# Research Insider
Price and Foreign Exchange Rate in North Korea: Observations, Trends, and Analysis
One of the most important variables in the study of the North Korean economy is market prices and foreign exchange rates. This is because of the assumption that the two variables immediately reflect the status and trends of the North Korean economy. In fact, many North Korean economic studies use observations on these variables as important analysis data. Despite such reality, however, market price and the foreign exchange rate are among the trickiest of all macroeconomic variables related to the economy. Researchers have yet to agree as to how the variables should be measured, what kind of methods should be used to analyze the measures, and how the outcomes should be interpreted.
In an attempt to find an answer to these questions, we invited Dr. Ji Young Choi, Research Fellow at the Korea Institute for National Unification (KINU). Dr. Choi has long studied prices and foreign exchange rates in North Korea. She is recognized as one of the most prominent experts in the area not only in Korea but also abroad
♦ Date and Venue: The Global Knowledge Exchange and Development Center, June 26, 2020
♦ Interviewer: Lee, Suk (Senior Fellow at KDI)
♦ Interviewee: Choi, Ji Young (Research Fellow at KINU)
The Concept of Price and Exchange Rate in North Korea
The KDI Office of North Korean Economic Studies publishes a series of articles under the title of Dialogue on diverse topics related to the North Korean economy. These articles are based on expert interviews. For this month, we have invited Dr. Choi, Ji Young, Research Fellow at the Korea Institute for National Unification.
Lee, Suk Q.
The variables that economists outside North Korea use most often when analyzing the North Korean economy are market prices and foreign exchange rates. They do so because the two variables well show the status of the North Korean economy and immediately reflect the changes in North Korean markets. Even if they do not cite the variables in their papers, they check them first when preparing their papers. However, there would be hardly anyone who could argue with confidence that they know what the terms-market prices and foreign exchange rates-really mean in North Korea.
At present, much of the data on the North Korean economy is produced by South Korean institutions. The Bank of Korea (BOK) releases its own estimates (e.g. gross national income) on economic growth of the North Korean economy every year, the Korea Trade Investment Promotion Agency (KOTRA) compiles trade statistics, and the Rural Development Administration releases data on agricultural production. Nevertheless, despite their importance and high applicability, official data on prices and foreign exchange rates in North Korea are not provided by any institution. Instead, we have only unofficial estimates. Due to these limitations, there are many ongoing discussions.
This is why we have chosen price and the foreign exchange rate as the topic of the third article of the Dialogue. Before joining the KINU, Dr. Choi dealt with the same subject also at the Bank of Korea for a long time. I am happy to have her here today, and expect her to share her insights and knowledge.
Before delving into the topic, could you please briefly explain how the concepts of price, price level, and foreign exchange rate are understood in North Korea? It is my understanding that socialist economies have a price system called “official price” or “state-set price” where the prices of goods and services are determined by the planning authority, and tends to be maintained for a long time without changes. Are these all true in North Korea? Please give us an overall picture about what price system is used, and how the system is operated.
Choi, Ji Young
The North Korean price system was originally based on “planned pricing.” Since it is based on a socialist economy, the planned price is set based on a certain principle of Marx’s economic theory. In the North Korean economic dictionary published in 1985, there is a separate entry for “Price Planning.” The entry stipulates that governments of socialist states shall determine the prices of goods and services through planning in accordance with the law of the value of socialist states for the sake of the planned development of the people’s economy. This planning of prices is called “consistency in price determination” in North Korea. The underlying principle of the price system is that the economic value of a good is determined by the amount of socially necessary labor required to produce it. Under the system, the government has the authority to determine prices while enterprises and other commercial entities do not. Of course, there are exceptions. Price controls are more stringent for goods manufactured by state-owned enterprises, which are mostly industrial products, but relatively flexible for products from cooperative farms, individual households, and so on.
"Overall, North Korea was following the basic socialist price system in which price is determined according to the ownership type of production units and the necessity of the goods and services."
In North Korea, there are different types of prices. For goods, there are wholesale, retail, and procurement prices, and for services, there are fees and charges. In principle, the price is set by the state, but the recent development of spontaneous system degeneration has not allowed all principles to be rigidly followed. In the case of wholesale prices, the prices of goods, especially industrial goods, are strictly set since it is relatively easy to calculate the cost of raw materials used and the input hours of labor. Retail prices are also determined by the state based on the valuation of essential and luxury goods, Essential goods are priced low through price subsidies while luxury goods are priced high. Prices are also affected by the form of ownership. Products from cooperative farms or other non-state production units are subject to more flexible pricing. On the other hand, the price of products produced by individuals from a side job or surplus farm products is set by supply and demand.
Overall, North Korea was following the basic socialist price system in which price is determined according to the ownership type of production units and the necessity of the goods and services. However, this type of price system can hardly be maintained while the socialist economic system was in the process of degeneration. It is not clear when the dysfunction of the planning system became quite so conspicuous, but we can speculate that the situation has seriously deteriorated since 1990. It is known that South Korea began to collect data on North Korea’s farmers’ market starting in the mid-1990s, but if we track the institutional changes of the North, the change in the price system occurred much earlier. In 1992, price reform was implemented to raise wages and state-set prices, and in 1994, the method of calculating wholesale prices was modified. It is presumed that a change in the price system was necessary because the planned economic system did not work properly under the existing price system due to the economic shock from the collapse of the old socialist bloc.
Despite these attempts to modify the planned price system, the North Korean economy has had a dual structure since the mid-1990s. In the formal sector, resources are distributed at the planned price, or the state-set price, while in the informal sector, resources are distributed at the market price. Given that market transactions are partially permitted in the 2000s, it is fair to say that both planned prices and market prices legally coexist. Moreover, after Chairman Kim Jong-un came into power, there was an institutional change to partially legalize the price-setting authority of production units. The Enterprise Act revised in 2015 expanded the price-setting autonomy to production units. The revised law stipulates that enterprises shall follow “socialistic principles and methods of price-setting”but may “set price by themselves by considering buyers’ demand and negotiated terms and then sell the goods at such a price.” This change seems to have been introduced with the implicit intention of allowing a certain level of market function in the operation of the North Korean economy. Market transactions were expanded to enable enterprises to procure raw materials by themselves in a situation where it became difficult to provide raw materials for production units through the planning system. In a sense, the change was an act of institutionalizing the price-setting function of enterprises, which had not been recognized by the formal mechanism until then.
"According to the Food and Agriculture Organization (FAO) reports, the price of foods traded in state-operated stores is marked in state-set prices."
The levels of state-set prices are maintained for a long period unless the price calculation method is modified. For example, wholesale prices, which consist of cost, profit, and profit income, may be revised when methods of cost calculation and profit distribution as well as the share of profit income change. Still, when compared to the changes in the market price based on supply and demand, the stateset price seems almost unchanging. Since the 1990s, the state-set price has twice gone through extensive changes. In 1992, there was a general increase in wages, procurement prices, and state-set prices, and in 2002, similar actions were taken. The latter, called the “July 1 Economic Management Improvement Measures” (or simply, the July 1 Measures), served as an opportunity to rationalize wages and stateset prices. The price of rice was adopted as a new criteria for price-setting, presumably because rice is one of the major items traded in the market and thus, its market price is a useful anchor for setting the price of other items. The change in the state-set prices, at that time, may be considered as a measure of price rationalization. If the gap between the planned and market prices widens, resources are diverted to the market for rent seeking. To prevent this, the authorities raised the planned price almost to the level of the market price. Given that North Korea took such a measure as early as 1992, it seems that supply shortages within the planned sector had already been chronic and widespread, and the gap between statutory and market prices was very significant.The two rounds of price rationalization in 1992 and 2002 are considered as failures.
In order to reduce the price gap between the market and planning sectors, supply in the planning sector should have been restored, but this failed. Still, the North Korean government had difficulties doing so. Since the adoption of the July 1 Measures in 2002, the authorities never attempted to raise the stateset price overall. While implementing a currency reform in 2009 that demanded people to exchange their existing notes with new ones at a ratio of 100:1, the North Korean government left the stateset price intact. This is partly because the existing price rationalization measures failed to achieve the intended purpose of restoring the planned economy, and on the other hand, it is also because the role of the state-set price has been reduced. As mentioned earlier, as enterprises sold some of their products in the market, prices similar to market prices were applied, even to the state-owned production units. It is not possible to estimate exactly what percentage of the state-set price is being applied throughout the North Korean economy. According to the Food and Agriculture Organization (FAO) reports, the price of foods traded in state-operated stores is marked in state-set prices. For instance, the price of rice stood at KPW 44-46 per kilogram, maintaining the level since the July 1, 2002 Measures even after the currency reform. Some people may have been subject to use the state-set price, but it is difficult to accurately know the extent to which resources are allocated according to state-set prices.
Your explanation gave me an overall picture of the price system in North Korea. As a socialist state, North Korea draws plans to set and control prices according to the labor theory of value as advocated by Karl Marx. Price is classified into wholesale, retail, and procurement prices for goods, and fees and charges for services. The labor theory of value is best applied to wholesale price, particularly for those of industrial goods, which are easy to calculate. Therefore, state-set prices are well observed in the production of industrial goods. Procurement prices seem to be flexible in implementation since their main users are farmers. cooperatives and individuals. You also said the price system seems to have been effective to some extent with some flexibility. When looking at the first price rationalization measure in 1992, the North Korean government seems to have recognized the incompetency of state-set price in distributing resources.
The measure was followed by significant chaos in the North Korean economy. In addition, the government once again introduced a similar measure, the so-called, July 1 Measures in 2002. Since then, state-set prices have become nominal in resource allocation, and market prices filled the void. Nevertheless, you said state-set prices still seem useful for the allocation of foods and other essential goods. Now, let’s turn to the foreign exchange rate. I wonder what official foreign exchange rates mean in North Korea and how they are set. I was told that in addition to the official exchange rate, there are sometimes state-set exchange rates, fair exchange rates, and foreign trade exchange rates. Please tell us how they are different from each other. Also, I especially wonder if the official exchange rate do still exists and function these days in North Korea.
In a socialist economy, the government has monopolistic control of foreign currency, and North Korea is not an exception. As there are state-set prices, there are also official exchange rates. In North Korea, exchange rates are referred to as the exchange rate quotation. There are multiple types of such exchange rates,
such as fixed exchange rate quotation, exchange rate quotation for settlement, and exchange rate quotation for cash. The revised Foreign Exchange Control Act in 2004 stipulates that the Ministry of Finance, the central agency with fiscal management authority, sets the fixed exchange rate quotation as the benchmark for the cash buying/selling rates (exchange rate quotation for cash), and telegraphic transfer buying/selling rates (exchange rate quotation for settlement) set by the Foreign Trade Bank of North Korea. In 2015, the authority to set the “benchmark exchange rate” was added to the Central Bank by the Central Bank Act revised during the same year. The intention of this seems to have been to transfer the authority to determine and stabilize exchange rates from the Ministry of Finance to the Central Bank.
The Foreign Exchange Control Act has not been revised since then. It is thus uncertain whether additional changes have been made to the institutions related to foreign currency management. Still, the existence of a benchmark exchange rate demonstrates that an “official exchange rate” does exist. According to the Fiscal and Financial Dictionary of North Korea, the official exchange rate is determined by considering the values of local and foreign currencies, international market prices of goods of trade, and so on. There have been sharp fluctuations in the international market price of goods of trade and the value of the North Korean won. However, except during times of significant institutional changes, such as price rationalization and currency reform, the official exchange rate has shown little changes. This suggests that the official exchange rate is also determined in an arbitrary manner.
Before the July 1 Measures, both the official exchange rate and foreign trade exchange rate had been in use. However, after the measures, the latter was merged with the former. Data on North Korea’s official exchange rate trends have been released by the Statistics Korea and the Bank of Korea on an annual basis, and by Germany’s Bundesbank on a monthly basis. According to the Exchange Report of Bundesbank, the official exchange rate of the North Korean won to US dollar skyrocketed from 2.2 won at the time the July 1 Measures were implemented to over 150 won. The significant devaluation was intended to rationalize the official exchange rate in a way to properly reflect the value of the North Korean won given the wide gap between the official and market exchange rates.
Little changed until the currency reform in 2009 when the value of the North Korean won appreciated to around 100 won to 1 US dollar. The appreciation in 2009 came without any adjustment of the level of state-set prices. No specific studies have been available on the background of the appreciation. Presumably, the North Korean government seems to have been determined to confiscate currency assets while maintaining state-set prices because the stateset price was not as meaningful as they had been before, and previous attempts to adjust the stateset price and wages only caused confusion. In fact, there was no need to rationalize exchange rates because the measures in 2009 were not to rationalize prices. On the other hand, the appreciation of the local currency seems to have the effect of buying in foreign currencies from foreign tourists with less domestic currency.
"Except during times of significant institutional changes, such as price rationalization and currency reform, the official exchange rate has shown little changes."
The existence of an official exchange rate was confirmed by the fact that exchange rates different from the market exchange rate were applied for foreign tourists
visiting North Korea. Accordingly, the exact figures of the official exchange rate can be checked from the rates applied to foreigners. For example, 1 US dollar would buy you 8,000 won in the market but only 100 won if you are a foreigner. This means that the market exchange rate was 80-times higher than the official exchange rate. Since the 2009 currency reform, the difference has been maintained without considerable modifications.
For more, please refer to the attached file.