commentary

(Asian Wall Street Journal)

November 21, 2006

Tokyo's Leverage Over Pyongyang

by Charles Wolf, Jr.

North Korea dominated the agenda at last week's Asia-Pacific Economic Cooperation meeting in Hanoi, as new rounds of negotiations with Pyongyang loomed. While all 21 member-states vowed to press Pyongyang to disarm, one nation may hold the key to a successful outcome: Japan.

While China and South Korea are most often cited as linchpins in managing Pyongyang, Japan has more leverage than is usually acknowledged and may feel less compunction about using it than China or South Korea, the North's two other major trading partners. Japan's financial leverage derives from the substantial volume of hard-currency remittances from Korean residents in Japan to North Korea.

Reliable data on the amount of these remittances are elusive, and range from less than $100 million to over $300 million annually. According to my recent estimates, total transfers to the North, originating in Japan, may equal more than $200 million annually. If correct, that sum would exceed China's current account surplus with North Korea, which represents China's approximate annual subsidy to the North Korean regime.

The lucrative revenues from Pachinko gaming parlors throughout Japan — one-quarter of which are owned by ethnic Koreans — are the principal source of these remittances. Whatever their views about Kim's regime — and most resolutely oppose it — many Korean residents of Japan have relatives in the North and are anxious to send some of the proceeds home in the hope of improving their families' abject living conditions.

To get an idea of scale, Pachinko, a popular pastime in Japan, generates gross revenues of over 30 trillion yen ($256 billion) annually. Most of this money is absorbed by the enterprises' business expenses, taxation and reinvestment, thereby reducing the net income accruing to Korean owners by 75% or more. But even if just 2% of the remaining net income is remitted to the North through a combination of legal and illegal channels — such as mail, tourism, ship, air and third-country transfers — the amount involved is huge, totaling more than $200 million. From Kim's perspective, these revenues have the advantage of being versatile. Unlike food and fuel aid from China, hard currency can be more readily subverted to sustain his regime.

Kim Jong Il needs a range of reliable external sources of liquid, easily accessible and flexible funds to maintain his dynastic state. The North's agreement to return to the stalled six-party talks is a clear indication that Kim is feeling squeezed. Pyongyang's presence at the talks is based on the explicit understanding that the current financial sanctions would be discussed, although no definitive assurance was provided that such measures would be relaxed.

These sanctions include the U.S. Treasury Department's designation last year of Macau's Banco Delta Asia as a primary vehicle for money laundering in Asia, and specifically, as a repository for North Korean accounts derived from the counterfeiting of U.S. dollar currency and from other illicit practices. With China's cooperation, this led to the closing of the bank and the freezing of North Korean accounts in several other banks. Other countries, such as Thailand and Mongolia, are cooperating with the U.S.-led program, too. So long as these sanctions remain in place, Japan's Pachinko revenues may be Kim's last reliable source of unfettered cash.

The critical importance of these revenues for the Kim dynastic regime can be inferred from the North's economic history and the regime's modus operandi. For more than 50 years, North Korea has incurred a current account deficit between $500 million and $1.5 billion, according to RAND estimates. In earlier decades, the Soviet Union primarily funded these deficits with unrequited capital transfers. But since its collapse, China and South Korea have become the major sources of subventions, along with a homegrown U.S. currency counterfeiting enterprise, revenues from weapons sales, drug trafficking, and remittances from Japan's Korean diaspora.

Most of these revenues have always been at the discretion of the dynastic Kim family. Like his father, Kim Jong Il uses this core of externally derived resources to provide the incentives and rewards that secure the loyalty and support of the key elites who manage the system: the generals in the Korean People's Army; the technocrats who direct the economy's industries, including its defense industry; and the top echelons of the Korean Workers Party. Any sign of weakened loyalty or diminished support within these elites may result in withdrawal of rewards and their replacement by more severe penalties. Compliant behavior enables the system to survive.

Viewed in this light, financial sanctions may plausibly appear to Kim Jong Il as constituting a fundamental threat to the regime's survival. So too, would any move by Japan's new prime minister, Shinzo Abe, to more closely monitor and curtail remittances from the lucrative Pachinko casinos in Japan. That gives Japan an important card to play, if and when the six-party talks resume.

After almost ten years of diplomatic cajoling and threats by the U.S., China and South Korea, it is ironic that Japan, the country most threatened by North Korea's aggression, might just hold the key to breaking Kim Jong Il's will. In the long run, Pyongyang's threat to regional stability could be moderated by encouraging it to use legal channels to raise capital. But that would require a change of heart by Kim, or a regime change. Watch the six-party talks — and Tokyo's role — closely.


Mr. Wolf is senior economic adviser and corporate fellow in international economics at the RAND Corporation, and a senior research fellow at the Hoover institution. He is co-author, with Kamil Akramov, of "North Korean Paradoxes" (RAND, 2005).

This commentary originally appeared in Asian Wall Street Journal on November 21, 2006. Commentary gives RAND researchers a platform to convey insights based on their professional expertise and often on their peer-reviewed research and analysis.