What Makes North Korea’s Economy Such a Terrible, Terrible Failure

You don’t have to be an economist or statistician to see a significant correlation between the level of freedom in an economy and its economic success.  – The Common Sense […]

You don’t have to be an economist or statistician to see a significant
correlation between the level of freedom in an economy and its economic
success.  – The Common Sense behind Basic Economics (Lexington Books)

Everyone knows that North Korea is just about the worst place on Earth to live.  But what made it this way?  Although it’s tempting to write it off as being run by a crazed dictator, in reality, Kim Jong Loco doesn’t come in contact with every citizen every day (though some will argue his regime does, but you get the point!).  Part of what makes it so unlivable – besides the possibility of being enslaved in a labor camp – is a poor economy that offers little opportunity for the average citizen to earn an income . . . no less eat a meal.

Of course, that brings us back to the main question: What made the economy so terrible?

In America, we’re all brought up with a basic understanding of the differences between command-style (i.e. socialism) and market (i.e. capitalism) economies, though you’ve likely forgotten most of it.  Even if you do remember the major distinctions, do you remember why our market-based economy has fared so much better than any command economy that has ever existed, including (and especially) North Korea’s?  Or, more close to home for North Korea, why did its border twin to the south leave little Kim’s economy so far behind?

The following is a snippet from my book that will shed a bit of light on the distinctions between the two economic styles, as well as a discussion on “The Korean Example.”  Not only is it impossible for any individual, or group of individuals, to coordinate all of the decisions and actors that make for an efficient and prosperous command economy, it’s also impossible to contain the exceptional growth of a free economy (though our politicians try awfully hard).

By the way, North Korea isn’t unique as much as it makes for an interesting example.  Feel free to insert “Venezuela,” “Cuba,” “Zimbabwe,” or any of your favorite economic failures from times gone by, whenever you see “North Korea.”

From The Common Sense behind Basic Economics (Lexington Books, 2015):

                                   Chapter SIX

                       Economies Come in All Shapes and Sizes

At some point in its development, every society makes a decision that
affects all future economic choices. In order to decide how to economize
those scarce resources, people have to decide between various economic
systems. These systems are differentiated by who owns and runs the
means of producing goods and services, how the activities within an
economy are encouraged and managed, and who gets the final goods
produced.

Luckily Uncle Sam didn’t risk this choice by pulling ideas out of a hat.
Realizing the million different ways in which to run an economy, our
founders, just like those of any country, had to answer the following
questions (or let the free market do so for us):

1. What goods and services will be created?
2. How will they be made?
3. What changes will the system allow?
4. How many casinos should we build?
5. How/when/to what extent will the system allow the economy to develop,
grow, and prosper?

Okay, so one of these questions doesn’t really belong (or does it?).
Among the choices societies make, we’ll consider the infamous command
system compared to America’s market system, and some of the implications
of each.

COMMAND SYSTEM

A command system is one extreme whereby a society’s economy is en-
tirely planned by a central government, usually by a central planning
board (think His Station and Four Aces). This form of economic system is
called socialism while a term describing an entire political philosophy of
central planning is deemed communism. (Communists always claim
they’ve been given a bad rap. If only they allowed marketing to exist.)
I describe this type of system as the we-know-what’s-best-for-you-
better-than-you-know-what’s-best-for-you philosophy. Bureaucrats run
the show and make every economic decision, down to who produces
what and how much by when. The government owns all of the economic
capital and directs all of its activity. If you try to sell something without
the government’s permission, Ivan Drago (yes, the one from Rocky IV)
will “crush you.”

In reality, nearly every country that even considers starting off as a
pure command economy eventually loosens its reigns slightly to allow
some private ownership and markets. The old U.S.S.R. (Soviet Union)
began unleashing its economy out of desperation before its eventual demise
in the early 1990s. China has also relaxed its reliance on central
planning by allowing an increasing number of free market interactions
within the last few decades. Cuba and North Korea are the two remaining
examples of pure command economies. But, even Ivan would have a
hard time selling these to late-night viewers: “But wait, buy right now
and we’ll throw in Turkmenistan and Myanmar free!”

MARKET SYSTEM

If Ivan represents the command system, the market system could have
none other than Rocky Balboa as its spokesman. It is the polar opposite of
socialism in its purest form, with private citizens and entities answering
all of the four economic questions, without government intervention. Individuals
are free to own property and coordinate their own form of
economic activity by using prices as their form of communication.
Whoever wants to enter the ring, can do so as they choose, knowing that
there is both the potential to win as well as to get the snot beat out of
them.

Competition results from entirely independent individuals acting
freely within markets, where buyers meet sellers to exchange their goods.
These individuals are incentivized to act purely based on the possibility
of profit to take care of themselves and their families.

In its most extreme form, capitalism is described as laissez-faire capital-
ism, after a French term that loosely means “leave it alone” (ironic, given
France’s recent disdain towards it). In this form of capitalism, only the
actors within the free markets make the decisions which affect every
other actor, prices, production, and profit. The government has no hand
in its existence. Most economists believe that there has never existed a
pure form of capitalism to this extent, much to the dismay of Adam
Smith and the French Physiocrats. (Look up the latter and you’ll find that
the French didn’t always spit upon capitalism.)

But we’ll see that in the ring that is the American economy, there is
another actor: the referee. Love him or hate him, he’s there getting his
hands in on the action. The form of capitalism we have in the U.S., along
with most other countries, is nowhere near the purest form of capitalism.
In our country, the referee is the government who ensures that certain
rules are followed, attempting to ensure economic growth and opportunity,
while also offering incentives or disincentives for producing certain
goods at certain levels of output. Although the ref doesn’t control where
the gloves land, he certainly has the ability to control the rhythm of the
fight and penalize as he sees fit. The government may not be the dominant
player, but it can have a significant impact on our economy.

WHO WOULD WIN IN A FIGHT?

Before we consider which system has been, or will be, most successful
when implemented, consider the following list of the world’s top ten
most command-dominated economies (in descending order):

1. North Korea
2. Cuba
3. Zimbabwe
4. Venezuela
5. Eritrea
6. Burma
7. Democratic Republic of Congo
8. Equatorial Guinea
9. Turkmenistan
10. Iran

The world’s top ten freest economies (per the Heritage Foundation/Wall
Street Journal Index of Economic Freedom):

1. Hong Kong
2. Singapore
3. New Zealand
4. Australia
5. Switzerland
6. Canada
7. Chile
8. Estonia
9. Ireland
10. Mauritius
*U.S.A. now comes in at number 12

You don’t have to be an economist or statistician to see a significant
correlation between the level of freedom in an economy and its economic
success. If you can find anyone interested in moving their family to a
country on the “command-dominated” list, send me an email and I will
personally go to their house, give them a signed a copy of this book, and
bake their family a cake (over a fire without icing or sugar, to introduce
them to the customs of their new home country).

WHY COMMAND SYSTEMS FAIL

If you’re expecting an articulate, academic riposte highlighting studies
that suggest the different psychologies of those in command economies,
you won’t find that here. It’s simply common sense.

As I mentioned before, it’s really difficult to make the millions of
decisions necessary to coordinate all of the activities of even small markets,
let alone large economies with millions of actors. Ever take a math
course that studied the number of ways a set of items can be arranged?
Even a small set of five, let’s say Cuban cigars, can be shuffled and rearranged
in 120 different ways. Increase that number to 20 different cigars
and the number shoots to nearly 2.5 quintillion. One quintillion is 1000
quadrillion. One quadrillion is 1000 trillion, which is more than 55 times
our national debt (as of the time of writing this book). There are far more
than twenty different resources to be coordinated within even the smallest
of tiny economies. Can you imagine some Soviet sitting around trying
to make 2.5 quintillion decisions that will provide for the best economic
return? (Don’t forget to include a lot of vodka breaks.) Coordinating the
market and its actors is one of the biggest reasons socialism fails.

As I also previously mentioned (but deserves repeating again and
again), one of the greatest incentives for entrepreneurs to create and innovate
is the financial reward that successful products, services, and ideas
can generate. Sure, many of us are honorable souls, willing to dedicate
our lives to a cause, but we all need to make a living. On top of that, even
the most benevolent among us realize that in order to give more back to
society, you have to have something to give. Without freedom, both financially
and in terms of time, Bill Gates could not have started the
largest private foundation in the world. For most of us, however, just
making a good living is sufficient enough motivation to risk our time and
earnings.

Socialism, however, allows for very little profit. Bonuses are generally
offered based on meeting arbitrary deadlines or production quotas, but
the lowest level worker is usually paid the same as the vast majority of
his coworkers, without any opportunity for advancement, no matter how
hard he or she works. Comrade Lebedev finds it hard to gain the motivation
to build the overpriced gadget that none of his fellow countrymen
can afford, especially when he can get away with a three hour liquid
lunch break instead.

WHY MARKET SYSTEMS SUCCEED

Again, it’s pretty simple. Free markets succeed because people strive
when given freedom. We are meant to be free and when allowed to work
hard to take care of ourselves, our families, and our brethren, we generally
do.

In Wealth of Nations, Adam Smith noted that, although market systems
thrive when individuals are allowed and incentivized to act in their own
self-interest, their self-interest is only satisfied when they satisfy the
needs and interests of others. As though guided by an “invisible hand,”
individuals and firms seeking to make their lives and companies profitable,
simultaneously promote the interests of the public. Although we
hear over and over how “greed” dominates the American business
psyche, no one can genuinely be out for themselves, without offering
something of value to others. The market system is therefore, the most
inherently benevolent system on Earth.

By guiding resources to their most efficient and desired uses, this
“invisible hand” ensures that the waste of resources rampant in socialist
economies has no place in ours. Resources are guided to their most efficient
uses, the most efficient techniques of production are used, and more
efficient production methods are created every day (“efficient” is a word
economists love, in case you couldn’t tell).

When given freedom, we all strive for higher standards of living; it’s
the American way. Our ancestors risked it all for the opportunity to be
free here in America, while our grandparents took factory jobs, so our
parents could get comfortable office jobs, so we could go to school and
have the choice to become entrepreneurs, entertainers, and CEOs. Entrepreneurs
are then free to take risks to innovate for even greater economic
rewards that benefit us all as well as future generations.

But the greatest argument for the benefits of a market system is the
success that comes from personal freedom. The market system does not
force others to work, or to take to a field of work that it deems appropriate
to our skills or society’s needs. It does not force us to buy goods from
one supplier, while refusing to purchase goods from another. In short,
with this freedom, there are no limits to our potential as individuals, and
collectively, as a nation.

THE KOREAN EXAMPLE

As I mentioned before, it’s impossible to set up a scientifically sound
experiment to test an economic theory. We have but history to look at
and learn from. Nonetheless, if anyone has doubts about how drastic the
differences can be between a command economy and a market-based
one, consider the Korean example.

After World War II, North Korea decided to establish a socialist econ-
omy headed by a succession of dictators named “Kim” (I know, what are
the chances so many would have the same name?). Its economy is one of
the most restricted environments on Earth, which has allowed for little
innovation and few business practices that aren’t explicitly directed by its
leaders. North Korea’s GDP per capita (per the trustworthy North Korean
government) is around 1800 dollars per annum, or about 4.90 dollars
per day, with unlimited stories of rampant starvation and overall unhealthy
lifestyles.

South Korea, on the other hand, went in another direction. It allows
for widespread and protected private property and the freedom to incentivize
the best use of that property and the advancement of self-interest.
Its GDP per capita is fifteen times that of North Korea at nearly 27,000
dollars, not too far below that of the U.S., promoting the opportunity for
successful and healthy lifestyles and a standard of living similar to that in
the Western world. If you had to pick one of the two in which to live for
the rest of your life, which would you choose?

This comparison alone should answer which type of economy we
strive for, but clearly there are other factors that motivate regulators’
interest in directing our economic interests towards a certain end and a
lot of the world’s leaders who contend that we can find a healthy inbetween.

Of all of the different styles of economies, most can be categorized as
either market or command oriented. Just like in Rocky IV, the little dictators
who run the command, or socialist, economies always try to step in
the ring with prosperous market economies just to show that they can
hang. We stand by idly, taking the verbal jabs thrown at us and we just sit
there and take them, for a while. In the end, if placed head-to-head in a
ring, free economies, like Rocky, always win and have proven throughout
history to be the most prosperous and beneficial to the citizens of a
nation.

FOCUS ON ECONOMIC POLICY: IS THE U.S. THE FREEST?

Here in America we tend to think of ourselves as the freest nation on
Earth. Well, that depends on how you measure “freedom,” but as you
can see from the Heritage Foundation/Wall Street Journal study noted in
this chapter, Uncle Sam has become a little more of a disciplinarian over
the years. After the recent financial crisis that ended in a nasty recession,
the number of new regulatory agencies and laws increasing governmental
oversight over business activity took off. But does that mean we’re
now a socialist country? No, not even close. But some do worry that
we’re leaning towards a more controlling model seen in many European
countries, where taxes are generally higher (sometimes a lot higher, see
Sweden’s near 60 percent max rate), 75 percent of employees fall under a
collective bargaining (more than 90 percent in Finland, Sweden, Portugal,
and France) compared to a mere 14 percent in the U.S. (Russell 2010), and
the costs and average time to start and grow a business have historically
been higher due to the increased regulatory environment. Economically,
the U.S. tends to fare better (in terms of GDP and employment, at least),
but some suggest the social benefits outweigh the economic costs in those
countries who choose to tax and spend a little more. I’ll leave you to
decide.