Adam Smith, Meet Kim Jong-Il

North Korea: leader in entrepreneurship! It sounds an unlikely tale that this closed, Stalinist, xenophobic, military-dominated nation should harbor some of the world's most entrepreneurial people.

Yet that is the essential and very serious implication of a new book by South Korean economist Lim Soo-Ho, "The Rise of Markets Within a Planned Economy" to be published by the Samsung Economic Research Institute. Rather than a state monolith, Lim sees North Korea now as a dual economy with the unofficial sector supporting the nation while undermining the regime's socialist principles.

The book makes a strong if indirect case for the ability of North Koreans to begin to prosper remarkably quickly should the regime either change its ways or be replaced by one which would allow their entrepreneurial talents fuller expression. Lim doubts that this is going to happen very quickly or very soon, as North Korea is unlikely to shift to a full China or Vietnam-style opening up. More likely is gradual modification of policies sufficient to obtain the raw materials to keep the economy ticking over at a very modest pace.

The book is basically a rather dry analysis of the twists and turns of Pyongyang's economic policies over the years, from its early focus on heavy industry and obsession with self-reliance through periods of giving more priority to light industry. It looks at the 1970s efforts to reduce dependence on the Soviet bloc and COMECON by developing economic relations with the west ending in debt default in the 1970s and return to reliance on socialist countries for trade – though this was never more than 10 percent of its GDP.

But the main theme is how individual and group level entrepreneurship has flourished since the sudden collapse of Soviet bloc trade in 1990 when then Russian Premier Mikhail Gorbachev demanded that trade with friendly socialist countries shift from barter to hard currency and aid came to a standstill. In the following decade, steel output fell by two thirds, oil imports by 75 percent, overall industrial output by 50 percent. Government revenues, closely linked to these industries, fell drastically. Trade collapsed and mechanized agriculture contracted.

Reforms since that time, notably the currency and price reforms introduced in 2002, have, says the author, simply been recognitions of the failure of the centrally planned, modern economy and acceptance of market practices which were illegal but had become the main means by which the economy operated at all.

At every level, the extreme shortages produced a spirit of entrepreneurship without which economic activity would have fallen even more steeply. Firstly the government had to recognize some private plots be allowed for non-grain crops, then famine conditions forced it to allow some private grain production as well where productivity was much higher. Over time the rules have become so stretched that significant land holdings by small groups or even individuals have emerged and revenue from these has become an important source of government finance.

Likewise too, the government was forced to acknowledge the sprouting of home-operated factories making consumer items like clothes and shoes when large scale industry collapsed because of material shortages. These activities in turn further undermined the state system because they became part of the competition for scarce materials which would be bought or stolen from official sources.

This trend of getting around a now dysfunctional planning system then spread to large parts of the formal state sector. Smart managers who wanted to keep their factories operating and meet their production or income targets had to find ways of getting enough materials themselves. Again this meant either through developing relations with other managers by-passing the official system, a practice which itself has now had to be legalized. The other route is outright bribery which remains illegal but has become commonplace, or by using machinery and materials to make and sell goods covertly.

Efforts to tackle corruption have further undermined the socialist system. The author correctly notes that in a mature socialist system cadres must be given incentives if corruption is to be checked. The main incentive then becomes to allow them to engage in private economic activity.

The boundary between official and unofficial becomes increasingly blurred. Cadres also want to accumulate real resources to protect themselves in the event of political change, meanwhile also positioning themselves as quasi-capitalist managers rather than just party functionaries. They see a future for themselves as "red capitalists" in the Chinese model.

Foreign trade, particularly with China, has also become a major source of entrepreneurial profits for North Koreans with links across the border. Some trade, notably smuggling of Japanese and other foreign goods into China, is especially lucrative. But state organs engaged in foreign trade are also involved in schemes of quota manipulation and false pricing to generate income.

An unofficial money-lending sector has also developed to bypass a state banking system which only lends to state enterprises. And a variety of service industries have grown up completely outside the state sector. These range from food stalls to photo studios and a sauna – operated as a sideline by a Pyongyang bakery.

All this activity further undermines the role of the state which now lives off the unofficial sector by imposing taxes. Officially 30 percent of consumer goods and 5 percent of producer goods are allowed to be marketed outside the state sector but in reality the figures are very much higher. The author estimates that 60% of grain and 70% of other basic essentials are sold in free markets.

The 2002 reforms attempted to suppress free markets by raising state level prices close to those prevailing in the markets. But this had limited success because shortages are endemic and the rationing system prone to leakages – not least via a military favored with extra rations.

The "military first" principle still rules at all levels and the government has merely attempted to modify the socialist system to accommodate the market reality. But the economy and the state itself has become ever more reliant on the unofficial sector.

This does not necessarily mean that with political change North Korea will become a vigorous entrepreneurial economy. Many of the same activities existed in the Soviet Union but subsequently led more to criminality than to capitalism. If the existing system collapsed as quickly as the Soviet one, similar chaos and banditry could result. On the other hand is deliberate harnessing of these forces accompanied by an opening up to the world which would enable a flow of materials and capital could well harness the entrepreneurial instincts which have been fostered in North Korea by nearly 20 years of desperate struggle for survival.