This briefing comes from Korea View, a weekly newsletter published by the Korea Economic Institute. Korea View aims to cover developments that reveal trends on the Korean Peninsula but receive little attention in the United States. If you would like to sign up, please find the online form here.

U.S. restriction on Huawei could be a boon to Korea’s struggling export industry, but potential gains may be erased by China’s retaliatory measures.

What Happened

• The Commerce Department added Huawei to its list of persons and entities deemed to be acting against U.S. security or foreign policy interests. This discourages U.S. companies from selling or transferring technology to Huawei.
• Analysts suggest that Huawei could increase purchases of Samsung memory chips to substitute gaps in the supply chain created by the U.S. government’s decision.
• Samsung is also expected to increase its global sales of handsets and 5G network equipment as other countries avoid purchasing Huawei products.
• Meanwhile, U.S. government officials are reportedly calling on South Korea to restrict the activities of Korean companies that use Huawei equipment.
• China is preparing its own list of “unreliable companies,” which would include entities that disrupt supplies to Chinese companies for “non-commercial purposes.”

Implications: Although many market commentators see the U.S. government’s restrictions on Huawei as an opportunity for Samsung specifically and South Korea more generally, Korea’s export sector remains vulnerable to retaliatory measures from both the United States and China. Huawei’s search for new chipmakers to substitute U.S. suppliers could boost sales for Korean companies, but Washington may pressure Seoul to limit these transactions. The U.S. government did not officially request that South Korea join its restriction on technology sales to Huawei. Nonetheless, a U.S. State Department official reportedly called on a South Korean counterpart to prohibit LG Uplus, which uses Huawei’s equipment, from participating in “sensitive areas” of the Korean economy. Seoul is still negotiating with the U.S. government on key issues like auto tariffs and cost sharing for U.S. forces in South Korea. In an effort to minimize friction with U.S. counterparts while these talks continue, Seoul may voluntarily take measures to limit trade with China.

South Korea is however vulnerable to potential retaliation from China as well. Beijing could respond to measures limiting business ties between Korean companies and Huawei by strategically punishing Korean firms with significant exposure to the China market.

This comes as Korea’s export sector is under duress. Between May 2018 and May 2019, export shipments dropped 9.4%, exceeding forecasts of a 6.6% decline. Semiconductor exports in particular plunged by roughly 30%. China is South Korea’s largest trading partner, accounting for 26.8% of the country’s exports in 2018 (compared with 12% for the United States). Both the potential retaliatory measures by the Chinese government and any voluntary measures to limit exports to China by the South Korean government present major headwinds for the Korean economy at this time.

Context: There is precedent for South Korea voluntarily restricting trade to advance its foreign policy interests. In response to growing U.S.-Iran tensions earlier this year, South Korea cut its oil imports from Iran ahead of any explicit reimposition of sanctions by the U.S. government. In 1992, Seoul severed ties with Taiwan to establish official diplomatic relations with the People’s Republic of China. As a consequence, Taipei nullified preferential agreements on Korean export of foodstuffs and autos. In both instances, however, the economic cost was considerably smaller than what South Korea is facing today.

Korea View is edited by Yong Kwon with the help of Haram Chung, Yea Ji Nam, Steven Lim, and Haeju Lee.

Photo from Kārlis Dambrāns’ photostream on flickr Creative Commons. 

By Robert R. King

On April 25, for the first time in the nine years that he has been Supreme Leader of North Korea, Kim Jong-un met face-to-face with Russian President Vladimir Putin in the Russian Far Eastern city of Vladivostok.  The principal focus of the meeting was the failed Hanoi summit between U.S. President Donald Trump and the North Korean leader.  Both Russian and North Korean media provided extensive coverage of the meeting, and in a press event after the meeting, Putin gave his own readout of the just-concluded meeting with Kim Jong-un.

That Putin media event did not have the rugby-scrum atmosphere of a Trump “press availability” as the American President walks from the White House to Marine One, with helicopter blades noisily whirring in the background and journalists shouting questions above the din.  The Russian President responded to formal polite questions from respectful journalists with carefully weighed answers.  The focus of the questions to Putin involved North Korean-United States issues as well as North Korea-Russian security issues.

One of the more interesting questions was from a Russian journalist who raised with Putin the issue of North Korean laborers in Russia.  In his response,the Russian President acknowledged that it was one of the topics he discussed with Kim Jong-un.  This is the text of the exchange with Putin.

Question: “Has the topic of North Koreans who work in Russia been raised during the talks? They are supposed to leave our country, but they do not want to. Thank you.”

Putin responded:  “Yes, we talked about this. There are several different options here. There are humanitarian issues, and there are issues related to the exercising of these people’s rights. There are smooth, non-confrontational solutions. I must say that the Koreans work well for us, never giving the local authorities any trouble. They are very hardworking people, law-abiding and disciplined. We discussed it.”

North Korean Workers and UN Sanctions

North Korean laborers in Russia (also in China and elsewhere) are a serious issue related to the United Nations Security Council’s sanctions on North Korea because of its nuclear and missile programs.  The United States government said North Korea was earning more than $500 million annually from an estimated 100,000 North Koreans working abroad in a number of countries, and that 50,000 North Koreans were working in China and 30,000 in Russia.  The UN Security Council sanctions (UNSC Resolution 2397, Paragraph 8) include a ban on all North Korean labor exports with deadlines for eliminating all North Korean foreign labor by the end of 2019.

In March 2019, the government of Russia informed the UN Security Council that it had sent back nearly two-thirds of the North Korean workers in Russia.  North Koreans with valid Russian work permits dropped from 30,023 to 11,490 according to Russian officials.  At the same time, China informed the Council that more than half of the North Korean workers in China had returned, though it did not give a number of total workers or the number who returned to the North.  (There have been some press reports, however, that new groups ofNorth Korean workers are going to China.)

These Russian and Chinese statements were submitted to the United Nations, but they were not formally made public. However, Reuters and other news media were shown the one-page reports from each country giving this information.The Moscow Times also published a similar report with the Russian figures.Consistent with UN sanctions requirements, a number of other countries who had North Korean workers in the past have ended the practice.  Mongolia, for example, sent the last 1,200 North Korean workers in Mongolia back to North Korea in December 2017.

In July 2018, the U.S. Departments of State, Treasury, and Homeland Security issued a notice regarding the serious risk for businesses with supply chain links to North Korea and warned against products from countries using North Korean labor.  The industries affected included apparel, construction, footwear, hospitality, IT services, logging, medical, pharmaceuticals, restaurant, seafood processing, textiles, and shipbuilding.  The United States listed 46 countries where North Korean labor was employed, although the notice said that China and Russia had more North Korean workers than all other countries combined.

Benefits for Moscow

For Moscow, there are distinct economic benefits to using North Korean workers.  First, North Korean workers are close to a large, resource rich area of Russia which is sparsely populated.  The Far Eastern Federal District, one of the eight Federal Districts of Russia, comprises 40 percent of the entire territory of country, and its 2.7 million square mile area, which is more than two-thirds the size of the entire United States (including Alaska).  TheFar Eastern Federal District extends from Lake Baikal in the center of Russia to the Pacific Ocean only a few miles from Alaska across the Bearing Strait.

This huge territory, however, has a population of only 8.4 million people.  Tiny North Korea alone has a population of 25 million people living in a territory equal to less than 2% of the land mass of Russia’s Far Eastern Federal District.  Russia needs labor to develop and exploit the extensive timber and other natural resources of this vast area.

Another important benefit to Russia of using North Korean workers is that they are relatively cheap.  The Russian Ambassador to North Korea, Alexander Matsegora, told reporters that Chinese laborers would be unwilling to take construction jobs in Russia’s Far East which are filled by North Koreans because the pay is too low to be attractive to the Chinese.  Furthermore, the Russian government would prefer to have non-Chinese workers in its Far East.  In the past, China, with its population of 1.4 billion people, has made claims against sparsely populated Russian controlled territory in East Asia.

Russia and other countries who host North Korean workers, have found these workers to be a disciplined work force, controlled and managed by their minders from home.  One Russian in Vladivostok enthusiastically expressed it this way, “They do nothing but work from morning until late at night.”  Russians are happy to employ North Koreans for household repair and painting or building a sports stadium.  Putin, as noted in his recent press conference said “the Koreans work well for us, never giving the local authorities any trouble.  They are very hardworking people, law-abiding and disciplined.”

Benefits for Pyongyang

There is a financial benefit to North Korea from the employment of its workers abroad.  Koreans working abroad are under strict control with party and government supervisors who monitor them.  The individual workers are not paid directly, but through the North Korean managers.  Under this system, a major portion of the wages goes to Pyongyang and a significant portion is also taken by the North Korean work unit managers and the supervisors in Pyongyang.  Earnings remaining for North Korean workers are reduced for payments to the Workers’ Party, and other donations are made to a loyalty fund.

United States officials have estimated that the North Korean take from all of these foreign workers around the world is as much as $500 million.  While that estimate may be excessive, there is little question that the cash benefit to the government of foreign workers is important—probably increasingly important as North Korean trade has declined and import costs have risen as a result of UN sanctions.

North Korean workers abroad are provided food and lodging as part of the effort to control the workers.  What is left as direct pay to the workers is only a small part of what the host country pays for their services, but workers can take home most of the modest earnings they are paid.  Even with this small take-home pay, most North Koreans who work abroad for the average two-year stint are able to accumulate a significant nest egg by North Korean standards.

Living and working conditions for North Koreans abroad are not good—particularly by international standards.  Working abroad does involve human rights abuse, and accounts of living conditions of North Koreans working abroad indicate conditions are very difficult.  Some attention was given to difficult working conditions for North Koreans in Russia in connection with their work on the Zenit Arena in St. Petersburg, which was used for 2018 World Cup games hosted by Russia.  But for North Korean workers accustomed to draconian working and living conditions at home, working abroad actually is attractive.

When North Koreans work abroad, they are not permitted to bring family members with them.  Wives and children remain in North Korea, held hostage to be certain the workers do not “defect.”  It also makes it easier to control workers abroad by threatening harm to family members.  Life is difficult for workers who go abroad, but also for their family members who remain behind.

Despite the difficult and abusive conditions for North Koreans working in Russia, reports indicate that would-be foreign laborers pay hefty bribes for the privilege of working there.  Andrei Lankov, Russian-born Korea specialist and professor at Kookmin University in Seoul, has discussed this phenomenon of North Koreans eager to work abroad.  Lankov is correct—when the alternative to work abroad is working under draconian conditions inside North Korea for lower wages, workers are eager to go abroad.

Working conditions, long hours, and low pay for North Koreans abroad are difficult, particularly in comparison to conditions and pay for workers of countries where they are sent.  In comparison with labor standards, conditions, and wages elsewhere, North Korean workers suffer rights abuse.  At the same time, compared to what they would earn and the conditions they would face if they remain in North Korea, there are benefits that make working abroad a sought-after alternative for many North Koreans.

Will Russia Observe its Commitment on North Korea Sanctions?

Despite the advantage for Russia of using North Korean labor and the desire of North Korea to continue the practice, the UN Security Council sanctions are quite explicit in requiring an end to use of North Korean foreign labor.  Russia and China—as well as the United States, France, the United Kingdom, and other UN member states—have an obligation to observe UN Security Council sanctions.  Russia and China have publicly stated to the United Nations that they are reducing the numbers of North Korean workers, and they intend to end the practice by December 2019.

Vladimir Putin’s response to the Russian journalist’s query in Vladivostok, however, indicated that North Korean laborers in Russia is an issue that received significant attention in his meeting with Kim Jong-un.  The Russians have been moving to reduce the number of North Korean workers, but Putin’s comments that “there are several options here” and “there are humanitarian issues. . . and these people’s rights,” suggests a possible softening of the Russian position on sanctions against employment of North Korean workers.

The fact that Kim Jong-un raised the foreign worker issue in Vladivostok makes it clear that the UN sanctions involving foreign workers are having an impact in Pyongyang.  The real question is whether Kim Jong-un’s appeal to Putin will lead Russia to backtrack from its United Nations sanctions commitment.

Robert R. King is a Non-Resident Fellow at the Korea Economic Institute of America. He is former U.S. Special Envoy for North Korea Human Rights.  The views expressed here are his own.  

Photo from the website of the President of the Russian Federation.

By William Brown

Many Asia specialists in Washington and elsewhere continue to think UN sanctions against North Korea are slipping and that without new resolutions or U.S. executive actions it is only a matter of time before economic pressure on the regime will ease up.  This may be true and there is evidence of North Korean and Chinese firms adjusting and quickly shifting production and trade to the few categories yet unsanctioned. Anecdotes of smuggling—which naturally increase as legal trade falls off—are also widespread. But much of this misses the point. Not all trade has or will stop, and no one ever suggested that it should or could.  For a country that trades so little anyway, and prides itself on its self-reliance, the trade that it does undertake is vital and even a small decline can be devastating, let alone something like the 50 percent drop in trade with China last year. Meanwhile, official data continue to indicate that extremely tough limits on trade remain in place by virtually all UN members.  Political leaders in the most relevant countries, China, Russia, South Korea, Japan, and the EU continue to show no willingness to ease up despite pleas by Kim Jong-un to make at least humanitarian exceptions. And Kim’s summits with the leaders of China, South Korea, Russia, and the United States just in the last year have raised Kim’s profile but have not gained him what he needs most, money.

Significant questions remain, nonetheless, about the exact impact of the trade actions on the economy and the livelihood of the people, especially as the UN Food and Agricultural Organization reports increased food shortages and hunger after a weak 2018 harvest and sharply reduced foreign aid, and as Kim shifts his public stance from prosperity to self-reliance.  A close look at Chinese trade patterns in recent quarters, discussed below, helps but does not answer all the questions. The food shortages, in particular, would seem to have little or nothing to do with trade sanctions but a general slowdown or decline in the economy, caused by the regime’s likely extremely tight monetary policy, may be hurting overall employment and business conditions. Observed price drops for rice and corn may not, in these circumstances, be evidence of plentiful food conditions.The food situation in particular thus will bear close examination in months to come.

Continued Depressed North Korea-China Trade

Despite a slight rebound in March from historic February lows, China’s trade with North Korea remains at very depressed levels, this according to official Chinese customs data released last week. UN sanctions are keeping imports from North Korea at minimal levels, only $54.6 million in the first quarter, about flat over the past four quarters and down from a quarterly average of about $600 million prior to 2018.[i] Fewer sanctions have been levied on sales to North Korea but these, and a loss of North Korean buying power, reduced Chinese exports to only $455 million, about half their pre-2018 quarterly levels.

With two years of data since strong sanctions were imposed by Beijing, year-over-year commodity details can show interesting trends and give hints as to how North Korean industry is responding to what must be regarded an all-out “trade war” between the two countries.  For instance, the largest two-way trade item is now timing devices, presumably since they are not sanctioned,with traders anxious to take advantage of North Korea’s skilled and available workforce and Chinese technology.  China shipped $18.2 million of these timing mechanisms in the first quarter and imported $19.1 million in finished clocks and watches, suggesting significant new job creation for North Korean workers in only a year. With time, more such small-scale manufacturing for export may give a little life to what must be a hard hit North Korean industrial workforce. Footwear is another unsanctioned item that would appear to have large potential.Clearly, though, it will take years for this kind of trade to replace the lost billions in trade in minerals, metals, and textiles trade.

Other Chinese imports are essentially non-consequential, as coal, metals, minerals, most textiles, fish products, and machinery are all embargoed. Ferro-silicon, an alloy used in the steel industry increased somewhat to $7 million in the first quarter, as China apparently classifies it as a non-metal.  Human hair wigs have jumped in value from almost nothing to about $7 million as well, interesting since this is one of the products that launched South Korea’s export drive in the early 1960s. North Korea thus quickly eclipsed the continuing South Korean wig sales to China in the first quarter. Molybdenum and tungsten ores, and electricity, produced in hydro plants along the Yalu River, also provided North Korea with $2-3 million each in the first quarter.

Chinese Imports from North Korea (million U.S. dollars)

The slight first quarter increase in aggregate Chinese exports to North Korea from year-earlier levels hides two important sub trends; a huge drop in capital goods exports—all kinds of machinery and electronic products, industrial parts, and vehicles, all prohibited by sanctions—and a fairly steady if not increasing flow of consumer products including foodstuffs, which are not embargoed.In addition to the jump in watch parts, Chinese sales of synthetic fibers, for instance, rebounded to $27 million, despite the freeze on Chinese imports of textiles suggesting either large scale sanction evasion or domestic, North Korean use of the Chinese products. With crude oil imports capped and refined product imports sharply reduced, North Korea has essentially no working petrochemical industry, and depends on poor quality coal-based materials. Other Chinese consumer goods continue to be exported, suggesting North Korean merchants are importing such products to sell in the markets with little hindrance from the authorities who presumably would prefer to save the foreign exchange.  Imports of Chinese tobacco, for instance, have soared, as have beverages and milled grain products. One might expect private grain imports to increase sharply as well if food shortages become prevalent.

Chinese Exports to North Korea (million U.S. dollars)

Pyongyang’s Response to Sanctions

The absence of official balance of payments data makes it difficult to assess how the $400 million first quarter goods trade deficit with China is being financed.  Trade with other countries is essentially negligible but North Korea likely runs a small services surplus from tourism and from transfer payments from the Korean diaspora and from the forced repatriation of wages of its overseas workers. These may fill about half the gap but UN restrictions on overseas labor are coming into force this year and by December, all North Korean workers are supposed to be sent home.  For the remainder, most likely the country is gradually expending down foreign exchange reserves held by the Kim family, the government itself, and out of the apparently large amounts of foreign cash held by the population and in circulation.

Oddly, despite the trade pressures, the won currency continues to trade in North Korean markets at what appears to be an almost pegged rate to the U.S. dollar and Chinese yuan, this for now five years.

China-North Korea Trade Balance (million U.S. dollars)

In the past, the North Korean regime, like many others facing this dilemma, would have either forcibly stopped foreign exchange trading and taken up all the foreign cash it could find, imposing tight currency controls, or it would let the won depreciate to the point foreign imports were unaffordable and exports highly advantaged. But in this case neither has happened, probably because of lessons learned in 2009 when an abrupt forced change back-fired and people began to resist the taking of their money.  Instead, evidence increasingly points to a reverse policy, one that limits the issuance of won currency and won credit to keep its supply in line with a dwindling dollar supply, and thus the rate between the two currencies steady. The steadiness over five years sharply reduces speculation against the won. And perhaps most importantly, by allowing the public to hold a viable money, either U.S. dollars or Chinese yuan, for the first time in generations the regime is allowing the public to build financial savings, a process that dampens demand and inflation, but which gives them private resources for the future.  But the policy is not costless. By restricting the won money supply, the regime harms its own budget and may have sent the economy into recession, with overall demand slumping, not just for foreign goods but for domestic goods and services as well. This is suggested by numerous stories from inside North Korea of factories closing for lack of demand, and of markets losing participants.  Complaints are not that prices are too high, or that goods are not available, but that no one has enough money to spend. [ii]And, to the limited extent that we can observe, the overall price level seems to be dropping, not rising as one might expect given a foreign exchange shortfall. Rice and corn prices, for example, are at many year lows, despite what foreign observers say was a poor harvest.

At some point presumably Kim will relent and issue more paper currency, hoping the exchange rate will hold or that no one will notice.  Foreign food aid or a reduction in sanctions might provide some, but temporary relief. A viable far reaching but non-socialist solution would be for him to issue more currency, perhaps by raising state salaries, and then to then pull it back in by selling off to private North Korean buyers some of the regime’s huge, but illiquid physical assets .Privatization on that scale occurred in China and in Russia decades ago. Private ownership of more of the country’s “means of production,” for instance the de-collectivization of agriculture, would enhance productivity and set the economy on a growth track, even with the sanctions intact, but much stronger if de-nuclearization occurs and sanctions are ended.  In the meantime, budgetary pressures must be enormous and growing, while tough decisions await resolution.

William Brown is a non-resident scholar at KEIA and teaches at Georgetown University and UMUC.  This and other related postings can be found on his website, NAEIA.com

Photo from Boaz-Guttman’s photostream on flickr Creative Commons.

[i] All trade data is from Global Trade Atlas and other trade data amalgamators which directly obtain official Chinese Customs Bureau data.

By Kyle Ferrier

Following President Trump’s decision to re-impose sanctions on Iran last May, the White House announced last week it will not be extending waivers on sanctions to countries importing Iranian oil. South Korea is one of only eight countries to be have been granted a waiver, which took effect as U.S. secondary sanctions went into force in early November and are now set to expire on May 2. Faced with this inevitability – though it may have come sooner than anticipated – Seoul’s efforts to diversify oil imports so far already suggest U.S. oil producers will play a key role in making up for the blockage of Iranian imports.

Demand for oil in South Korea has been growing in recent years, all of which must be met with imports. Total crude oil imports grew over from $44.3 billion in 2016 to $80.3 billion in 2018, making South Korea the fifth largest oil importing country last year. This demand has continued into 2019 – the volume of oil imports for the first three months this year is higher than it was during the same period last year.

Before the U.S. withdrawal from the Joint Comprehensive Plan of Action last spring, Iran was South Korea’s third largest source of oil. In 2017, Iran’s $7.5 billion in crude oil exports to South Korea were only behind Saudi Arabia’s $17 billion and Kuwait’s $8.3 billion. However, from September to December, 2018, Seoul cut off oil from Iran in response to Trump’s decision to reintroduce sanctions on Tehran. As a result, Iranian exports to South Korea last year only totaled $3.9 billion, dropping it down to the eighth largest provider of oil to South Korea.

Seoul has reopened the spigot since January, but the flow of Iranian oil has been relatively modest. From January to March, South Korea imported $1.2 billion in oil from Iran. The April imports will likely provide the final figure for the year, but, even with numbers suggesting a last big push before the May deadline, it seems unlikely to come close to last year’s total.

During the period of Iran’s diminishing exports, no other county among the largest exporters of oil to South Korea gained as much as the United States. The $4.5 billion in U.S. oil exports to South Korea last year was a 520% jump from 2017. The numbers for 2019 continue to be promising as the $1.8 billion in U.S. oil exports through March already represents an over 360% increase from the same period last year.

U.S. Secretary of State Mike Pompeo’s remarks that the U.S., Saudi Arabia, and the U.A.E will help to offset the losses from Iranian trade further provides reason to be bullish on U.S. oil exports to South Korea, but there also limitations.

Iranian and American crude oil are not perfect substitutes. There are some American sources that produce oil similar to that from Iran, but at a much lower rate. These may also be needed for more domestic consumption in the U.S. in the face of limited oil supply from Mexico and Canada and the now completely cut off supply from Venezuela after new sanctions enacted in in January. That many South Korean refineries are set up to specifically process Iranian oil will also add to the cost of the adjustment.

Still, the growing demand for oil in South Korea and the removal of a major competitor from the field – irrespective of the politics behind the decision – bodes well for American producers, now churning out more oil than any country thanks to the Shale Revolution.

Kyle Ferrier is the Director of Academic Affairs and Research at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Enrico Strocchi’s photostream on flickr Creative Commons.

By Mark Tokola

Reporting on the April 10, 2019 meeting of the Central Committee of the Worker’s Party of Korea, the North Korean state media headline was: “N. Korea must deal a ‘blow’ against hostile forces, Kim Jung-un tells the ruling party.” The Central Committee meeting was held in advance of the 14^th Supreme People’s Assembly (SPA) that was held on April 11. Particular attention was paid to the belligerent headline in the U.S. media because commentators were waiting to see how Kim would react to the failure to reach an agreement with President Trump at the February 27-28 Hanoi Summit.  In context, however, Kim’s remarks were not as alarming as they appeared to be in the headline.

Kim Jong-un’s presentation to the Central Committee was mostly noteworthy for its heavy emphasis on the North Korean economy and for its lack of any direct criticism of the United States.  There were some references to defending the DPRK, but mostly in terms of what North Koreans need to do to advance their own country rather than about the evil intentions of hostile outsiders.

What Kim said about a “telling blow” as reported in the North Korean media beyond the headline was, “[North Korea] should vigorously advance socialist construction…to deal a telling blow to hostile forces who with bloodshot eyes miscalculate that sanctions can bring the DPRK to its knees.”  In other words, the “telling blow” would be that North Korea would be able to confound its enemies by withstanding economic sanctions.

The North Korean media reported that Kim Jong-un in his report to the Central Committee had “made a scientific analysis of the changed international landscape and the peculiarities of the present situation becoming daily acute and clarified the main tenor of the recent DPRK-U.S. summit talks and the Party’s stance towards it.”  Kim’s prescription to deal with the ”peculiarities of the present situation,” is to “more vigorously advance socialist construction by dint of self-supporting national economy… Self-reliance and self-supporting national economy are the bedrock of the existence of our own style socialism.”

Kim’s appeals for more efforts to advance the North Korean economy came close to admitting that it has underperformed in the past, “[there is a need to] put the national economy on a new phase of growth by expanding and reinforcing the foundation of the economy.”  North Korea has “reserved strength…and tremendous potential” — words which imply that its strength is not being exercised and its potential is not being met.  One difference between Kim Jong-un and his predecessors is his willingness to admit that everything is not perfect in North Korea.

What can be drawn from Kim Jong-un’s comments to the Central Committee?  Two main points are: (1) sanctions must be having an effect on the North Korean economy or he wouldn’t be so vociferous about the need to mobilize the country to resist them; and (2) he is continuing to stake his legitimacy on a promise to improve the North Korean economy.  Kim called on “the entire party, the whole country, and all the people [to] courageously wage an all-out, death-defying campaign to bring about a great surge in socialist construction.  Building an economic power is the main political task.”  That doesn’t sound like a man who is satisfied with the way things are going.

Mark Tokola is the Vice President of the Korea Economic Institute of America. The views expressed here are his own.

Photo from user MarsmanRom on Wikimedia Commons.

By William Brown

New data shows North Korea’s imports of agricultural consumer goods from China, generally sold in markets, are holding up well in contrast to plummeting imports of investment goods procured by and for the state. This may be helping Kim control inflation and supports the won but carries ominous implications for the future of his socialist command economy. With a little perseverance, and continued help from China, we might pull him away from nukes and socialism.

The Hanoi summit brings into sharp focus the role of the UN and bilateral sanctions on North Korea, as does the new annual report of the Panel of Experts.  They beg the question. Are sanctions working?  Pundits of all stripes in Washington have differing views; some use the Hanoi Summit walk-away to insist they are not and assert the U.S. should return to “maximum pressure” even without further provocation [CNN commentator Max Boot]. Others see sanctions as valuable but want to trade them incrementally, tit-for-tat, for North Korean denuclearization moves [Washington Post editorial board]. And still others think the sanctions have done their job and want to accept Kim Jung-un’s latest gambit, trading most of them for, another, take-down of the Yongbyon nuclear facility [former negotiator Ambassador Chris Hill].  A common denominator, however, is none of these views seem to look closely at the impact sanctions are having on North Korea’s economy.  Are they bringing useful pressure on Kim and, if so, in what ways? Pressure to do what?  It’s complex and difficult to know but ultimately these are the all-important questions that U.S., South Korean, and UNSC policymakers must address.

Most perplexing is the Panel of Experts report itself. The panel does an outstanding job of ferreting out breeches in the sanction’s regime, especially with respect to “ship-to-ship” imports of petroleum products, allowing, it suggests, North Korea to bring in much more than the 500,000 barrels per-year UN Security Council cap allows. (This is on top of the legally acquired 3,500,000 bbl.[i] of crude oil provided each year as aid from China.) And it gives evidence of member state imports of prohibited North Korean anthracite, with corrupt buyers, even in South Korea, taking advantage of low prices offered by the North Koreans. This is important work and needs to continue, applying political and legal pressures on the violators. But at times the panel seems to be its own worst enemy. Just a week after Kim pleaded for sanctions relief in Hanoi, the Panel, in the first paragraph, declares “These violations render the recent UN sanctions ineffective by flouting the caps on the import of petroleum products and crude oil by the DPRK as well as the coal ban, imposed by the Security Council in response to the country’s unprecedented nuclear and missile testing.“

Are the sanctions thus “ineffective”?  Perhaps it’s just an overstatement in a report focused on a laundry list of interesting smuggling activities; after all the testing has stopped and Kim Jong-un is engaged in unprecedented summitry to get sanctions lifted.  But, inexplicably, nothing in the 300-page paper points to the official UN trade data that shows customs authorities in each member state reporting a near shutdown in imports from North Korea and a severe drop in exports to that state, just in the last eighteen months since the tougher sanctions were imposed. [ii] Data from China is shown above but it is true of all other UN members as well. Almost no trade. No indication in the report is given as to how such official data, if it is to be faulted, should be adjusted to reflect the smuggling and the real world of North Korea’s trade and finance that the Panel has discovered.[iii]

Certainly, there are puzzles that need to be worked out and explained.  Did China really sell only 20trucks to North Korea last year, and no machinery or spare parts, as its customs data say?  And why if indeed the world’s, and especially Chinese, customs officials are not lying on a massive scale, do we not see a commensurate impact on Kim’s economy, especially as we can observe stability in the won-dollar exchange rate and in other key prices?  Wouldn’t a sudden collapse in exports and a smaller drop in imports shock the economy’s price structure and cause panic selling of the won?  Prices of imported goods should soar while prices of exported goods should fall.  Perhaps not in an orthodox communist country, where the government produces and distributes according to plan and money and prices have no real meaning.

In today’s North Korea, however, that explanation holds no water.  It is obvious that Pyongyang no longer runs a communist economy in that orthodox sense and use of money is pervasive. The centralized plan and its fixed price and rationing system is likely working for only a small minority of its people.  It’s now a dual economy, and a partially dollarized one.  The official exchange rate, used to guide the plan, is about 130 won per U.S. dollar but only foreign diplomats pay attention; everyone else uses a market rate of about 8,000 won per dollar.  Typical wages for the millions of state workers are about 3,500 won per month, with rations that are supposed to give them food and other necessities at highly subsidized prices; while market wages for millions of others range around 350,000 won per month, 100 times more, but without the cheap rations, and still are less than $50 a month at market prices.  As the state has had difficulty supplying rationed products over the years, and as the distribution of essentially free food, housing, electricity, education, and medical services has crumbled, state workers, including Workers Party officials and the military are privatizing their work activities in a slow but steady erosion of the socialist state.

In this odd mix of an economy, with liberal use of U.S. dollars and market forces operating side-by-side a fixed-price rationed economy, run by the state, Kim Jong-un early in his administration was able to get inflation under control and stabilize the won, pegging it at close to an 8,000 won-to-dollar rate, something his father was never able to do.[iv]  Bringing this monetary stability is no doubt a remarkable achievement, especially over the course of the last two years as Chinese sanctions began to bite, cutting off virtually all the country’s exports and presumably causing an outflow of dollars needed to pay for essential imports.  Even if the trade data is drastically falsified, widespread publicity over Chinese official actions to halt purchases of North Korean products should have been enough to cause a run on the won, or one would think.

There are several possible explanations, but for me only one makes a lot of sense.  It is in accord with standard macroeconomic theory and is not novel but, for Pyongyang, may be embarrassingly capitalistic in nature.  I suspect that won stability and suppression of inflation is maintained by severely curbing won credit and printing of won currency–what we in the U.S. would call an extremely tight Federal Reserve policy aimed at protecting the dollar and stopping inflation yet carrying a high risk of recession.  A shortage of won, both cash and credit, thus keeps it valuable relative to equally short U.S. dollars. If dollars leave to buy imports from China, won loans have to be called in from the state enterprises, which then must make do by trying to sell some of their products privately, rather than contributing them to the plan; by squeezing worker pay; and by foregoing investment and maintenance.   And the authorities, by employing a pegged mechanism, which they must defend by selling dollars and buying won as needed to stymie outbursts of speculation, over time they build public credibility and market interventions become less necessary.  This, by itself, might not protect the won, given the interest rate tool is generally not available in the socialist system, but, ironically, the wide availability of U.S. currency gives even the average North Korean citizen a sound financial savings vehicle, perhaps stored under mattresses, taking money out of circulation.  I expect, if it could be measured, we would see private savings soaring in the last few years, taking out inflation with it. Such real savings are great for the public, offering some recourse against a vile government that in theory doesn’t allow private ownership of capital, but must be concerning to the state which must feel it is losing economic and even social control.

The system is thus not too dissimilar from Hong Kong’s currency board mechanism, which employs a dollar peg supported by a monetary policy that allows an increase in the HK dollar money supply only as U.S. dollar reserves are increased.  If Hong Kong’s current or capital account falls into deficit, its money supply contracts automatically, interest rates rise, government spending falls, and imports plummet, resolving the imbalance all without a change in the exchange rate. I expect it is the same in Kim’s brave new North Korea, ironically mimicking one of the most liberal monetary systems imaginable.

The implications for the domestic economy of such a policy should be profound, especially given the state still directly or indirectly employs probably half the labor force.  Most importantly, the inability to print currency or extend credit puts pressure on a state budget that has long been a meaningless accounting exercise.  An analogy might be made to a U.S. state, which after a long bout of borrowing finds it can no longer roll over its debts.  Unable to create money in our federated system, the state then must slash expenditures or raise taxes, establishing a surplus that it can use to repay debt.

Direct evidence of such budget tension is hard to come by but given our incomplete understanding of the country’s finance, this should not be a surprise.  Several recent hints have cast some light and suggest that Kim’s government is feeling a growing budget constraint of this kind, the indirect result of the current account deficit and thus of sanctions.  Citizens interviewed by Daily North Korea, for instance, increasingly complain of a lack of money in the system, not increased prices. Apartment lease prices are said to be falling.  And everywhere they complain about regime efforts to raise fees and collect more cash, either dollars or won.  Citizens can now pay cash to get out of all kinds of normal socialist system community work requirements, and even from military conscription.  Electricity meters are being installed in some apartments, suggesting an end to virtually free (and famously unreliable) power supply. And now we see complaints from a New York based North Korean diplomat who says food rations are being cut in half.  Aid agencies are arguing this is the result of a weak harvest, but I find this a bit disingenuous. Market prices for rice and corn have been falling in recent months, an indication of deflation caused by tight money rather than rising as one would expect if a poor harvest was to blame. In depressed conditions, falling prices could occur even with decreased supply, but the inferior corn staple seems to have fallen more than rice, suggesting people are willing to trade calories for taste, a good sign. The more important point is that these markets are for ordinary people who procure grain privately and whose state provided rations long ago disappeared. A cut in food rations in 2019 thus probably means a cut for state employees, not the general public, and suggests the regime is unwilling or unable to purchase adequate grain from the collective farms, given its new budget constraints.

Budget issues also may also be showing up in trade data.  The country’s exports have been hardest hit by sanctions but, with a lag, imports are now falling as well, down 33 percent in 2018 from China and down 5 percent in January from January a year ago.  As shown in the table below,  imports from China since 2017 by two aggregate commodity groups, agricultural and similar products sold to consumers in markets, and machinery and transportation equipment, the “means of production”, items purchased by state enterprises and the government itself.[v]  The former have held up well, increasingly steadily during the sanction’s era and even last year.  But the latter have been decimated; a combination of general UN sanctions on exports of such goods to North Korea and, likely, a decline in foreign exchange available to make such purchases.  This indicates the state’s budget for capital equipment is likely being slashed to the core, spelling big trouble for Kim’s economic growth program while alleviating short term pressure on the won and on prices. But the commodity detail shows not only are investment goods slashed. Imports of intermediate production goods, such as spare parts for complex machinery, have been eliminated as well, squeezing to the bone enterprise managers called upon by Kim to increase output.

On his long train ride home from Hanoi, Kim is said by his deputy foreign minister to have grossed over why he even bothered to take the trip, given he got no relief from the sanctions.  He reached out, gambling perhaps, that the smaller deals discussed in negotiations would not provide anything in the way of real relief for his budget problems, and asked for removal of virtually all economic sanctions.  But he got nothing, and domestic pressures are sure to rise as a result.  This is budget time in Pyongyang and the state, probably the hapless premier, will soon roll out its 2019 budget, always in the past a dull affair, rubber stamped by the hand-picked legislature and amazingly devoid of numbers.  But this year, at least behind the scenes, I suspect it might be a little different.

Sanctions look to me like they are biting.  But they should not be forever.  Our question is can they be wiggled like a wrench back and forth to get what we need from Kim, not only on nuclear issues but economic reforms as well.

William Brown is a non-resident scholar at KEIA and teaches at Georgetown University and UMUC.  This and other related postings can be found on his website, NAEIA.com

Graphics by Juni Kim, Program Manager at KEI.

UN image from zhrefch’s photostream on flickr Creative Commons.

[i] China is assumed to provide 500,000 tons of crude oil a year by pipeline on a long-term zero-interest loan agreement, which Pyongyang never repays. This corresponds to about 3,500,000 million bbl. for Daqing quality crude, as we assume to be the case. North Korea is able to refine the crude into about an equivalent mix of petroleum products.

[ii] See Global Trade Atlas or any trade data aggregator, or the UN’s own data.

[iii] One of the largest inflows citied is from cybercurrency hacking. …

[iv] Some argue the won is pegged to RMB, not the dollar, but since the dollar and RMB have been relatively stable against each other, it hasn’t made much difference. Large transactions are usually made in dollars, market transactions in RMB.  Government transactions are likely still largely in won.

[v] Cell phones also are included as machinery in the antiquated UN trade nomenclature, and these were large until officially falling to zero, last year.

By William B. Brown

North Korea’s won has slipped ever so slightly against the dollar in recent weeks. This is not surprising given the dollar’s worldwide strength but presents an interesting conundrum for the Chosun central bank. It no doubt knows that pegged currencies could break suddenly when a small divergence, a wiggle, catches the public’s attention. Any signs of the country running out of reserves could lead to people dumping the local money in a panic to exchange for safer assets. A self-sustaining downward spiral can occur, eviscerating the currency and causing all kinds of social instability.

North Korea Daily reports the dollar traded at 8,500 won in Pyongyang on 26 December, up from a steady 8,000 won through the middle of the year, a devaluation of 6 percent.

Against the globally weaker yuan, won has been more volatile, but without the trend decline.

An incipient currency crisis began in North Korea in 2009 and stopped only with the execution of the party finance chief and a very rare Worker’s Party apology.  Since then, financial authorities under Kim Jong-un have done an extraordinary job keeping the won stable. Despite the extremely tough sanctions against the economy, free circulation of competing assets – the U.S. dollar and the Chinese yuan – helped moderate the won’s volatility.

The gap between U.S. dollar/yuan exchange rate as measured by their value in the North Korean market (cross rate) and the actual exchange rate value in overseas markets did grow in 2018, indicating the potential for corrosive arbitrage behavior.

But the cross rate implied by the won for dollars and yuan is now exactly consistent with the overseas dollar/yuan rate. This suggests a remarkably free-flowing foreign exchange market in North Korea despite its socialist underpinnings.

Parsimonious printing of notes and limited credit expansion probably contributed to the won’s steadiness as well, although a tight monetary policy adds its own stresses to the state’s economy.

So, the question on every North Korean’s mind, and especially on Kim’s as he travels to Beijing, must be, how long this can last.

One is hesitant to guess what caused the recent dollar uptick, either market forces surrounding the strong dollar overseas or the continuing drain on the country’s foreign exchange exhibited by the huge drop in its exports due to sanctions.  Chinese merchandise trade data suggest a $200 million monthly outflow for most of 2018, unlikely offset by significant services or remittances inflows.

Recent commodity-by-country trade data released by China (with a six-month delay) reveal the conspicuous absence of exports of electrical and non-electrical machinery, and vehicles to North Korea. This may suggest that the country is running out of foreign exchange and can’t afford any investment related purchases.

Alternatively, the authorities may be trying to inoculate the market so that participants do not expect a firm peg. This ensures that future movements are not seen as policy failures or an impending crisis. If this is the case, we should see the dollar fall back to the 8,000 won level quickly as the central bank intervenes and spends dollars for won repurchases.

Another guess, expressed recently by some scholars, is that the won is actually more closely tied to yuan; therefore, the yuan’s decline against the dollar automatically made for the won decline.  As the above graphs show, however, the won’s value against the yuan has tended to be much more volatile than against the dollar.  Alternatively, some kind of basket approach may be in use but that removes the confidence-building features of a simple dollar peg, and confidence is what North Korean markets need more than anything.

What we do know is that anyone holding dollar assets in North Korea over the past few weeks has become relatively better off than those holding dollar liabilities such as apartment mortgages. One might think this could be cause for regime concern. We don’t know but is it enough for a quick trip to Beijing and a friendly chat with President Trump?

William Brown is an Adjunct Professor at the Georgetown University School of Foreign Service and a Non-Resident Fellow at the Korea Economic Institute of America. He is retired from the federal government. The views expressed here are the author’s alone.

The author is indebted to Daily North Korea which diligently reports North Korean prices and exchange rates in its newsletter.  https://www.dailynk.com/ 

Picture from user Price Roy on flickr

By Mark Tokola, Phil Eskeland, Troy Stangarone, Kyle Ferrier, Juni Kim, Yong Kwon, and Sang Kim

2018 was a year of dramatic change on the Korean Peninsula. The prospect of war that seemed to growth with each North Korean nuclear or missile test receded as North Korea, the United States, and South Korea moved towards diplomacy which culminated in the historic summit meeting between U.S. President Donald Trump and North Korean Chairman Kim Jong-un in Singapore.

While the move towards diplomacy with North Korea was the top story of 2018, the year also saw South Korea successfully host the 2018 Winter Olympics, South Korean President Moon Jae-in move more directly towards implementing his income lead growth strategy, and K-pop take another significant step towards breaking out in the United States.

As we move into 2019, some of the big questions facing the Korean Peninsula will center around whether real progress can be made with North Korea now that we are beyond the initial stages of diplomacy and what that means for inter-Korean relations. Other key issues for 2019 will be how the U.S.-China trade war plays out and the implications for South Korea, as well as whether income lead growth will be able to overcome some of the initial implementation challenges it has faced.

With that in mind, here are 10 issues related to North Korea, South Korean politics, and U.S.-Korea relations to follow that will have an impact on the Korean peninsula in the year ahead:

Whether a Peace Process Can Develop

It is generally believed that the denuclearization of North Korea will be accompanied by a “peace process” (or peace regime, or peace declaration, or end-of-war declaration – there are many terms being tossed around) but what this would actually mean or whether it would come before or after an agreement on denuclearization is unclear.  The “peace process” may come in pieces.  There is nothing to prevent North and South Korea from declaring on their own that peace has come to the peninsula.  Similarly, the United States and North Korea could issue a joint statement saying that have no hostile intent towards one another.  If such statements can promote denuclearization or decrease tensions, well and good.  The devilish details would be in what concrete steps if any would accompany a declaration of peace.

2019 may well see announcements of peace on the Korean Peninsula.  It would seem like an irresistible flourish to mark Kim Jong-un’s visit to Seoul, or to give an appearance of progress for a second Trump-Kim Summit.  But, watch for the details.  Would a declaration of peace be accompanied by a road map towards denuclearization? A normalization of relations with liaison offices being established in Washington and Pyongyang?  A more wide-ranging commitment by North Korea to restrain its belligerent behavior beyond denuclearization, such as in cyber or other weapons systems?  Would there be a move towards formally ending the Korean War by winding up the armistice? Thinking through what a peace process would mean reveals that there are big issues beyond denuclearization.

Will the United States Lift Sanctions on North Korea?

In his New Year’s Day address, Kim Jong-un called for the United States to lift sanctions if it wants the process of dismantling North Korea’s nuclear weapons to go forward. In the past, the Trump administration has said that North Korea would have to dismantle or substantially dismantle its weapons programs before sanctions relief would be possible. With progress with North Korea stalled, one of the key questions for the Trump administration will be whether it sticks to its stance or accommodates North Korea’s push for sanctions relief.

If the Trump administration decided to move forward on sanctions relief there are four general ways it could look to pursue to move the talks forward and demonstrate good faith. The first area would be to support inter-Korean engagement. Here the administration could support further sanctions waivers to allow inter-Korean economic projects to advance. At the United Nations, the administration could support removing one or more specific sanctions that have been placed on North Korea. Another, more likely option at the UN, would be for the administration to pursue time-limited waivers of sanctions that are contingent on progress by North Korea in dismantling its nuclear programs. The final option would be for the administration to waive one or more specific U.S. sanctions where it has the authority to provide a national interest waiver.

Burden Sharing and the U.S.-Korea Military Relationship

As part of his professed “America First” values, U.S. President Donald Trump has repeatedly criticized South Korea, and other U.S. allies, for what he views as an unfair defense burden to America for stationing U.S. troops. The U.S. has maintained a military presence in South Korea since the Korean War in the 1950s and South Korea currently hosts 28,500 American troops, the third largest number of troops stationed in a foreign country after Japan and Germany. Ten rounds of negotiations occurred throughout 2018 between U.S. and South Korean officials to renew the Special Measures Agreement, a 2014 burden sharing deal that is set to expire at the end of 2018. The latest round failed to reach a deal over demands from the U.S. for South Korea to greatly increase its contribution and has prompted fresh concerns over the U.S.’s commitment to the alliance. Without a new deal in place, Korean workers at U.S. military bases in South Korea are in danger of being put on leave in the New Year. If left unresolved, the ongoing debate over cost-sharing could greatly hinder future U.S.-ROK relations.

The Future of THAAD in South Korea

China’s protest of the deployment of Terminal High Altitude Area Defense (THAAD) batteries, which were provided by the U.S. military, in South Korea in 2017 led to a political and economic row between the two countries. A resulting Chinese ban on tourism to South Korea and South Korean goods eventually gave way to an agreement late last year to normalize trade relations. Although trade and tourism numbers have started to rebound in 2018 after dramatic decreases in 2017, negative repercussions still remain, though the exact cost of the sanctions are hard to definitively quantify South Korea has likely lost more than $13 billion from the decline in tourism alone. In particular, the Korean conglomerate Lotte, which provided the land for THAAD deployment, has suffered from the after-effects of China’s sanctions with its stores in China shuttering due to lost business.

For 2019, it will be worth watching if the numbers continue to recover and how South Korean businesses adapt to the potential risks of dealing with a volatile Chinese market. For Lotte’s part, the company has actively courted Southeast Asian markets to make up for Chinese losses. It will also be worth watching if THAAD becomes part of talks with North Korea or the expected results of a South Korean environmental impact study affect its deployment.

U.S.-Korea Trade Relations – Section 232 Investigation

The past year has seen great progress in ameliorating initial uncertainties:  exports of U.S. goods and services to Korea increased 10 percent; the bilateral trade deficit declined by 43 percent; and agreements were reached and ratified to modify the Korea-U.S. Free Trade Agreement (KORUS FTA) and to limit Korean steel exports to the United States.

Nonetheless, there is still one looming threat – the possible imposition of U.S. tariffs as high as 25 percent on imported motor vehicles and parts from South Korea.  The Commerce Department has until February 17, 2019, to release the results of its Section 232 investigation into the national security implications of imported autos and parts.  If the report concludes that these products are a threat to U.S. national security, the President has until May 17, 2019, to make a final decision on tariffs.  However, because Korea and the U.S. concluded their negotiations on KORUS and steel two months before the Commerce Department launched this investigation, other major auto producers – Canada, Mexico, Japan, and the European Union – received reprieves or waivers on higher tariffs during their trade talks with the United States.  No decision has yet been made to exempt South Korea from higher tariffs even though Korea imposes zero tariffs on motor vehicles imported from the United States; the revisions to KORUS made several changes benefiting U.S. automakers, including a 20-year extension of the 25 percent U.S. tariff on imported pick-up trucks; and the value of U.S. imports of motor vehicles and parts from Korea has steadily declined since 2015.  Imposing a 25 percent tariff on imported cars and parts would also add approximately 10 percent to the production cost of Korean name-plated cars assembled in Georgia and Alabama, making their vehicles less affordable to the American public, resulting in a significant reduction in employment at both their manufacturing facilities and their dealerships.

Compounding the issue is the frustration that President Trump expressed on November 28^th regarding the recent announcement of the closure of four GM plants in the U.S. that make auto parts and smaller vehicles.  The President tweeted, “the countries that send us cars have taken advantage of the U.S. for decades,” reflecting a fundamental worldview that he has believed for over 30 years.  Trump added, “if we [imposed a 25 percent tariff on] cars coming in, many more cars would be built here.”  Because Korea still exports some cars to the U.S. that compete against GM, the threat of a higher tariff could be used to pressure Korean car manufacturers to move even more production to the United States.  President Trump also desires that Korea pay much more to continue stationing U.S. troops on the Korean peninsula.  He could use the threat of higher car tariffs as another pressure point on South Korea.  Unless Korea is granted an exemption on the auto tariffs, much of the goodwill in the bilateral trade relationship that has been generated over the past year will quickly dissipate because it will be perceived as bad faith in terms of moving the goalposts in bilateral trade negotiations.

The U.S.-China Trade Conflict

On the surface, tension in U.S.-China trade relations does not appear to affect South Korea too much because South Korea’s economy is more aligned with the United States.  However, because China is now Korea’s largest trading partner, South Korea could be caught in the undertow of the churn in U.S.-China friction.  Some Korean brand consumer electronic products are assembled in China and subsequently exported to the United States, which now has to be re-thought in light of the threat of U.S. tariffs as high as 25 percent on Chinese exports.  Other products assembled in China also contain significant Korean content.  For example, the screen on the new Apple iPhone XS is made by either Samsung or LG.  The Korean stock market frequently gyrates at any movement in U.S.-China trade talks – up when negotiations progress and down when discussions stall.  The two sides have given themselves until March 1, 2019, to conclude a successful agreement.

However, many of the irritants in the U.S.-China trade relationship are deep and foundational problems to the Chinese economy and most likely cannot be cured in less than three months.  If an agreement is reached that just makes marginal changes on the edges, such as a commitment by China to purchase more U.S. products or lowering the tariff on imported autos, then the U.S., and by extension, Korea, will continue to face long-term economic challenges from China.  If the U.S. acts in concert with other nations that have similar concerns about unfair and trade-illegal Chinese practices, then multilateral action can spark necessary reform to China’s economy.  However, if the talks break down and the U.S. continues to act alone by imposing more and more tariffs irrespective of how it affects constituencies in the U.S. or other nations like Korea, China will ironically gain the moral high ground as the defender of free trade and unnecessarily delay the market-oriented changes the free world needs to see take place in China.

U.S.-Korea Cooperation in the Indo-Pacific

The “Free and Open Indo-Pacific Strategy,” first introduced over a year ago, now underlies Washington’s approach to the region. South Korea has yet to officially join the strategy nor is it likely to in 2019 due to concerns in Seoul that it could be interpreted as “containing” China or even forcing its hand to choose between Beijing and Washington. However, the overlapping goals between the Indo-Pacific Strategy and the Moon administration’s “New Southern Policy” provide new opportunities for both the U.S. and South Korea to work together beyond the Peninsula.

Both visions focus on increasing engagement with South and Southeast Asia on many of the same key issues based on the same core values, albeit in different ways. The clearest means to bridge the two is through infrastructure projects. The U.S. is looking to mobilize large, high-standard loans and the quality and cooperative nature of South Korean loans, Seoul’s efforts to direct more development assistance to ASEAN countries and India, and the competitiveness of Korean firms in building modern infrastructure make South Korea an ideal partner in achieving this goal. In 2019, look for Seoul and Washington to cooperate on infrastructure projects in the region as well as highlight their joint efforts.

Improving the Environment in South Korea

Although air pollution arose as an issue during the 2017 presidential election, leading candidates at the time focused largely on expanding dialogue with China and remained quiet on domestic sources of this public health threat. The issue returned with a vengeance this past November when extreme levels of ultrafine dust forced Seoul to restrict the number of vehicles on the road and construction. This comes at a particularly awkward time for the Moon administration, which responded to public concerns following the 2011 Fukushima Daiichi disaster by promising to phase out nuclear power in Korea.

Absent nuclear power, cleaner energy could be drawn from natural gas, which South Korea has been importing in increasing amount – particularly from the United States. However, this exposes Korea to geopolitical issues and market volatility. The Moon government is also making a big push to increase renewable energy capacity.

At this juncture, South Korea may consider looking to Taiwan – voters there rejected the phase-out policy in a referendum this year. With nuclear energy satisfying both clean air and energy security, this issue is poised to be revisited by both the government and the public in 2019.

South Korea’s Income Lead Growth/Job Creation

The state of the economy remains the biggest source of concern for South Koreans. After taking several months to get up and running, the first full year of the Moon administration’s income-led growth agenda has fallen short of its ambitious goals. Responding to his falling approval rating in light of underwhelming initial results that have increasingly become a major issue of public debate, President Moon has devoted more government resources to his economic agenda this year. However, the key question for 2019 is will this be enough to win back public support and reinvigorate the economy?

Moon’s income-led growth strategy is a novel approach to resolving the stubborn structural issues in the economy, but this also means it is largely unproven. The IMF and OECD support the agenda’s increased social spending, particularly given the government’s fiscal space, but these policies must also start creating jobs and bolstering growth to be sustainable. Even if the agenda is on the right path, the window to push it through may be closing. More interest rate hikes by the Federal Reserve and the prospect of worsening trade tensions between China and the U.S., both of which have already impacted the economy, could make it harder for Moon’s agenda to find more success this year.

The #MeToo Movement and Women’s Right 

Heightened advocacy for women’s rights was a global trend in 2018. In South Korea, the #MeToo movement gained momentum with women stepping forward with allegations of sexual harassment and violence against high-profile figures, including presidential-hopeful Ahn Hee-jung, poet Ko Un, and award-winning movie director Kim Ki-duk. However, advocates faced obstacles ranging from a relatively lenient legal code to deeply-entrenched social attitudes. Providing further proof of the current society’s antipathy to women’s concerns, the brave actions of women who came out publicly with testimonies of abuse – despite receiving international attention – resulted in very few prosecutions.

Korean women last year also confronted a proliferation of hidden cameras, which prompted protests demanding stronger punishment for trafficking of digital material that was filmed without consent. In response, the government has so-far announced tougher punishments for trafficking of these materials and announced plans to better police online sex crimes and remove illegal footage from the internet more swiftly. These will go hand-in-hand with broader protections such as extensions to the statute of limitations in sexual abuse cases and measures that would allow victims of harassment and abuse to report these crimes anonymously.

Notwithstanding, many advocates recognize that strengthening the legal system is a necessary but insufficient means to achieve true social change. With many women’s rights organizations now mobilized in the wake of the scandals in 2018, open debates about how cultural attitudes will be reformed will likely intensify in 2019.

Bonus Issue: Will Kim Jong-un Go to Seoul?

At their summit meeting in Pyongyang, Kim Jong-un agreed to Moon Jae-in’s proposal that he visit Seoul before 2018 ended. Kim never took that trip, but in his recent letter to Moon he expressed a desire to meet with Moon frequently in 2019 and “a strong determination to visit Seoul while watching future situation.” Whether Kim makes that trip will be one issue that many will be watching in 2019.

It is not surprising that Kim did not meet with Moon in Seoul in 2018. With progress in talks with the United States stalled and his meeting with Trump postponed until early 2019, there would have been little that Kim could have achieved in Seoul. Any trip to Seoul in 2019 will likely be dependent on how Kim’s next meeting with Trump goes and whether there is any historical progress Kim can make in Seoul. He will likely want to achieve more that than act of a North Korean leader visiting Seoul for the trip to go forward.

Beyond whether Kim will visit Seoul will be the question of how his visit is received. At the moment, Kim’s image has improved in South Korea with the current diplomacy and 60 percent of South Koreans would have supported the trip if he had taken it in December. One issue to watch from any visit will be whether it builds support for inter-Korean ties among South Koreans or causes them to reassess the current opening with North Korea?

Mark Tokola is the Vice President of the Korea Economic Institute of America, Phil Eskeland is the Executive Director of Operations and Policy, Troy Stangarone is the Senior Director for Congressional Affairs and Trade, Yong Kwon is the Director of Communications, Kyle Ferrier is the Director of Academic Affairs and Research, Sang Kim is the Director of Public Affairs and Intern Coordinator, and Juni Kim is the Program Manager and Executive Assistant. The views expressed here are the authors’ alone.

Image created by Juni Kim.

By Troy Stangarone

If 2017 was the year of “fire and fury,” 2018 saw the United States and North Korea turn from the rhetoric of war to diplomacy as U.S. President Donald Trump met North Korean Chairman Kim Jong-un at the first ever U.S.-North Korea summit in Singapore.

If 2018 was the year the diplomacy on the Korean Peninsula, it was also a year of frustrations as the United States and North Korea have been unable to make progress on agreeing to a path towards the dismantlement of North Korea’s nuclear weapon and missile programs, or in taking steps to build the new relationship promised in Singapore. With U.S.-North Korea relations stalled, North-South relations have been unable to move forward at the pace hoped for despite more extensive agreements on inter-Korean cooperation.

While North Korea dominated the headlines in 2018, the past year began with South Korea’s successful hosting of the Winter Olympics. It saw the United States and South Korea agree to revise the U.S.-Korea FTA (KORUS), but South Korea also become caught in the United States trade war with China. The United States and South Korea also failed to reach an agreement on burden sharing.

On the domestic front, the Moon Jae-in administration implemented a series of new policies to advance an income lead approach to economic growth, but so far has yet to see the results hoped for from its reforms.

As we take our annual look back at the events that helped to shape the Korean peninsula during the past year, it is also an opportunity to review the events we highlighted on The Peninsula in our annual 10 Issues to Watch for on The Korean Peninsula in 2018 blog and the events we didn’t see coming.

Looking back, we largely touched on what would be the key issues on the Korean peninsula in 2018, but we missed on the sudden shift to summit diplomacy on the Korean Peninsula and what in one poll has been identified as the top news story in the United States in 2018 – the summit meeting between Trump and Kim. Here are the issues we identified:

1. Could War Break Out on the Korean Peninsula?

Coming into 2017, tensions between the United States and North Korea had been growing. Pyongyang’s December 2017 inter-continental ballistic missile (ICBM) test demonstrated it had the ability to reach anywhere in the continental United States, even if it had not yet completely mastered ICBMs. Despite the increasing threat of war, we were largely right in our analysis when we said that “war can, and most likely will, be avoided as long as cooler heads in Washington and Pyongyang prevail.” What we largely didn’t foresee is that war would be avoided not just because “cooler heads” would prevail, but that would lead to a year of North Korean summits with South Korea, China, and the United States.

2. The Advancement of North Korea’s Nuclear and Missile Programs

With the movement towards dialogue between the United States and North Korea, our prediction that North Korea would continue to test missiles fell flat. For all of 2018, North Korea refrained from conducting missile tests to either demonstrate new capabilities or to express its displeasure at the progress of talks with the United States. At the same time, there is every indication that our second prediction was correct. Kim Jong-un pledged in his 2018 New Year’s Address that North Korea would continue to expand its supply of missiles and fissile material and has yet to shut down its nuclear facilities at Yongbyon or its missile production facilities.

3. The Impact of Sanctions on North Korea

On the surface, sanctions have worked. Exports to China, North Korea’s primary trading partner have fallen to under $200 million through November. At the same time, despite sanctions causing declines in exports to China and other countries, there are signs that the markets are remarkably stable. In data published by DailyNK, the exchange rate and the price of commodities in markets have been fairly stable. Contrast this with Iran, where the U.S. withdraw has caused the Iranian Rial to drop in value. While the North Korean economy is not in a good position, the effect of sanctions seems to be less than many would have expected.

4. The 2018 Winter Olympics

By all measures the 2018 Winter Olympics in Pyeongchang were a success. South Korea finished tied for sixth for the most medals won, and concerns about attendance were ultimately relieved as the organizers came within their goal of selling 90 percent of the tickets. Most importantly, North Korea took part in the games easing concerns that it could disrupt the festivities and its participation helped to jump start a year of diplomacy.

5. Special Measures Agreement/Burden Sharing

The United States and South Korea have yet to conclude discussions on a new Special Measures Agreement to determine how much South Korea will contribute to the non-personnel costs of U.S. troops in South Korea. While the failure to conclude an agreement has not yet affected the alliance, the current agreement expires at the end of 2018. Indications are that the talks are stalled over an insistence by the Trump administration that South Korea raise its contribution to burden sharing by potentially twice as much as South Korea was previously contributing.

6. U.S.-Korea Trade Policy

The United States and South Korea were able to quickly reach an agreement on modest adjustments to the KORUS FTA. With the National Assembly having approved the changes and the U.S. trade deficit with Korea continuing to decline, the concerns around the KORUS FTA have begun to dissipate.

However, the KORUS FTA was not the only trade issue in the U.S.-Korea economic relationship. As we noted last year, the U.S. used a Section 232 national security investigation to push South Korea into agreeing to a quota on its steel exports to the United States equal to 70 percent of its shipments over the last three years, and also imposed tariffs on Korean washing machines as part of a safeguard case. South Korea may not be out of the woods yet, as a decision will likely come on a Section 232 case on automobiles and automotive parts early next year. South Korea is only major automotive producer to not receive some type of assurance that it will not have tariffs imposed on its exports if automotive imports are found to have national security implications.

7. Will China’s Economic Pressure on South Korea Over THAAD End?

As we foresaw at the beginning of the year, China’s pressure over the decision to deploy THAAD has moderated rather than disappeared. Despite South Korea and China agreeing in October of 2017 to normalize economic relations, Lotte is in the process of closing its Lotte Mart stores in China, and the effects on tourism can still be felt. Based on the latest data from the Korea Tourism Organization, a bit more than 400,000 Chinese tourists traveled to South Korea in November. This is up from just under 300,000 at the same point last year. However, despite the increase in Chinese tourism in November, it is still below its pre-THAAD highs. All told, the South Korean economy has lost more than $13 billion from the decline in Chinese tourism alone.

8. Moon Jae-in’s Promised Economic Reforms

The Moon administration continued to implement its income lead growth policies in 2018 taking steps to shorten the work week and raising the minimum wage for the second year in a row. However, the results have been mixed, especially with slowing job growth in August and September. South Korea also saw estimates for its GDP growth in 2018 and 2019 revised down. Some of this revision is due to external factors, but declines in investment and job growth are also weighing on the economy. The new year will be an important period for determining whether the current challenges are due more to the markets adjusting to the new policies or whether the policies themselves will need to be adjusted.

9. South Korean Local Elections

The ruling Minjoo Party won a resounding victory in the 2018 local elections. The party won 14 of the 17 mayoral and gubernatorial posts up for grabs, as well as 11 of 12 by-elections for the National Assembly. Seoul Mayor Park Won-soon also won a third term as mayor.

10. Hallyu’s Ongoing Rollercoaster Will Continue

The growth of K-pop around the globe was one of the major stories in 2018, even being highlighted by the BBC as BTS became the first Korean group to enter the UK Top 40 and land in the top spot of the iTunes album chart in 60 countries. Despite still facing challenges in China as part of the fallout from THAAD, K-pop saw growth in Japan and in Latin American markets. However, the big success for K-pop came in its breakthrough in the United States. BTS had two albums reach the top of the Billboard 200 and three songs on the Billboard Hot 100. However, the success extended beyond BTS as four other Korean acts landed albums in the top 40 of the Billboard 200 and BLACKPINK saw its video Ddu-Du Ddu-Du gain the fifth most views on YouTube in a 24 hour period among all genres.

The Bonus Issue: Will There Be Constitutional Reform?

While the Moon administration pushed for a package on Constitutional reform to be concluded in time for the local elections, ultimately reform efforts stalled in the National Assembly.

Beyond the events that we expected, here is a look at some of the unexpected events that helped to shape 2018:

1. When Donald Met Jong-un

Prior to 2018 no sitting U.S. president had met with the leader of North Korea. That changed in 2018 as U.S. President Donald Trump altered the normal protocol of only meeting a foreign leader, especially one such as Kim Jong-un, until after a series of deliverables have been agreed to by both sides. The summit in Singapore produced an outline for moving relations forward, but there has been virtually no progress in talks with North Korea, despite the United States canceling military exercises with North Korea. In spite of the lack of progress, Trump has professed his goodwill for Kim saying “And then we fell in love, OK? No, really, he wrote me beautiful letters, and they’re great letters. We fell in love.”

2. Perceptions of Kim Jong-un in South Korea Improved – A Lot

If meeting a sitting U.S. president was an historic moment, it was preceded by Kim Jong-un being the first North Korean leader to cross into South Korea, even if only to the South Korean side of the DMZ. Your author was in Seoul at the time watching Kim cross the demarcation line live on his cell phone in a taxi to the National Assembly. What struck me at the time was lack of coordination on the North Korean side as the delegation walked to the DMZ and the lighthearted nature of Kim Jong-un as he invited South Korean President Moon Jae-in to briefly visit North Korea before their meeting.

Kim’s visit made an impression on South Koreans as well. Prior to the April Summit Kim had an approval rating in South Korea of 10 percent, though that rose to 31 percent after the summit. More impressive, after the summit a new poll found that 78 percent of South Koreans saw Kim as trustworthy. A degree of goodwill remains as 60 percent of South Korea would have welcomed Kim to Seoul had he come in December as expected.

3. Inter-Korean Relations

In addition to the April summit, Kim and Moon held two additional summit meetings – a second summit in the DMZ and Moon’s visit to Pyongyang. These summits resulted in the Panmunjom and Pyongyang Declarations which laid out steps to improve inter-Korean relations. While sanctions related to North Korea’s weapons programs have prevented significant movement on inter-Korea relations, the two Korea’s did take steps to advance relations in 2018. In addition to the summit meetings, the two Koreas held the first family reunion since 2015, took steps to reduce military tensions and implement a new military agreement in the DMZ, and conducted a joint survey and groundbreaking ceremony for a project to reconnect the railways on the Korean Peninsula.

4. North Korea’s Cyber Activities

North Korean has become one of the world’s most active cyber powers and despite the diplomacy with the United States and South Korea, Pyongyang kept up its activities in 2018. According to Group-IB, since the beginning of 2017 approximately two-thirds of the theft of cryptocurrency has been by North Korea, netting the regime $571 million. It also used the Pyeongchang Olympics and summit meetings with Kim Jong-un as potential bait for phishing attacks.

5. The U.S.-China Trade War

In a globalized world where countries are part of supply chains, tariffs are an imprecise tool and South Korea found itself one the countries most exposed to a trade war between the United States and China. More than 40 percent of South Korea’s GDP is accounted for by exports, while China and the United States are South Korea’s top two trading partners, respectively. For most of 2018, South Korea had managed the conflict fairly well by increasing exports to China and resolving the issues around the KORUS FTA. However, in the year’s last quarter South Korea began to see declining demand for its top export to China, semiconductors, while overall sales of automobiles began to decline significantly in China – signs that the effects of the trade war are beginning to set in.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade at the Korea Economic Institute of America (KEI). The views expressed here are the author’s alone.

Image created by Juni Kim is the Program Manager and Executive Assistant at KEI.

By William B. Brown

Presidents Xi Jinping and Moon Jae-In might like to shift public attention away from economics as they travel to the G-20 talks in Argentina later this month, given last week’s not so great third quarter GDP releases.  North Korea’s continuing charm offensive is a likely positive, confidence building alternative for them, even if U.S.-led de-nuclearization talks remain jammed.  And Prime Minister Shinzo Abe may be struggling to find good news as well after Japan’s third quarter GDP is announced November 14th.  This all in contrast to accelerating U.S. growth and President Trump’s “the best U.S. economy, ever” proclamations.  But can Trump use this economic strength to keep China and South Korea in line with his delicate task of negotiating North Korean de-nuclearization while maintaining tough sanction pressures?  The issues are invariably complicated, but Trump may be gaining leverage as other Asian leaders become ever more dependent on U.S. economic and trade policies to stay above water.  Simply a phone call between Trump and Xi last Thursday, followed by mildly positive Trump remarks, is said to have caused the 3 percent jump in China’s beleaguered stock prices. Much will ride on the Xi-Trump dinner conversation in Buenos Aires at the end of the month where presumably the “trade war” and North Korea sanctions will be addressed. One might think Xi will be more concerned with the former than the latter, and pressures on North Korea will be maintained.

The third quarter data was not alarming for East Asia, especially as seen from the stabilized year-on-year perspective, but important trends appear to have set in that favor U.S. strength, with U.S. demand supporting rest-of-the-world growth.  U.S. GDP slightly exceeded expectations with growth at 3.0 percent from the same quarter of 2017, higher than South Korea’s disappointing 2.0 percent—a rare quarter in which the U.S. has grown faster than Korea.And it came despite a large negative contribution from net exports as surging imports pushed the U.S. trade deficit to record levels.   China’s growth was more than double that, at 6.5 percent, but is steadily slowing from pre-Xi Jinping boom years, a fact not lost on a Chinese public used to much more rapid gains.  Japan will release its data November 14^th and is expected to record negligible or even negative growth.

More volatile quarter-to-quarter data gives similar results, with the U.S. showing 3.5 percent seasonally adjusted annualized growth in the third quarter; South Korea about 2.5 percent (.6 percent q/q) and China close to a steady 6.5 percent (1.6 percent q/q).

South Korea’s third quarter performance only barely missed expectations of 2.2 percent growth from third quarter 2017, but the components are more disappointing.  Growth was boosted by a decline in imports, especially of factory equipment, and a big rise in government spending.  Exports were strong, despite all the talk of trade tensions with China and the U.S., its first and second largest markets. But facility investment and construction fell at the fastest rates since the global recession a decade ago, adding to big declines in the second quarter. Private consumption maintained steady 2 percent growth despite growing household indebtedness.  Employment is weak and confidence in the economy seems to be slipping, a big determinant of future growth.

China’s GDP also slightly missed expectations in the third quarter, registering 6.5 percent instead of 6.6 percent growth from year-earlier levels, the slowest rate in a decade.  As with South Korea, net trade, especially exports to the U.S., added substantially to growth while investment spending grew much more slowly than in the past.  The impact of the “trade war” so far has not so much impacted Chinese exports—there may be some front loading ahead of U.S. tariff bites later in the year—but rather seems to be dealing a blow to investor confidence. Middle class consumer confidence also is off as worries about trade wars intensify, according to analysis by the South China Morning Post.  Since talk of U.S. tariffs began last spring, the yuan has dropped against the dollar by nearly ten percent, offsetting to a large extent the announced, average U.S. tariff increases. Stock index averages also are off about ten percent over the same six months.

Japan’s GDP surged in the second quarter but is widely expected to have shown zero or negative growth in the third, and like its East Asian partners, a victim of lost investor confidence and high dependency on exports to the United States. Given the strains, all three East Asian leaders will need to improve public confidence in their leadership skills if investment spending is to recover enough to avoid real trouble.  Getting in line with Trump on trade policies at the G-20 may be difficult but staying in line on North Korea might be a good way to start.

William Brown is an Adjunct Professor at the Georgetown University School of Foreign Service, a Non-Resident Fellow at the Korea Economic Institute of America, and the Principal at Northeast Asia Economics and Intelligence Advisory, LLC (NAEIA.com). The views expressed here are the author’s alone.

Photo from Jason’s photostream on flickr Creative Commons.