and China account for 60% of North Korean exports and 71% of North Korean imports. Economic sanctions imposed by Japan have reduced that bilateral trade to almost nothing.

The South Korea Trade-Investment Promotion Agency (KOTRA) has estimated that in 2008, North Korea exported $1,130 million while importing $2,685 million for a trade deficit of $1,555 million. The KOTRA data, however, exclude data for about 60 developing countries (including most countries of the Middle East) and do not include South Korean trade with the DPRK. What can be said is that the DPRK's trade deficit has been running in the range of $1 billion to $1.5 billion per year.

North Korea's major trading partners have been China, South Korea, Japan, Russia, Germany, Thailand and India (as well as Brazil, Singapore, and Hong Kong). As shown in Figure 5 and Table 2 , North Korea's major import sources have been China, South Korea, Russia, Japan, and Thailand. Germany and India also are major suppliers. Major imports by North Korea include machinery, minerals, plant products, and chemical products. In particular, imports of energy materials and foods reflect Pyongyang's attempts to remedy these fundamental shortages.

Despite current tensions over Pyongyang's nuclear program, imports appear to be growing and are estimated to have exceeded their peak in 2001 when a large shipment of food aid from Japan (mainly rice valued at high Japanese prices) artificially increased the import total. Fuel imports from China, food imports from various countries, and supplies of material and components for assembly in the Kaesong Industrial Complex account for most of the increases. Imports from the United States and Japan have been virtually nonexistent. China and South Korea have become the largest sources of imports for the DPRK, but other sources recently also have become significant.

Major export markets for the DPRK have been China, Thailand, and South Korea (primarily because of production from South Korean factories in the Kaesong Industrial Complex). (See Figure 6 and Table 2 .) In Europe, Germany has been North Korea's major trading partner, and in Latin America, Brazil is developing as a market for North Korea's exports. Since 2003, exports to Japan have declined—due to trade sanctions and friction over the DPRK's admitted kidnappings of Japanese citizens. North Korea's major exports include ores, coal, animal products, textiles, machinery, electronic products, and base metals.

A recent remarkable development has been North Korea's increase in exports of primary products (such as fish, shellfish and agro-forest products) as well as mineral products (such as base metallic minerals). Pyongyang reportedly has imported aquaculture technology to increase production of cultivated fish and agricultural equipment to increase output of grains and livestock. It also has imported equipment for its coal and mineral mines. Much of the coal and mineral exports have resulted from partnering with Chinese firms through which the Chinese side provides modern equipment in exchange for a supply of the product being mined or manufactured. The production from the Kaesong Industrial Complex also has become significant. North Korean imports from South Korea and China both exceeded $1 billion in 2006, and North Korean exports to South Korea reached $765 million and to China $582 million.

Meanwhile, traditional exports of textiles and electrical appliances have been declining. This reflects North Korea's unstable power supply, lack of raw materials and components imported from abroad, and the need to ship finished goods to China or another third country for final inspection. This diminishing ability of North Korea to provide a reliable manufacturing platform for the least complicated assembly operations without help from foreign investors does not bode well for the country's future ability to generate the exports necessary to balance its trade accounts.

UN Resolution 1874 includes a ban on all arms transfers from the DPRK, including small arms. Data on small arms trade are available to a certain extent, but such exports are likely to be under-reported in official statistics.

Table 3 shows imports of small arms and ammunition by trading partner countries from North Korea from 2001 to 2008. The total reported transactions has been about $5.3 million over the eight years. The importers have included countries from Latin America, Europe, Southeast Asia, and the Middle East.

Other Sources of Foreign Exchange

North Korea's annual merchandise trade deficit of about $1 billion implies that Pyongyang must either be receiving imports without immediate payment required (aid and capital flows) or be generating foreign exchange through some means—either legal or illegal. Legal means include borrowing, foreign investments, foreign aid, remittances from overseas North Korean workers, selling military equipment not reflected in trade data, and by selling services abroad. Illegal methods include the counterfeiting of hard currency, illegal sales of military equipment or technology, sales of illegal drugs, or by shipping illegal cargo between third countries. The country also can dip into its foreign exchange reserves.

Legal Sources of Funds

North Korea is able to borrow on international capital markets. As of the second quarter of 2009, the country had loans from foreign located banks that report to the Bank of International Settlements (BIS) of $73 million, down from $494 million as recently as March 2008. The amount of loans is a relatively small amount, less than $4 per capita. Total liabilities in the first quarter 2009 to BIS banks (including those located in North Korea) came to $996 million (of which $718 million was short term), down considerably from $1,532 million for the fourth quarter of 2007. Most of these liabilities appear to be export credits. North Korea also had deposits of $96 million with BIS banks, down from $398 million at the end of 2007.

International bond issues are not a major source of funds for North Korea. In May 2003, the country issued ten-year bonds—the first since 1950—but since its sovereign securities are not rated by major Western credit rating agencies, the issue has generated little interest on international financial markets and is aimed at domestic investors. Pyongyang claims that a million people had signed up to receive the bonds, but many speculate that the deductions from the salaries of North Korean purchasers in amounts equivalent to four months' wages to buy the bonds was not voluntary. North Korea does not pay interest on the bonds. Rather the government holds a lottery in which the winners receive monetary prizes greater than the foregone interest on the bonds.

Although North Korea is not a major recipient of foreign direct investment (FDI), in 2007, the stock of foreign direct investment in the DPRK was $1,378 million. The inflow that year was $53 million, up from the outflow of $105 million in 2006, and the inflow of $50 million in 2005, but less than the $197 million in 2004, and $158 million in 2003. The FDI comes mainly from South Korea and China. North Korea's free trade zones, particularly the Kaesong Industrial Complex, however, are attracting more foreign direct investment.

A major source of funding for imports into the DPRK has been foreign aid or direct government transfers. Both developmental and humanitarian aid and past assistance under KEDO (Korean Peninsula Energy Development Organization, created under the 1994 Agreed Framework, but construction was terminated in 2003) to build two light water nuclear reactors and provide heavy fuel oil have enabled imports into North Korea without financing from Pyongyang.

North Korea also receives funds in the form of official development assistance (ODA) from aid donor nations and other organizations; other official flows; and private flows. The Organisation for Economic Co-operation and Development (OECD) compiles these data from its member nations plus 12 others and from multilateral agencies. The OECD data, however, do not include reporting from South Korea (Seoul considers transactions with the North as intra-country, not as foreign), China, or Russia (not members of the OECD). As shown in Table 4 , in 2004, net total receipts for North Korea came to $1,529.6 million from donors, primarily because of a $1.151.1 million receipt from France, $142.3 million from the United Kingdom, and $56.5 million from the United States. In 2005, however, the net total dropped to $148.7 million as the dispute over North Korea's nuclear program escalated, fell further to $59.6 million in 2006 as North Korea made significant repayments of previously received funds, and rose to $178.1 million in 2007. Of this amount, $102 million came from the Netherlands.

As shown in Table 5 , much of the total receipts by North Korea came in the form of official development assistance. In recent years, the country has received between $55 and $265 million in net official development assistance (ODA) from the countries and agencies that report such data to the OECD (does not include Russia, China, and South Korea). In 2004, total net ODA was $160.8 million, in 2005 was $86.8 million, in 2006 was $54.5 million, and in 2007 was $97.6 million. The major donors have been the multilateral agencies, European Community, the United States, Sweden, Norway, and Australia. In 2008, the United States provided the DPRK with $$93.7 million in food aid and $106.0 million in fuel oil for a total of $199.7 million.

The United States also has paid North Korea to search for remains of American servicemen missing from the Korean War. In 2003, it paid $2.1 million to conduct four searches.

As indicated in Table 6 , since 1991, the South Korean government has provided a total of $3,337.0 million in assistance to the DPRK. Of this, $2,221.99 million was humanitarian assistance (food aid, fertilizer, or assistance provided through non-governmental organizations). Total assistance reached a high of $635.43 million in 2007 but dropped to $159.36 million in 2008 as deliveries of food and fertilizer were halted. South Korean civilian organizations also have provided assistance to North Korea ($71 million in 2003).

As shown in Table 7 , in addition to humanitarian assistance, South Korea has provided $1,115.01 million in economic and other assistance to the DPRK since 1991. This has taken the form of road and rail construction, business subsidies, development of the Kaesong Industrial Complex, tours of Kumgang Mountain, family reunions, and other. The road and rail assistance was mainly for connecting the Kaesong Industrial Complex located across the demilitarized zone in North Korea to South Korea. Also related to Kaesong was much of the aid to ROK businesses as well as direct expenditures to develop the industrial complex. Not included in South Korean assistance to the DPRK are the wages of North Korean workers in Kaesong or other internal business transactions.

Another major source of income for certain North Korean families has been in remittances from overseas Koreans, particularly those who live in Japan. Most of the North Koreans in Japan either remained there after World War II or are descendants of those people. Some had been forcibly brought there to work in coal mines or factories during the 50-year Japanese occupation of Korea. Currently, of the approximately 650,000 ethnic Koreans who live in Japan, an estimated 56,000 to 90,000 are from the North Korean area, and many are reported to be actively involved in supporting the Pyongyang regime. Ethnic Koreans in Japan work in a variety of businesses and occupations, but they face discrimination in Japanese society and are known for operating pachinko (pinball) parlors and other enterprises providing entertainment and night life as well as being involved with Japan's yakuza or gangsters. Many of these, as well as managers of North Korean-related credit unions, regularly have sent remittances to relatives or associates in North Korea. One unusual method of smuggling money to North Korea has been to hide 10,000 yen bills (worth roughly $90 each) under expensive melons being shipped to Kim Jong-il as gifts.

Given the decade of stagnation (1992-2002) of the Japanese economy and rising tensions between Japan and North Korea, these remittances have reportedly been declining. A 2003 Japanese newspaper report placed the amount at between $200 million and $600 million per year, but that figure could be exaggerated. In testimony before parliament, Japan's Finance Minister stated that in Japan's FY2002, $34 million had been sent from Japan to North Korea through financial channels that required reports to the Japanese government. Recent Japanese sanctions include a lowering of the amount on remittances to North Korea that require reporting from 30 million to 10 million yen (. from reported to April, following North Korea's rocket launch, Japan imposed fresh sanctions including reducing the amount of remittance to North Korea subject to reporting to the Japanese government from more than 30 million yen ($300,000) to more than 10 million yen ($100,000). Anecdotal evidence indicates that considerable amounts of currency from Japan are simply carried by individuals on ships or sent through China and not reported. Japan, however, has tightened inspections of North Korean ships and curtailed operations of ferry boats traveling between the two countries. Remittances by North Koreans living in South Korea and China also are reportedly growing. These could amount to around $6 million per year from 6,000 (of 10,000) refugees in South Korea and some more from the 100,000 refugees living in China.

In summary, the DPRK's net total receipts plus remittances, aid and investments from South Korea, and special food and fuel assistance in connection with negotiations over Pyongyang's nuclear program, constitute most of the overt resource inflows that North Korea has received each year over and above its export earnings. These have amounted to perhaps $700 million on net per year. North Korea must finance the remainder of its trade deficit—about $300 to $500 million—by other means. It appears that these other means have included exports of military equipment and illicit activity.

Illegal or Questionable Sources of Funds115

Data on North Korean sales of military equipment abroad is understandably murky, but the country is thought to have sold hundreds of ballistic missiles to Iran, Iraq, Syria, Pakistan, and other nations in the past decade to earn foreign currency. The interdiction by Spain of an unmarked vessel in December 2002 containing parts for 12 to 15 Scud missiles (valued at about $4 million each) bound for Yemen from North Korea is one example of such arms sales. Another was the December 2008 interception of a cargo plane loaded with 35 tons of arms from North Korea by the Thai government. In testimony in 2003 before the House Committee on International Relations, the Undersecretary of State for Arms Control and International Security pointed out that North Korea possesses Scud and No-Dong missiles and is developing the Taepo-Dong 2. He stated that the country is by far the most aggressive proliferator of missiles and related technologies to countries of concern. These sales are one of the North's major sources of hard currency. According to a U.S. military officer quoted in the Japanese press, North Korea exported $580 million worth of ballistic missiles to the Middle East in 2001. Between 1998 and 2001, North Korea is estimated to have exported some $1 billion in conventional arms to developing nations. In a 2009 article, the Wall Street Journal quotes analysts as saying that North Korean sales of short- and medium-range missile systems remain among North Korea's largest export earners, part of an arms trade that generates $1.5 billion annually. This trade appears to be curtailed significantly following the implementation of U.N. Security Council Resolution 1874.

With respect to illegal drug trade, the State Department has indicated that "drug trafficking with a connection to the Democratic People's Republic of Korea (DPRK, or North Korea) appears to be down sharply. There have been no instances of drug trafficking suggestive of state-directed trafficking for six years, but there still is insufficient evidence to say for certain that state-sponsored trafficking has stopped at this time. Small-scale trafficking along the DPRK-China border continues. In March 2007 the DPRK acceded to the three drug conventions." In the past, North Korea apparently was engaged in illegal drug trade. Officials from the U.S. military command in Seoul reportedly said that North Korea had earned between $500 million and $1 billion annually from the narcotics trade. North Korea is thought to have produced more than 40 tons of opium per year which would have made it the world's third-largest opium exporter and sixth-largest heroin exporter. The regime also is accused of trafficking in methamphetamine stimulants. In 2003, U.S. counter-narcotics officials are reported to have said that since 1976, there had been at least 50 arrests or drug seizures involving North Koreans in more than 20 countries. Japanese authorities have said that nearly 50% of illegal drug imports into Japan come from North Korea. According to the U.S. State Department, although such reports have not been conclusively verified by independent sources, defector statements have been consistent over years and occur in the context of regular narcotics seizures linked to North Korea.

According to the State Department, in March 2006, a new decree warned citizens, state factories and groups in the DPRK to "… not sell, buy, or use drugs illegally" and that "organizations, factories and groups should not illegally produce or export drugs." Punishment is severe, up to death, and the family members and shop mates of offenders face collective responsibility and punishment with the perpetrator.

In a blatant incident in May 2003, the Australian navy and special forces commandeered a North Korean ship (Pong Su) off the country's southern coast that allegedly was moving 110 pounds of almost pure heroin valued at $50 million. The ship apparently picked up the heroin elsewhere in Asia and took a circuitous route to Australia.

Allegations also have been made that North Korea engages in counterfeiting operations, particularly of U.S. $100 notes. It is believed that the country has earned $15 million to $20 million per year in counterfeiting, but it is not clear that North Korea currently engages in counterfeit currency production, although such notes still reportedly circulate. North Korean General O Kuk-ryol, who recently was promoted to the country's National Defense Commission and who reportedly is in charge of arranging the succession of Kim Jong-il's third son, Kim Jong-un, was identified by U.S. and foreign intelligence sources as a key figure in the covert production and distribution of high-quality counterfeit $100 bills.

Since late 2005, the United States has taken several measures to reduce illicit financial activities by North Korea. On June 28, 2006, President Bush issued Executive Order 13382 (Blocking Property of Weapons of Mass Destruction Proliferators and Their Supporters). On October 21, 2005, pursuant to Executive Order 13382, the U.S. Treasury designated eight North Korean entities as proliferators of weapons of mass destruction and their delivery vehicles. The action prohibited all transactions between the designated entities and any U.S. person and froze any assets the entities may have had under U.S. jurisdiction.

On September 15, 2005, the U.S. Treasury designated Banco Delta Asia SARL as a "primary money laundering concern" under Section 311 of the Patriot Act because it represented an unacceptable risk of money laundering and other financial crimes. Treasury stated that "Banco Delta Asia has been a willing pawn for the North Korean government to engage in corrupt financial activities through Macau.... " On March 14, 2007, the Treasury finalized its rule against Banco Delta Asia, barring the bank from accessing the U.S. financial system, but allowing the $25 million in North Korean funds held to be released.

U.S.-DPRK Trade Relations

U.S. trade with the DPRK is quite limited. The United States does not maintain any diplomatic, consular, or trade relations with North Korea, and the country does not have normal trade relations (most favored nation) status. This means that North Korean exports are subject to the relatively high tariffs existing before World War II in the United States. For example, women's blouses of wool or cotton carry a 90% import duty if from North Korea but are duty free if from free-trade agreement countries, such as Canada, Israel, or Mexico, or are subject to 9 to 10% duty if from most other nations. As a communist nation, North Korea also does not qualify for duty-free treatment of certain products that are imported from designated developing countries under the generalized system of preferences program.

The United States, moreover, maintains various economic sanctions on North Korea because the country is considered a threat to national security, is a communist state, and it proliferates weapons of mass destruction. In 2008, however, the Bush Administration lifted restrictions on the DPRK under the Trading with the Enemy Act and removed the DPRK from the list of State Sponsors of Terrorism. Some bills in the 111 th Congress would relist the DPRK. Other sanctions, including U.N. sanctions imposed following North Korea's nuclear test, still remain in place. The United States resumed shipments of food and heavy fuel oil to North Korea as humanitarian aid but subsequently halted them. Travel to and trade with North Korea in other than dual-use goods are allowed if overarching requirements are met, and there are no restrictions on the amount of money Americans may spend in the DPRK. The sanctions that are related to the proliferation of weapons of mass destruction generally target the offending entities. North Korean assets in the United States frozen prior to June 19, 2000, remain frozen. North Korea is on the most restricted list of countries for U.S. exports (Country Group E list) of items such as computers, software, national security-controlled items, items on the Commerce Control List, and service or repair of such items. Except for the UN sanctions, economic sanctions on North Korea are essentially unilateral by the United States. Most other nations (except Japan) allow relatively free trade in non-sensitive goods with the DPRK.

In October 2007, President Bush approved the lifting of some sanctions imposed on the DPRK under an act governing human trafficking. This easing allowed the United States to provide assistance in educational and cultural exchanges to the extent that the aid doesn't damage its national interest. In February 2008, the New York Philharmonic Orchestra performed in Pyongyang.

The United States uses trade with North Korea as leverage and to send a message of disapproval for various activities by Pyongyang. As the Six-Party nuclear talks progressed, however, the United States expressed its willingness to begin discussions to normalize relations with the DPRK, has removed it from the terrorism list, and has indicated its willingness to negotiate a peace treaty to formally end the Korean Conflict. These actions, however, are contingent on the DPRK returning to the Six Party Talks and abiding by previous agreements. The way also could be opened for North Korea's admission to membership in international financial institutions (such as the World Bank, International Monetary Fund, and Asian Development Bank). This would allow the DPRK to receive development assistance that would help finance additional imports from countries such as the United States.

Table 8 shows U.S. merchandise exports, imports, and trade balances with North Korea since 1990. Imports have been zero or relatively low with a peak of $1,495,000 in 2004. Almost all of these imports from North Korea were organic chemicals and woven apparel. A possible concern is that imports of books, newspapers, and manuscripts have dropped to zero. For a country with great strategic importance to the United States, information on North Korea is not flowing directly into the U.S. market. U.S. exports at $23,750,000 in 2004 rose from $32,000 in 1990 to $25,012,000 in 2002 and to $52 million in 2008. However, much of this has been food and energy assistance provided as part of North Korea's process of denuclearization. The small annual surplus in U.S. trade with North Korea arises primarily from food and energy assistance that has been provided to the DPRK.

U.S. businesses have virtually no direct investment in North Korea, although non-governmental groups do run operations in the DPRK in activities such as goat dairy farming and transportation.

North-South Korean Economic Relations

Economic relations have been a major route for opening relations between North and South Korea. Seoul has a major stake in relations with the DPRK and the outcome of the current Six-Party Talks. It seeks a "soft landing" for the current standoff over the North's nuclear program—one that will lead to a lessening of tensions and steady integration of North Korea's economy into the global economic and financial system. As with other countries divided by ideology and a history of hostilities as "pawns" on the chess board of the Cold War, the two halves of the peninsula face numerous issues to be resolved before they can normalize relations—let alone contemplate reunification.

South Korea has much to gain from rapprochement with the North. Its strategy has been to use its economic leverage and family reunions (families separated by the division of the Korean Peninsula) to open channels with the North Korean people while maintaining a credible military deterrent to overt hostile action by Pyongyang. South Korea recognizes that essentially it has won the Cold War on the Korean peninsula, but it recoils at the prospect of funding economic rehabilitation in the DPRK as West Germany did with East Germany. Seoul also recognizes that its economic ties are gradually shifting from reliance on the American market to greater integration with China, Japan, and other countries of Asia. Its labor costs are rising, and many of its companies are remaining competitive only by manufacturing in China and other low-wage markets. For them, the prospect of abundant cheap labor just a short distance to the north is appealing and perhaps an alternative to cheap labor in China.

In 2008, total merchandise trade between North and South Korea was $1,820 million, up from $1,797.9 million in 2007, $1,349.7 million in 2006, and more than triple the $403.0 million just seven years earlier. South Korean exports, which had reached $1,032.6 million in 2007, fell to $888 million in 2008. South Korean imports from North Korea rose to $930 million, up from $765.3 million in 2007. Much of the increase in exports has been in the form of food and industrial goods. In 2006, $419.3 million in South Korean exports to the North were actually South Korean aid shipments.

The major items purchased by South Korea from the North include food/aquatic/forestry products, textiles, steel/metal products, and electronics. The major South Korean exports to North Korea include chemicals, textiles, machinery, steel/metal products, and food/forestry products.

As indicated in Table 6 and Table 7 above, South Korea also provides the DPRK with humanitarian and economic assistance. Since 1991, this has amounted to a total of $3,337.00 million with $2,221.99 million in humanitarian assistance and $1,115.01 million in economic and other assistance. Since 2008, this assistance has largely come to a stop.

Since 1992, particularly under the Sunshine Policy of former South Korean President Kim Dae Jung and under the Policy for Peace and Prosperity of former President Roh Moo-hyun, Seoul has permitted its corporations to pursue business interests in North Korea. In 2003, the government allowed activities by 89 companies including 35 involved in contract processing (assembly, sewing, or other processing done under contract) by North Koreans. The companies included Daewoo (jackets, bags), Samsung Electronics (communications center, switchboard), Samcholi Bicycle, Green Cross (medicine), International Corn Foundation (corn seeds), Hyundai (Mt. Kumkang tourism, development), and Hanshin Co. (glass). The Korea Electronic Power Corporation's work on the construction of a light water nuclear power plant under the U.S.-North Korean 1994 Agreed Framework has been halted. One global strategy of South Korean businesses is to develop processing sites in North Korea to take advantage of low labor costs there; in some cases, labor costs are competitive with those in China. The two countries also have taken some halting steps toward linking their economic systems. In addition to the business relationships, since September 2002, the two countries have been reconnecting the Gyeongui (Seoul-Sinuiju) and Donghae (East Sea) railway lines and adjacent highways.

As discussed in the section above on Economic Reforms and Free Trade Zones, the focus of North-South economic cooperation now is the Kaesong Industrial Complex (KIC). Managed by South Korea's Hyundai Asan and Korea Land Corporation and located just over the border in North Korea, this 810 acre complex already has attracted small and medium sized enterprises from South Korea. The KIC accounts for much of the increased commercial trade between the North and the South. In 2008, the KIC produced some $20 million worth of goods each month. It provides small- and medium-sized South Korean firms with a low-cost supply of labor for manufacturing products, provides jobs for North Korean workers, and provides needed hard currency for Pyongyang.

North Korea depends more on South Korea in international trade than South Korea does on the North. North Korea accounts for less than 1% of total South Korean exports, while North Korean exports to South Korea account for more than a third of total North Korean exports. South Korea has access to global markets for many of its world class industries (automobiles, semiconductors, consumer electronics, etc.), while North Korea faces restricted markets for its limited array of exports.

In his inaugural speech on February 25, 2008, President Lee Myung-bak indicated that South Korea attitude toward inter-Korean relations should be pragmatic, not ideological. He reiterated his plan to provide assistance in order to raise the per capita income of North Korea to $3,000 within ten years if Pyongyang denuclearizes. In September 2009, President Lee offered North Korea a grand bargain to give up its nuclear program in return for aid and security guarantees. This was rejected by Pyongyang.

China-DPRK Economic Relations

China remains the DPRK's chief ally. In addition to sharing its status as one of the last communist regimes in the world, China views the Korean peninsula as vital to its strategic interests. Beijing values North Korea as a buffer between the democratic South Korea and the U.S. forces stationed there, as a rationale to divert U.S. and Japanese resources in the Asia Pacific toward dealing with Pyongyang and less focused on the growing military might of China, and as a destination for Chinese foreign investment and trade. Beijing arguably has more influence in Pyongyang than any other nation.

Cooperation between the two countries is extensive but often strained. In 1961, China and the DPRK signed a mutual defense pact, but recently a Chinese official reportedly said that they are not "well informed of the internal situation of the North Korean military" and that the DPRK "does not listen to what China has to say." (This presumably referred to Pyongyang's missile and nuclear tests.) Also with respect to North Korean refugees, their first destination is usually northeastern China. According to Human Rights Watch, China labels North Korean border-crossers as illegal economic migrants, rather than refugees or asylum seekers, and usually sends them back to North Korea.

China also is hosting and facilitating the ongoing Six-Party Talks that seek a resolution to the North Korean nuclear problem.

In August 2001, Chinese President Jiang Zemin visited Pyongyang and promised increased humanitarian and economic assistance. In April 2004, Kim Jong-il visited Beijing to discuss food aid and nuclear issues. On October 4, 2009, the sixtieth anniversary of diplomatic relations between China and the DPRK, Chinese Premier Wen Jiabao made a "goodwill trip" to Pyongyang, the first by a Chinese Premier in eighteen years. He was accompanied by a large delegation of high ranking officials. Both countries vowed to support each other and signed several documents including an agreement on economic and technological cooperation.

According to Jane's Information Group, several issues have arisen to cause friction in the Sino-North Korean relationship. These include

Chinese exasperation at the DPRK's failure to reform its economy; Pyongyang's prevarication over the nuclear and peace treaty issues and the consequent dangerous stimulus this provides to proliferation in the region; The nuclear standoff with the United States and Pyongyang's possession of nuclear weapons; Growing economic and political rapport between Pyongyang and Taipei; The North Korean refugee problem on the China-DPRK border; Pyongyang's missile testing, prompting Japan to acquire a Theater Missile Defense system, with Taiwan wishing to be included; North Korea's construction of underground missile sites close to the Chinese border; and North Korea's cavalier attitude towards business. (China occasionally suspends shipments of humanitarian aid to the DPRK because Pyongyang regularly 'forgets' to return Chinese railroad rolling stock.)

In 2006, Pyongyang's missile and nuclear tests severely strained relations between China and the DPRK. Beijing had warned the DPRK not to conduct either of the tests and "lost face" when Pyongyang went ahead with them anyway. As a result, for the first time China agreed to UN resolutions imposing sanctions on the DPRK and also took measures to halt banking transactions with North Korean entities and to curtail shipments of petroleum. China, however, did not agree to conduct inspections of shipments along its borders with North Korea. Some analysts indicate that Pyongyang may be growing weary of its lop-sided relations with Beijing and may be attempting to become more independent. Pyongyang may view nuclear weapons as a "trump card to intimidate China as much as the United States." After North Korea's long-range missile test in April 2009, China agreed to stronger U.N. sanctions on three North Korean companies. After North Korea's second nuclear test in May 2009, China issued a strong statement of condemnation and in June 2009 backed UN Security Council resolution 1874 that provided for additional sanctions on the DPRK. In 2008, China exported and estimated $100 million to $160 million in luxury goods that now appear to be under sanction by UN Security Council resolutions.

Since the collapse of the Soviet Union, China has been the DPRK's largest trading partner and supplier of concessional assistance (through subsidized trade and direct transfers). As an export market and source of imports, however, North Korea plays a relatively minor role for China. In 2007, the DPRK ranked 64 th among China's export markets—smaller than Peru, Egypt, or Hungary. As a source of imports, North Korea ranked 70 th —below Gabon, Yemen, or Belgium. Table 10 shows China's merchandise trade with the DPRK.

China is a major source for North Korea of imports of petroleum. According to Chinese data, exports to the DPRK of crude oil reached $414 million and shipments of oil (not crude) totaled $120 million. Total exports of mineral fuel oil of $585 million accounted for 29% of all Chinese exports to the DPRK. China, however, does not appear to be selling this oil to North Korea at concessionary prices. In 2008, the average price for Chinese exports of crude oil to North Korea was $0.78 per kilogram, while it was $0.71 for such exports to the United States, $0.66 for South Korea, $0.81 for Japan, and $0.50 for Thailand.

China also provides aid directly to Pyongyang. By bypassing the United Nations, China is able to use its assistance to pursue its own political goals independently of the goals of other countries. It is widely believed that Chinese food aid is channeled to the military. This allows the World Food Program's food aid to be targeted at the general population without risk that the military-first policy or regime stability would be undermined by foreign aid policies of other countries.

In November 2003, China reportedly transferred responsibility for securing its border with North Korea from the police to its army. Many of China's two million ethnic Koreans live along this border, and it is a favorite crossing point for refugees from North Korea. In 2006, China built a 20-kilometer long fence along its border with North Korea. It is located primarily along areas where the Yalu River dividing the two countries is narrow and the river banks low. Much of China's trade with the DPRK goes through the port of Dandong on the Yalu River. In 2002, 40% of Chinese exports to and 11% of its imports from North Korea passed through Dandong.

China's major imports from North Korea include mineral ores, mineral fuels (coal), woven apparel, fish and seafood, iron and steel, and wood. China's major exports to North Korea include mineral fuels and oil, meat, electrical machinery, machinery, plastic, man-made filament, vehicles, and iron and steel. (See section of this report on foreign investments for activity by Chinese firms in the DPRK.)

Japan-DPRK Economic Relations

Japan's economic relations with North Korea have declined sharply as tension over Pyongyang's nuclear and missile programs has spiked, and there has been no resolution of the Japanese abducted by North Korea's intelligence agency. North Korea's May 2009 test of a nuclear device reinforced existing trends in DPRK-Japan economic relations. Trade and investment flows have virtually stopped.

After North Korea test launched several missiles in July 2006 and then detonated a nuclear device in October 2006, Japan imposed strict unilateral sanctions, causing bilateral trade to plummet. Japan banned imports and most North Korean nationals from entering Japan, prohibited all North Korean ships from entering Japanese ports, and outlawed the export of "luxury goods" to North Korea, including caviar, jewelry, liquor, and any food known to be favored by North Korean leader Kim Jong-il. Tokyo has also ceased sending any humanitarian aid to North Korea, and has refused to provide economic or energy assistance until their concerns with Pyongyang are resolved.

This pattern is a reversal of earlier economic relations. Although Japan and North Korea have never established official diplomatic relations, the two nations maintained significant economic ties for well over a decade. From the end of the Cold War, Japan was second only to China among North Korea's top trading partners. Bilateral trade declined considerably in the 1980s, but the drop was attributed primarily to the steep overall downturn of the North Korean economy as much as the state of bilateral relations. Before relations deteriorated, Japanese leaders made several efforts to normalize relations with North Korea, promising considerable economic assistance to the country. Since 2002, however, North Korea's provocative missile and nuclear device tests, along with the issue of Japanese citizens kidnapped by North Korean agents in the 1970s and 1980s, has stalled any further diplomatic progress and retarded economic relations. From 2001-2005, Japan's share of North Korean trade declined as China, South Korea, and Russia expanded trade with Pyongyang.

As indicated in Table 11 , by 2008, total trade between Japan and the DPRK had fallen to $8 million from $1,290 million in 2001. In 2007, Japan had no imports from the DPRK and reported exports of $8 million.

Before Japan stopped importing from North Korea, seafood made up almost half of the North's exports to Japan, followed by electrical machinery, aluminum and articles thereof, mineral fuels, and apparel. North Korean clams and matsutake mushrooms are particularly prized in the Japanese market. Japan sent items such as vehicles, electrical machinery, boilers/reactors, manmade filaments, wool, and articles of iron or steel to North Korea. Some Japanese lawmakers have argued that Japan should expand the ban on imports from North Korea to cover exports as well.

Japan's food aid to North Korea has also dwindled as relations soured. The pattern of Japanese aid reflects developments in the political relationship between Tokyo and Pyongyang: shipments began in 1995 and 1996 when relations warmed, were temporarily suspended periodically as tensions mounted, and eventually ceased altogether in late 2004 because of disagreement over the abduction issue. Between 1995 and 2004, Japan provided 1.2 million metric tons of humanitarian food aid to North Korea, mostly through the United Nations World Food Program.

A group of pro-Pyongyang ethnic Koreans living in Japan known as the Chosen Soren (Chongryun in Korean) in the past provided North Korea with additional funds in the form of cash remittances and, possibly, facilitated illicit trade such as drug trafficking and counterfeiting. Although the exact amount of remittances is unknown, the total appeared to be in the neighborhood of $100 million per year but declined sharply since the early 1990s. A series of scandals involving ethnic Korean banks in Japan revealed that money was illegally channeled to North Korea through the network of Chosen Soren-affiliated credit unions. Following the missile tests in 2006, Japan froze fund transfers and overseas remittances by 15 groups and one individual suspected of links to North Korean weapons programs, and established rules that require financial institutions to report to the Japanese government remittances overseas of more than 300 million yen.

Russia-DPRK Economic Relations

Russian reforms and the end of the Cold War greatly reduced the priority of the DPRK in the strategy of Russian foreign policy. Following Soviet support of North Korea in the Korean War, the USSR provided assistance to Pyongyang that helped equip its military and create its heavy industrial sector. In 1998, at the peak of the bilateral relationship, about 60% of North Korea's trade was with the Soviet Union. Much of the trade was in raw materials and petroleum that Moscow provided to Pyongyang at concessional prices. Relations between the two cooled in the 1990s as Russia recognized South Korea, announced that trade with North Korea was to be conducted in hard currencies, and opted out of its bilateral defense agreement.

Recently, overall relations between Russia and North Korea have been improving. Russia is upgrading its railway connections with the DPRK and has been participating in an ambitious plan to build a trans-Korean railway. As is the case with China and South Korea, Russia is critical to North Korean security, since Russia shares a border with the DPRK, and Russian cooperation would be necessary to enforce any security guarantee. As fuel aid from abroad has decreased, moreover, North Korea has turned again toward Russia as a source of supply.

An observer of Russia-DPRK relations views Russian policy toward North Korea as an important component of Moscow's general strategy toward what it considers the critically important Asia-Pacific region. Russia's strategic course includes a calculating and pragmatic approach toward North Korea and the Korean Peninsula in general. Moscow has gained unique and exclusive communications capabilities with Pyongyang based on the development of trust between the leadership of the two states at the highest political levels.

This observer also points out that the perspective of Russia on the North Korea nuclear issue does not fully coincide with that of the United States. While Moscow has insisted on a denuclearized Korean peninsula and the irreversible dismantlement of North Korea's nuclear weapons and nuclear development programs, it also firmly supports the peaceful resolution of the issue. Russia is a participant in the Six-Party Talks. Moscow apparently has concluded that the Kim Jong-il regime does not face impending collapse, and therefore, outside pressure and economic sanctions intended to bring about regime change work only to increase tensions and the probability of a military confrontation. Russia also does not favor a Korean Peninsula unified by military force with American help. This would put U.S. forces on the Russia-Korean border. Rather, Russia supports a unified Korea that would maintain friendly relations with all countries, including Russia, and opposes foreign interference in the unification process.

As is the case with China, Russia also is concerned that economic hardships in the DPRK push refugees across the border into Russian territory. Moscow also supported U.N. Security Council Resolutions in 2006 that condemned North Korea's missile and nuclear tests. This has cooled the relationship to some extent. Russia also condemned the May 2009 nuclear test and supported U.N. Security Council Resolution 1874.

The DPRK's trade with Russian lags behind what it has been in the past. In 2008, North Korea ranked 107 th among Russia's sources of imports (below Jamaica and Ghana) and 92 nd in terms of markets for Russian exports (below the Virgin Islands and Gibraltar). The increasing volume of Russian mineral fuel exports to the DPRK has moved Russia past Japan, Germany, and Thailand to become North Korea's third largest trading partner.

Major Russian exports to the DPRK include mineral fuels, wood pulp, machinery, non-rail vehicles, iron and steel, and wood. Russian exports of mineral fuels have been declining from a peak of $224.4 million in 2005 to $73.5 million in 2007 and $41.6 million in 2008. Major Russian imports from North Korea include machinery, electrical machinery, glass, and plastics.

In December 2006, Russia reportedly agreed to write off some 80% of the $8 billion in debt owed it by the DPRK. North Korea had borrowed the funds in the 1960s to build power plants. This opened the way for Russia to engage in more economic cooperation with the DPRK.

Possible Economic Incentives

Normalizing Diplomatic Relations

Normalization of diplomatic relations with the DPRK would apply to the United States, Japan, and South Korea. North Korea already has diplomatic relations with China, Russia, and the European Union (including an embassy in London). Associated with normalizing relations would be a peace treaty formally ending the Korean War. For Japan, the DPRK would have to resolve certain issues, including a full accounting of the status of kidnapped Japanese citizens, North Korea's missile firings over Japan, and incursions by suspected DPRK espionage and drug-running ships into Japanese waters. Upon conclusion of these normalization talks, Japan is likely to offer $5 billion to $10 billion to North Korea in compensation for its occupation.

Normalizing diplomatic relations allows countries to communicate with each other in a more direct fashion, enables diplomats to gather information directly, and provides more interaction on a personal level. Normalized relations can help to overcome the Pyongyang propaganda machine both within the DPRK and on the world stage. Normalization, however, can imply that the United States is willing to tolerate conditions in North Korea. This may be unacceptable to some. Absent normalized relations, Washington could seek a relationship similar to that with Cuba. Even without diplomatic ties, the U.S. mission in Havana is attached to that of Switzerland and maintains a staff similar in size to a regular embassy. (North Korea has been a member of the United Nations since 1991 and has representatives in New York.) Japan has initiated talks with Pyongyang that could lead to normalized relations, and South Korea has been seeking diplomatic ties and possibly some form of reunification in the future. In 2007, bilateral talks between Japan and the DPRK on normalization were stymied by the abduction issue, but they have resumed in 2008.

Negotiating a Trade Agreement

After normalization, the United States could negotiate a trade agreement with the DPRK that would cover goods, services, and investments and could be modeled after the 2001 bilateral trade agreement concluded between the United States and the Socialist Republic of Vietnam. Upon implementation of the trade agreement, each country would accord the other normal trade relations (most favored nation) status. The immediate effect would be to allow North Korean exports to the United States to enter at the lower rates of duty accorded to nearly all other nations of the world. The trade agreement also could cover investment and other U.S. interests.

Although the DPRK's market currently is small, eventually it could re-industrialize and become a larger economic player in the region. Liberalization of North Korean trade and investment relations, moreover, can work through the economy in the same way that it did in China and Russia by exposing the public to the benefits of increased wealth. The major negative to establishing trade with North Korea is that, unless it is part of a larger package that includes other concessions, the United States could be viewed as exchanging an important bargaining chip for minimal gain.

Easing U.S. Sanctions

The United States could ease economic sanctions on North Korea if the country resolves the issues that caused the sanctions to be imposed initially. Since North Korea's other trading partners have more liberal trade with North Korea, it is mainly American companies and traders that are impacted by the sanctions. Pyongyang can spend its available foreign exchange in any of a number of world markets—in China, Russia, Europe, Southeast Asia, or elsewhere. Moreover, as North Korea opens its economy, U.S. businesses would be able to decide whether or not to invest there based on their own economic interests and not because they are hindered from doing so by U.S. law.

Allowing the DPRK to Join International Financial Institutions (IFIs)

The United States could stop blocking the DPRK from joining the major IFIs, particularly the Asian Development Bank, World Bank, and International Monetary Fund. Pyongyang is particularly interested in joining the Asian Development Bank, but IFI procedures require membership first in the International Monetary Fund. The IMF requires certain economic data which the World Bank or Asian Development Bank needs to evaluate projects and loan requests. Membership in IFIs requires that a country establish data gathering and reporting mechanisms as well as open their country to visits, surveys, or assessments by the IFI. As an incentive, a special fund could be set up in the World Bank or Asian Development Bank to assist North Korea in its economic transition. This fund could be financed by Japan or South Korea in conjunction with their normalization of relations with the DPRK.

Fuel and Food Aid

The Bush administration resumed shipping fuel and food aid on a humanitarian basis to the DPRK. South Korea also has resumed shipments of fuel, but it has insisted that food and fertilizer aid be sent only if requested by North Korea.

Products from the Kaesong Industrial Complex

When South Korea was negotiating the proposed Korea-U.S. Free Trade Agreement (signed but not yet approved by Congress), they asked that products from the Kaesong Industrial Complex in North Korea be included under the FTA and be accorded duty-free entry into the United States. The resulting FTA language, however, does not provide for duty-free entry into the United States for products made in Kaesong. Annex 22-B to the proposed FTA, however, does provide for a Committee on Outward Processing Zones (OPZ) to be formed and to designate zones (such as the Kaesong Industrial Complex) to receive preferential treatment under the FTA. Such a designation apparently would require legislative approval by both countries.