Asia-Pacific News

Inside North Korea's not so isolated, free-enterprise economy

Kim Jong Un and Dennis Rodman at a basketball game in North Korea in February 2013
Source: HBO

As Dennis Rodman plans to return to North Korea this week with hopes of securing the release of a captive American, the former NBA star's trip brings the peninsula into focus, still divided since the Korean War 60 years ago. But North Korea and its economy are far from isolated. Growing pockets of private enterprise are thriving, as the country's fate is increasingly tied to China.

Even in North Korea—the world's most totalitarian state—grass-roots market forces have taken root.

Entrepreneurs conduct cash transactions in markets. Some enterprises are large and span industries and specialty goods—fishing, transportation, restaurants and medical herbs. "The average North Korean family derives some three-quarters of its income from the private—that is, capitalist—economy," said Andrei Lankov, history professor at Kookmin University in Seoul.

North Korea's foreign trade also is almost entirely with China. And thanks to Chinese middlemen, who serve as brokers between North Korean state trading firms and China-based companies, North Koreans no longer have to reach out globally to secure goods—everything from alcohol to agriculture equipment, said John Park, a Korean specialist. Just phone your China-based fixer.

So take a closer look at North Korea's underbelly and you'll find pockets of capitalism. "Pretty large pockets," Lankov said.

(Read more: Korean culture may offer clues in Asiana crash)

A father and daughter on a bicycle in Rajin, North Korea.
Mark Edward Harris | Getty Images

Entrepreneurs in the 'Hermit Kingdom'? You bet

Whether we're talking about Cuba or other political hot spots, private enterprise as a survival tactic is not new. But what's unique about North Korea is its neighbor to the north. As China's economy has grown, its influence has spilled into North Korea.

The initiation of a state development bank in early 2010 is rumored to have been initiated by the Chinese, frustrated by the degree of corruption in North Korea and fearful of risks facing Chinese investors, according to Stephan Haggard and Marcus Noland. They explore North Korea in their blog and book, "Witness to Transformation: Refugee Insights into North Korea."

Quick history lesson here. North Korea—as large as Pennsylvania—sometimes is called the "Hermit Kingdom." It has largely been isolated from the world since 1945, at World War II's close. About 36,000 Americans were killed during the Korean War, from 1950 to 1953, and a physical border was created between the communist North and democratic South. The border today is still the most militarized region in the world.

Amid this life-and-death scenario, North Koreans—from housewives to the well-connected elite—are managing an existence with discreet private-economy practices. If you visit a North Korean open market, for example, you'll find barter has given way to cash-based deals. Transactions are often in foreign currency—the Chinese yuan in particular, said Lankov, who highlights the country in a new book, "The Real North Korea: Life and Politics in the Failed Stalinist Utopia."

North Korean per capita GDP in 2010 was about $1,800, on par with Ghana, according to the CIA Factbook. Economic statistics suggest that by 2005, North Korean GDP overall retreated to late-1980s levels, according to Haggard and Noland. In contrast, South Korean per capita GDP has soared from around $1,200 in the early 1960s to more than $22,000 today.

Grass-roots market forces

Grass-roots market forces emerged after a combination of political fumbles and an agrarian policy, which included terraced fields. That led to soil erosion amid torrential rains during the mid-1990s. Food rations were halted, and roughly 1.5 million North Koreans died during the famine, though estimates vary widely.

Whether we're talking about North Korea or other socialist states, when food runs out and the men are away seeking work, women look around their homes and ask: "What household goods can I sell? What can I trade?"

In North Korea's cities, markets popped up, where women earn family income. While men often work for state enterprises, some three-quarters of the market vendors today are women, Lankov said.

Around 2000, those markets were replaced by larger ones that are tacitly tolerated by authorities. "I would not describe them as 'black markets,'" said Lankov. A native of the former Soviet Union, Lankov lived in North Korea as an exchange student in the 1980s. And the markets were just beginning.

(Read more: Inside Cuba: Market economy takes hold in socialist state)

North Koreans wave flags and walk with statues of former leaders Kim Il-Sung and Kim Jong-Il during a military parade past Kim Il-Sung square marking the 60th anniversary of the Korean War armistice in Pyongyang on July 27, 2013.
Ed Jones | AFP | Getty Images

How North Korean trading companies make money

A unique feature of the current North Korean economy is the increasingly blurred line between state and private income-generating activities, according to Lankov. He originally explored this topic for NK News. This gray area is especially true for so-called foreign currency earning companies. They sell resources to China, and import consumer goods to North Korea—even cognac and Mercedes. There are roughly 200 to 250 such companies.

There has also been a group of cross-border joint economic projects. The last remaining project, an industrial complex at Kaesong, so far has failed to reopen after the North's nuclear test in February. The industrial park's fate is being watched as a barometer of North-South Korean relations.

Criminalization of economic activity

So what's the North Korean regime's response to free enterprise? Broadly it's about tolerating some market activity, while maintaining a firm grip. But Haggard and Noland note government repression has been increasing with illicit economic activity. "Illegal commercial activities" can mean time in labor camps, with severe punishments for acts such as state-property theft.

As modest markets forces take hold, there's a more striking shift among North Koreans—particularly their attitudes about getting ahead. Securing a government or party position is highly desirable, not because hard work and merit pay off, but because public office offers a platform to engage in business, according to Haggard and Noland.

Bottom line: A nascent entrepreneurial class is emerging in North Korea.

(Read more: The return of the 'opportunity' entrepreneur)

North Korea's growing threats and China
North Korea's growing threats and China

The growing China factor

Amid this basic marketization of the North Korean economy, the country has had a growing trade relationship with China. The North Korean minerals sector, for example, produces for China, Korea expert Park told CNBC in April.

China wants stability in and around the Koreas. And the continued division of the peninsula does have economic advantages for China including cheap access to mineral resources and low-cost, but relatively skilled labor, compared with China, Lankov writes.

With private enterprise, you can't help but wonder about the impact of financial sanctions, the main tool the international community has been using to strong arm North Korea toward denuclearization. Park contends sanctions may be creating unintended, reverse effects.

Sanctions are designed to raise transaction costs and make life difficult. North Korea faces various sanctions from the U.S. and United Nations. Sanctions include an embargo on the import and export of nuclear and missile technology, ban on all arms exports as well as unilateral sanctions.

But as sanctions have ratcheted up, some North Koreans and Chinese have responded by growing more sophisticated—not shutting down. "Increasingly these transactions are happening inside of China in the Chinese national economy," said Park, of Harvard University's Belfer Center for Science and International Affairs. He made the comments during a Korea Society talk in March.

"North Korean state trading companies now have the opportunity to rent the capabilities of these middlemen," Park said. "That is a function that didn't exist before."

(Read more: North Korea and China get cozier on trade)

Basketball diplomacy

But who needs middlemen or sanctions to engage North Korea, when you have a basketball-playing diplomat?

Rodman, who traveled to North Korea's capitol Pyongyang in February with a documentary film crew and some Harlem Globetrotters, said in May he was scheduled to return to North Korea Aug. 1. He wants to gain the release of Kenneth Bae, a Korean-American recently sentenced to 15 years of hard labor. Rodman did not elaborate on how he was gaining entry. In February, Rodman sat next to North Korean leader Kim Jong Un—a die-hard basketball fan, believed to be in his early 30s. They watched an exhibition game.

By CNBC's Heesun Wee. Follow her on Twitter @heesunwee