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NORTH KOREA NEWSLETTER NO. 89 (January 14, 2010)
*** OPINION FROM EXPERTS

Currency Exchange in North Korea: Impact and Outlook

By Park Hyeong-jung, Director, Center for South Korean Cooperation Studies at the KINU in Seoul

North Korea's purpose of the recent currency exchange was to increase the regime's control over the economy and its people and to bolster economic conditions of the defunct state sector and still state-dependent strata in a single stroke. With that in mind, it has achieved some satisfactory results, at least temporarily. However, the cost and negative effects are also significant. Therefore, in an overall assessment, the accomplishments will temporary, and the problems will be lasting.

   First, while the measure and follow-up measures will certainly strengthen state-run sectors for the short-term, they will not make areas self-sustaining in the mid- to long-term. Second, under the name of the currency exchange, the measure has extorted the general public of their assets accumulated through trading activities in the market and other livelihood activities. A significant proportion of North Korean residents seems to have suffered a major blow, causing frustration and anger among the people. Moreover, this measure has clearly reminded the people of the fact that the reason for their suffering comes from the policy of the central government. People's resistance against the regime is likely to be stronger and more manifest.

  
Temporary Accomplishment

The essence of the temporary accomplishment in detail can be summarized in two points: the first is that the measure has significantly strengthened the regime's control over the economy and the people for the time being; the second is that there now a wedge between groups of the population, mainly between those who are regularly going to official workplaces and those who are seeking their livelihoods outside.

   To begin, let's look at the first point. Exercising its right to issue currency, the regime will issue new currency in large amounts and use the money for its priority projects. The money will primarily be put into reviving the planned system of the state and regaining control over state-run businesses and workers. Mobilizing the recovered financial resources, the state will provide an industrial materials supply system and supplies for the state-run consumer goods trading system. The state is expected to first put resources in the leading industries, such as coal mining, electricity, railway, metallurgy and chemistry in an aim to revive these sectors. It is likely that the attempt will result in substantial accomplishments within the next year. On the other hand, many of those who lost their property and means of living will have to return to their original jobs. If the workers are paid their salary in the new currency that is of the face value of the old currency, their earnings will be at the corresponding level with the money they used to earn through market activities. Most of the state-run companies will face an improved energy and labor situation.

   Now we turn to the second point of driving a wedge between groups. A measure of the money exchange is the salary (called "payment for living costs" in North Korea) that "will be paid in new currency according to the previous nominal amount." Additionally, North Korean authorities legitimized the currency exchange for "protecting interests and stabilizing and improving the living of the workers." Under these conditions, those who benefit from the currency exchange are those who regularly go to official workplaces and who are more dependent on the salary. Among them are mainly officials above the city level of party organization, as well as state security, police, the prosecution, the judiciary and military members.

   In reality, they are living more off corruption than salaries. The group that will benefit most from the currency exchange will be most likely the low-level factory workers, who have still been going regularly to official workplaces. Considering the operation level of North Korean industrial factories is known to be about 20 percent, a great portion of factory workers have had to make a living outside their official workplaces. Among them are those who have been relatively successful in adapting to market relations, and those who have not. It is undeniable that between them, there has been jealousy and envy. In this sense, the currency exchange has been designed to provide favor to the middle and lower classes, who could not have successfully adapted to the emerging market relations or who have to be on the job, whether from choice or necessity.

  
Limits of the Accomplishment and Negative Impact From an Economic Point of View

Nevertheless, these changes are not sufficient to predict that the management conditions and self-sustainability of state-run companies in general will be improved in the long-term. There are seven reasons, outlined as follows.

   First, the facilities, industrial structure and management structure of the state firms were destroyed in the 1990s. Even if the workers return to their workplaces, it will be difficult, if not impossible, to organize production activities that are sustainable. Therefore, the effort to normalize the management of state-run companies with the sudden increase of the government's resources may be a temporary campaign, but it is not likely to last in the mid-term.

   Second, the workers who return to work will be a big burden for the management of the state-run companies. In the past, state-run companies enjoyed the benefits of downsizing and restructuring by dismissing many "8.3 workers," who maintained their official status as workers at a state firm, but who were also allowed to earn their living outside the firms in return for paying their due to the firms. However, according to the recent measure, most of them will have to come back to their old workplaces. The state will be able to give them paychecks for two to three months from now on, regardless of their performance. However, in the longer term, the issue of production normalization and surplus labor will resurface as an insurmountable challenge. After a certain period of time, most of the state-run companies will go back to the past for better management, and the workers will do so for their own well-being. In other words, the companies will have to let go of surplus labor, and the workers will have to earn their living outside the factories even as they are employed by the factory for formality's sake.

   Third, many state-run companies are already engaged in sectors other than what had been required under the original planned system. Even the state-run companies have changed their internal management structure for survival and have been deeply involved in market activities in external relations. Therefore, the existing management environment and survival system that is tailored to the current situation through trial and error will be destroyed in the process of bringing them back to the planned system. Even though the state gives orders and provides financial resources, it is likely that the companies do not have the capability to follow the orders under the current circumstances. Even with the state's financial dominance recovered, reconstructing the nationwide division of the labor system with state-run companies at the center in a short period of time comes close to a delusion.

   Fourth, the prerequisite of the success of this measure is the normalization of the national material supply system and the state-run consumer goods trading network in one stroke, which is far-fetched. Until now, most material-purchasing and product-selling has been done voluntarily among companies or between companies and the market, without state intervention, and 80-90 percent of necessities have also been distributed through market activities. It is unimaginable that the state would be able to replace the existing system all at once. In fact, the North Korean authority has been constantly trying to recover the state distribution system or the state-run trading network. The failed attempt to introduce a state-monopolized food system in October 2005 was part of the effort in this regard. This time, the authority has chosen the drastic measure of killing its competitor -- the market. However, while the currency exchange brings market transactions to a halt, it fails to provide goods through the state-run trading network. This is incomprehensible because the obvious result is the ultimate chaos of the economy. Even though the competitor of the state-run trading network is gone, its ability to operate itself properly is questionable. It is more likely that the network will fail, which means that the market will have to resurface after a while. The same can be expected in the transactions of materials and finished goods among the companies.

   Fifth, it is doubtful that the new currency of North Korea will stay credible as a means of exchange and a store of value. The monetary reform is attempting to restore the planned economy and state resource distribution while closing the market. The most probable result in the near future would be that the state sectors will remain mostly defunct, and extreme shortages of goods for distribution by the state will persist while the market remains closed. Under these circumstances, those who have only the new money would get nothing, while those who are privileged or corrupt enough to have special access to state goods would get something at a fraction of the market price. The inevitable result will be that the drain of resources from the state sectors would be aggravated, and market transactions will persist with higher prices due to the need to compensate for the higher risk of a crackdown.

   Ironically, the old currency of North Korea, though weak, was hard money, in the sense that it had real purchasing power in the market. The background is that, due to the collapse of the planned system, the state order to distribute resources became ineffective, and actual distribution was affected by the market transactions. Of course, North Korean currency has been shunned even in major transactions between state-run companies, as well as on many other occasions in favor of foreign currency. After the monetary reform, North Korean authorities would like to dictate the flow of resources, though it will not function in reality. Under this circumstance, the new money will become even softer than the old money, so the former will be shunned even more than the latter.

   Sixth, quasi-public companies, which are not under the planned system of the state, have emerged in great number and have been playing an important role in North Korea. These are the companies that are set up and run by major power authorities of the military, the party and the government for their survival. These companies are not bound to the planned economy and basically run on market transactions. They have been vibrant amid the collapse of general state-run companies, thanks to the power and privilege given by their operators. In short, they are the private subsidiaries of the power authorities in the military, the party and the government. Therefore, it would be hard to meddle with these companies without touching power authorities. As independent players, they have been running state-run companies as subsidiaries, taking advantage of their power, financial resources and exclusive right to engage in overseas trading. It is certain that these companies already hold a large amount of foreign currency. They will most certainly try to exchange all of their old currency for the new currency, using their power and privilege.

   Seventh, for the above reasons, the state's control over the economy will be uneven across different sectors. The operating capacity of factories of the priority sectors and military sectors will be significantly improved. However, confusion is likely to be unavoidable for the majority of state-run companies. They have gradually and illicitly adapted themselves to the new environment of plan collapse and market surge since the 1990s, and deviated widely from the state planning system. Now the challenge for them is to overturn the current situation and to readapt themselves to the dictate of plan restoration. This will not only be a great blow to market transactions in general, but it will also temporarily cripple the industry sectors, such as the fisheries, self-auspice mines, construction and transportation. They have run on collusion between private money and public organizations and have prospered on market relations and private capital. Considering they are being seriously damaged, the result will be that the energetic part of the North Korean economy will be eliminated, and therefore production and employment in North Korea will be significantly reduced.

  
Short- to Mid-Term Impact From a Socio-Political Point of View

The following is the short- to mid-term impact of this measure on the socio-political front. The biggest outcome, first of all, is that it has dramatically boosted the economic power of the privileged class and companies run by power authorities in North Korea. Second, it will accelerate the tendency of "the rich getting richer and the poor getting poorer." Third, the people's expression of discontent with the regime could take on a new dimension with this measure in place.

   First, a certain part of the society has made large gains out of this measure -- the privileged class and the companies under the privileged power authorities. The measure has been a serious blow to small- and medium-sized merchants and the general public who have been using the North Korean currency as their means of business and saving. On the contrary, it was of relative benefit to those who manage their assets in foreign currencies, such as the dollar or the Chinese yuan. Even though they have also suffered some damage, their benefit from the soaring value of the foreign assets outweighs their loss.

   Second, the privileged class and companies have not only seen an increase in their assets, but they will also expand their control over the market. As a result, the rich will get richer and the poor will get poorer all across the country. Under the current circumstances, market transactions have already become indispensable for consumer goods, certain producer goods, production service and finished goods. Market transactions could be contracted for a short while, but will return soon. When market expansion resumes in a while, the privileged class and companies will be faced with a favorable environment for the following reasons: First, the majority of the small- and medium-sized merchants who had been dominating the market have been ruined and weakened after the currency exchange. Therefore, the privileged class and companies will be able to easily seize the ground that was originally in the hands of small- and medium-sized merchants. Second, as the currency exchange was a serious blow to the mid- to low-income class, the cost of production factors provided by the class will go down. They will be reemployed by state-run companies for the time being, but will have to be dismissed into the market in the medium-term. Then, they will have to put out the production factors they have in the market at a low price. The buyers of these production factors will be the privileged class and companies.

   Third, while the measure was a big blow to many people, the relation between cause and effect is quite clear. The cause is the central government, Kim Jong-il or his third son, Kim Jong-un, which can result in a different situation from the past. The 1990s saw the co-collapse of the regime and the people. Conventionally, under the dictatorship, residents tend to blame corrupt officials with whom they have direct contact, while believing in the good intentions of the central regime. However, in this currency exchange, people can see clearly that the cause of the disaster is the decision of the central government or a certain person.

   In the short term, North Korean residents will not be able to put up aggressive resistance against the authority. However, such a high level of frustration and anger raises the possibility of accidental clashes. In the short term, this type of accidental uprising will be subdued rather easily, but it could accelerate the process of a paradigm shift. Also, it is more likely that North Korean residents will start realizing that the ultimate cause of the problem is not just the corrupt officials before their eyes, but also the decision-makers in the central government.

  (END)