[VIEWPOINT]U.S. ‘pocketbook policing’ is flawed

The United States has been tracing the funds North Korea manages around the world to put pressure on the regime since September last year when Washington raised the dollar counterfeiting issue. Washington’s assessment is that the policy of “pocketbook policing” has been quite effective. It seems that North Korea has got quite a shock. However, it is not yet clear whether financial sanctions and the interception of the flow of illegal funds into North Korea will have such a decisive effect as to shake the foundation of the North Korean regime as Washington expects.
I think that the U.S. evaluation of the sanctions and the claims about its impact on the North are somewhat inflated. That’s because the evaluation is made on the basis of insufficient information and faulty assumptions.
Let’s look first at the question of the size of North Korea’s illegal funds. Washington speculates that the North’s illegal funds amount to some $500 million every year. As the basis for this calculation, the U.S. Congressional Research Service suggested that the North has made around $100 million to $200 million through drug trafficking and $15 million to $25 million through counterfeiting ― but it failed to provide details about the rest of the funds from other illegal activities. It means that the actual size and the sources of the North’s illegal funds have not been verified.
Next is the question of how the illegal funds are used. American experts estimate that Pyongyang spends around $100 million as Kim Jong-il’s fund to secure his personal rule and the remainder for the procurement of arms. The money for Kim Jong-il’s personal rule includes money he spends to purchase foreign currencies, or doles out to party and government officials to secure their allegiance.
Some observers say that, to the contrary, the illegal funds play a vital role in maintaining the operation of the North Korean economy. North Korea’s trade deficit in recent years is about $800 million per annum, excluding the trade between the two Koreas. When we deduct grants-in-aid and donations from various sources from this total, the remaining deficit comes to around $600 million. According to a recent report by the same Congressional Research Service, above, North Korea is alleged to make up for this $600-million-gap with money from illegal business transactions.
To a great degree, the estimates by U.S. authorities on the size of the North’s illegal funds seem to be based on analysis like this. This figure is used as the basis for speculating that the North Korean economy will suffer a severe blow when the illegal funds are intercepted.
But such an analysis and speculation on the North Korean economy overlooks important characteristics of the North’s trade statistics.
Although they are not included in the trade statistics accumulated on the basis of customs clearance, there are various other sources from which Pyongyang can earn foreign currencies in a legitimate way.
Most representative are the trade between the two Koreas (inter-Korean trade), foreign exchange earnings from the Mount Kumgang tourism projects, remittances from relatives of North Koreans living abroad, income from North Korean restaurants doing business overseas and wages of North Korean workers at overseas workplaces. It is speculated that the average annual income from these sources amounts to around $300 million. And the economic aid and loan-based crude oil imports from China amount to an average $150 million each year.
North Korea can make up for a large part of its trade deficit with the money it makes through normal means.
There is a problem in speculating on the size of North Korea’s illegal funds by using the amount of its trade deficit. It is, therefore, not reasonable to use the amount as the basis for speculating on the impact of measures freezing the North’s illegal funds.
The U.S. financial sanctions may have the effect of putting pressure on North Korea politically by freezing Kim Jong-il’s funds for his personal use, but it is difficult to say that the sanctions will have a critical effect on the North Korean economy. In practice, there has neither been a big change in the North’s trade volume nor a sudden rise in the North’s foreign exchange rates from a lack of foreign currency.
This indicates that the U.S. asessment of the effect of its financial sanctions may be greatly exaggerated.
In principle, North Korea-U.S. relations should be resolved through bilateral dialogue. There is no objection, of course, to insisting that in order to establish normal ties with other countries North Korea must root out such illegal activities as counterfeiting and drug trafficking.
But analysis and speculation based on insufficient information can create an obstacle to the search for solutions on issues surrounding the Korean Peninsula ― and leave the negative effect of forcing North Korea to lean toward China.

* The writer is an economist at the Institute for Monetary and Economic Research of the Bank of Korea.

by Lee Young-hoon