Mr. Chairman, distinguished guests, it’s always an honor to appear before this committee.

Since I have no security clearances, I can offer no analysis of privileged information about North Korea’s illicit financial activities.  What I thought I would do instead is, so to speak, share with you some of my homework about North Korea’s international sources of financing and revenues.  With your permission, I’ll do so over the next several minutes. 

What I offer here in the following four accompanying charts are some estimates of North Korea’s international trade patterns.  North Korea itself, you know well, provides no official data on its international trade or financial situation, so these figures, which in the parlance are called “mirror statistics,” are reconstructions of North Korea’s trade situation based upon the reports of North Korea’s trading partners, what those partners report about North Korea’s purchases and sales of goods and merchandise, summarized on a worldwide basis.

The first figure presented here is a reconstruction of North Korea’s commercial merchandise exports over the period from 1989 to 2002.  You’ll see that North Korea’s exports dropped dramatically after the end of the Soviet era, falling radically into the late 1990s, during the period of intense famine in the DPRK.

There is some indication of an upswing in these legitimate reported commercial merchandise sales by the DPRK since the late 1990s.  But if North Korea were a business and we looked at this chart, we would say it has essentially no legitimate means of support.  The country is selling less than $1 billion worth of commercial goods internationally, on an annual basis.  This, for a country of 20-plus million people, works out to less than $50 per citizen per year.  For an urbanized, literate, industrialized society, that is an extraordinarily low level of legitimate international exports.

Let’s now look at Figure 2, please, if we could.

This figure reconstructs reported imports by North Korea of merchandise from around the world.  It follows the same sort of general patterns as Figure 1, but at a much higher level.  North Kroea always seems to buy more merchandise from abroad than it is reported having sold, and now North Korea’s level of reported merchandise sales from around the world exceeds $2 billion a year.

If you remember what I said just a moment ago, this discrepancy suggests that there’s a big deficit--a big, unexplained balance of trade deficit--for the DPRK, and we can see that in Figure 3.  Figure 3 represents the unexplained difference between imports and exports for the DPRK on an annual basis from the eighties to the present.  You will see this discrepancy amounted to about $600 million in the mid-nineties and late nineties, when the DPRK was in its period of most severe famine.  Now that difference has risen to well over a billion dollars, and was probably about $1.2 billion in the year 2002.

This deficit, this difference, is a sum total, and can be accounted for by a number of different activities.  It’s explained in part by official aid from other countries, including China, Japan, Russia, the European Union, United States, and South Korea.

It is also explained in part by illicit aid.  What comes to mind here are the illicit payments by the South Korean Government in 2000 to help to obtain the heralded Pyongyang summit of June 2000, illicit payments which are under investigation by, and elicited prosecutions from, the South Korean Government.

Counterfeit activities also account for part of this gap.  So, too, the drug trade, and military sales.  If North Korea has savings to draw down, these may also be represented here.  It’s impossible, from looking at this curve, however, to tell just which components are accounted for in different fashions there.

The curve in Figure 3 includes support from China, which, of course, we have long heard is a major supporter of the DPRK.  But I think it’s interesting to take Chinese implicit aid out of the picture and see what’s left after that.  We do this in Figure 4.  I think these results are quite interesting.

Look at what happens if we take China out of the picture.  North Korea’s unexplained extra purchases drop to almost nothing in 1997--which, as you will recall, was the most arduous year of what the North Korean Government officially called the Arduous March.  But since 1997, this unexplained extra has risen from about $50 million to over $900 million, almost towards a billion dollars.  It’s a curve that goes almost straight up from 1997 to 2002.

I would offer four comments in looking at this final graphic, which I think tells us quite a bit about North Korea’s external sources of financial support.

First, as of 2002, North Korea seemed to be enjoying a greater inflow of goods than at any time since the collapse of Soviet communism.  Second, at least to judge by these data, North Korea has been increasingly successful in acquiring noncommercial sources of funding for its State activities in the recent years. Third, this success has continued into at least the first 2 years of the Bush administration. (We do not have figures for 2003 yet, so I can’t reconstruct the patterns for the last 7 months.)

Finally, these charts suggest that enhanced noncommercial sources of income may be one of the reasons the North Korean system has managed to survive for these last number of years, when it seemed to be under such extraordinary pressure.

I’ll stop there.  Thank you, sir.

Senator Brownback: Thank you, Mr. Horowitz, and thank you for the eloquence of your presentation and the passion of your thoughts, too.  I want to pursue some discussion of that in the questioning.

Dr. Eberstadt, how long can this regime last without the illicit income?

Let me sharpen the point on that question.  You take away, or by international pressure you really try to suffocate off the illegal drug trade, trafficking in persons, weapons trade, counterfeiting, you really focus, and you get the regional community to say, okay, we are going to do everything in our power to stop this illegal trade, and you pressure the Chinese, the Japanese, and really when you look at us about our direct subsidization of the North Korean economy and you say, okay, this can’t continue until after they reform, so you really go at those two tranches of funds for coming in, how long does the regime last if those sorts of aggressive actions are taken?

Dr. Eberstadt: Senator, that is an absolutely critical question.  Of course, I don’t know the exact answer to you question, but I can try to talk to it.

We’ve learned, in the period since the end of the Soviet era, that the North Korea system is very bad at responding to international market conditions.  It’s very bad at attempting to earn revenues legally and commercially.

There are plenty of international commercial opportunities for North Korea, Lord knows.  There’s an enormous international market in OECD countries that doesn’t sanction the DPRK the way the Untied States does, with trillions and trillions of dollars of global purchases from abroad.  North Korea’s performance has been miserable in those markets.

The reason North Korea has responded so very poorly to those opportunities is that the North Korean leadership views increased interaction with the world economy as a danger, a risk that will lead to destabilization and eventual dissolution of the regime.  Pyongyang views the Soviet and the Eastern European communist experience as suggesting that “ideological and cultural infiltration”--their phrase--would seep in through greater trade and financial contacts with the outside world.

That’s why the North Korean regime has been so keen upon what is essentially a policy of military extortion.  That way, it could get revenues from abroad and transfer them directly to the bank account without any sort of polluting or poisoning contacts with its own population.

If the North Korea Government does not make major adjustments to increase its own legitimate trade revenues, then a program of reducing international financial aid and illicit sources of funding like drugs and counterfeiting and weapons sales would have an immediate and perhaps very severe impact upon the operations of that State, and I think that it is not fanciful to talk about the possibility of pushing towards an economic collapse of the North Korean system.

Economic collapse is a very fuzzy, elastic sort of word.  It can be defined in many different ways.  I would offer you one very particular definition for economic collapse.  That would be the breakdown of the food system in the country: more particularly, the breakdown of the ordinary division of labor by which ordinary men and women trade their work for food on a national basis.  That trade happens in every country under ordinary circumstances, even in countries like Bangladesh or elsewhere where there are hungry people.  Those who are hungry simply aren’t able to participate in the division of labor as effectively as they should.

There were a few instances in the 20th Century where an economic collapse of the sort that I just described actually took place.  There was an economic collapse in Japan in the months before the end of World War II.  There was an economic collapse, a breakdown of the division of labor and the food system, in Nazi Germany in the months before the Nazi defeat.

One of the things that happens when you have a breakdown of that sort, a breakdown of the national food system, is a massive deurbanization of the population.  As might be imagined: the society breaks into individual family units, and these millions of family units move from cities to countryside in a desperate hunt for food.

Japan did not reattain its 1944 urbanization level until the mid-fifties, just to give an indication of how far its economy collapsed at the end of the war.

I think it is certainly plausible to talk about bringing sufficient economic pressure on the very unusual and distorted DPRK economy, sufficient pressure to force it to this kind of economic collapse.  What we would have to recognize, I think, is an economic collapse would also entail some very, very big humanitarian risks of the sorts that we saw in end-of-war Germany, end-of-war Japan, with major movement of desperate peoples out of the cities looking for shelter and sustenance.

Senator Brownback: A huge responsibility, to address those humanitarian needs. Mr. Horowitz?

Mr. Horowitz: I have a somewhat different perspective on that question, Senator.

[Mr. Horowitz’ response]

Senator Brownback: Dr. Eberstadt, and I would note, too, that the numbers that I’ve seen is that currently about a third of the North Korean population is currently being fed by international food donations.  That’s the best estimate.  Would you agree or disagree with that?

Dr. Eberstadt: Sir, up until the end of last year, beginning of this year, those were the same numbers that I’ve seen.  They’re not being fed entirely, exclusively by the World Food Program and other sources, but part of their diet includes food from those groups.

Senator Brownback: One of your charts points to 1997, and I take it from your testimony you’re suggesting that that really was a turning point for the Kim Jong Il regime to start aggressively engaging in the illicit income source.  Am I interpreting that correctly and, if so, what were the key areas that they really stepped up after 1997?

Dr. Eberstadt: 1997 and 1998 are described by North Korean statements as being the “turning point” for their regime, for their system, a transition they describe as moving from “Arduous March” to the phase they now describe themselves as being in.  They describe that current phase as being the building of a “strong and prosperous State”--a strong and prosperous socialist State.

When they talk about what it means to be a “strong and prosperous State,” they further explain by saying that the road to prosperity leads from the barrel of a gun.  This is, I suppose, a very beautiful way of describing the process of international military extortion.

A number of different programs came together in that period between 1997 and 1998.  One of them was signified in 1998 by Kim Jong Il’s officially acceding to the highest living post of State.  You know that the highest post of State is actually held by Kim Il Sung, the “eternal president” who has been dead for the past 9 years.  But with the accession to the highest living post of State, and with South Korea’s advent of the Kim Dae Jung sunshine policy, possibilities for international financial aid improved very greatly for the DPRK.

On the one hand, South Korea, and then the Clinton administration, and then the Japanese Government began to subsidize the DPRK through official flows of financial aid, above board and on the table, paid for by taxpayers.  From the western standpoint, this was part of the engagement process, or the “sunshine policy.”  In effect, engagement policy meant subsidizing the North Korean State through taxpayer funds.  That’s what the engagement policy has been.
 But there were also illicit, revenue-enhancing activities, as you indicated.  There seems to have been, during this period of time, a determination to ramp up international military sales and military exports by the DPRK.  There seems to have been an explicit effort to ramp up international counterfeiting activities--and likewise an attempt to ramp up the sale and commerce in amphetamines and narcotics.

I only learn about those illicit activities as a newspaper reader.  I have no privileged sources of information.  Yet newspaper accounts are completely consistent with the proposition that the North Korean Government put an extra emphasis upon these efforts, and they seem to have been successful.  As far as I can tell from my own research in trade statistics, inflows of merchandise and goods to North Korea seem essentially to have doubled between 1997/1998 and 2002.  By all appearances, it’s been a very effective program.

Senator Brownback: And this is what Kim Jong Il has used to keep himself in power and the people around him somewhat satisfied, and to continue to fund a weapons of mass destruction development program?

Dr. Eberstadt: Absolutely.  This is what it means, in North Korean terms, to be a “strong and prosperous State.”

Senator Brownback: Mr. Horowitz,

[question to Mr. Horowitz]

[response by Mr. Horowitz]

Dr. Eberstadt: May I say a word on that topic?  I endorse and amplify what Mike just said.  And I think that in the future sometime, when historians look back on the current crisis in the Korean peninsula, one of the things which will look most striking and perhaps most perverse is that two successive presidents of South Korea were champions of human rights--one a winner, you mentioned, of the Nobel Peace Prize, the second a human rights activist and lawyer--and that these two Governments nevertheless studiously disregarded the humanitarian and human rights tragedy that was befalling their compatriots north of the DMZ.

This is not just a perverse situation.  In some sense, one can argue, it is an unconstitutional situation for the ROK democracy, because in Article 3 of the ROK constitution it very specifically states that any person who lives on the Korean peninsula qualifies as an ROK citizen, with the rights and protections that that constitution guarantees.  That person merely need raise his or her hand to be guaranteed their South Korean citizenship, and the South Korean supreme court has gone through a number of cases, including cases adjudicating the status of ethnic Koreans from China, to say yes, indeed, such persons, ethnic Koreans, qualify for the right of return to the ROK.

Since 1998, the South Korean Government has been looking as hard as it can the other way, trying not to offer the constitutional guarantees to these unfortunates who have crossed the border into China, much less offer these rights to people who are living in the northern half of the peninsula. 

[Senator Brownback]

[Mr. Horowitz]

[Senator Brownback closing remarks; adjournment.]

Nicholas Eberstadt is the Henry Wendt Scholar at AEI.