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How Kim Jong Un is bankrolling his nuclear ambitions

New sanctions put North Korea's human rights under scrutiny

The international community is working to rein in North Korea through tightened sanctions after the rogue nation launched a fourth nuclear test in January. But how is leader Kim Jong Un even funding such military activity? Where is the money coming from?

A key source of income is exported commodities, namely minerals. Other sources of cash flow include exported North Korean slave labor to China, and as far away as Europe. Plus, there's a growing financial ecosystem that crosses borders and includes the use of outside commercial banks, as well as front and shell companies. This expanding financial web allows the ruling elite to move money and acquire everything, from luxury goods to weapons of mass destruction components, according to United Nations documents, congressional testimony and research by North Korea experts.

Kim Jong Un
KCNA | Reuters
Kim Jong Un

For years, confronting a problem like North Korea has fallen under key talking points — security and denuclearization, financial sanctions and human rights abuses. Now, after the nuclear test and a long-range rocket launch earlier this month, these issues are evolving and overlapping with growing urgency.

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"I think the countries of the world have to have a multiple approach to the issue," said Michael Kirby, chairman of the United Nations Commission of Inquiry on Human Rights in North Korea. Kirby made the comments last week in Washington.

Kirby, a former justice of the Australian High Court, authored a landmark U.N. report in 2014 that found wide-ranging human rights violations. The report accused the North Korean regime of "crimes against humanity." An estimated 80,000 and 120,000 political prisoners are detained in four political prison camps, akin to modern-day gulags.

"We can't expect North Korea to bargain its way out of the current attraction to nuclear weapons," Kirby told CNBC.com. "We have to continue to prepare for rendering accountable those who defy humanity and defy the institutions of humanity which include the [UN] Security Council, which has adopted very strong resolutions that North Korea has simply ignored."

Michael Kirby is chair of the United Nations Commission of Inquiry on Human Rights in North Korea, and former justice of the Australian High Court.
Kazuhiro Nogi | AFP | Getty Images
Michael Kirby is chair of the United Nations Commission of Inquiry on Human Rights in North Korea, and former justice of the Australian High Court.

More recently, North Korea's nuclear program and human rights have come under tighter sanctions.

"In fact, many of the country's human rights abuses underwrite its weapons program including forced labor, through mass mobilizations, political prisoners and overseas labor contracts, and food distribution policies that favor the military and lead to chronic malnourishment among its citizens," said Tom Malinowski, assistant U.S. secretary of state for democracy, human rights and labor. Both Malinowski and Kirby made the comments last week at the Center for Strategic & International Studies in Washington.

The Obama administration, meanwhile, believes it must address both Pyongyang's nuclear ambitions and human rights violations that have received more attention since the groundbreaking U.N. investigation. The report by the U.N. commission of inquiry accused the North Korean government of multiple offenses against its citizens, and concluded "the gravity, scale and nature of these violations reveal a state that does not have any parallel in the contemporary world."

And one key nation in the cross hairs of security and human rights is China, by far North Korea's largest financial ally. China has long sought engagement with North Korea. But Pyongyang's recent activity is testing its relationship with Chinese leadership.

China provides North Korea with the "lion's share" of financial access, said Daniel Glaser, assistant U.S. treasury secretary for terrorist financing. He made the comments in January 2015 at a House Foreign Affairs Committee briefing on North Korea's potential cybersecurity threats after the Sony data breach in 2014.

Read MoreTargeting North Korea's financial allies

On Thursday, the U.S. and China agreed on a draft resolution that would expand U.N. Security Council sanctions against North Korea, diplomats told Reuters.

"I think the Chinese are very frustrated with Kim Jong Un's behavior," Victor Cha, a longtime Korea watcher, told CNBC.com. "They don't want the regime to collapse. Saying they're caught between a rock and a hard place would be underestimating how difficult it is for them," said Cha, senior advisor and Korea chair for CSIS.

The North's economy has actually expanded under Kim — a young ruler who has been in power for roughly four years. And that's mainly due to the influx of Chinese currency.

Most average North Korean citizens rely on large black markets as a key source of food and other staples including rice, beer and school supplies. Some markets are quite large and have become fixtures in the economy. In open markets, people use Chinese yuan for transactions.

"The [North Korean] economy has grown, but that is not a function of reform," said Cha, a Georgetown University professor. "That's largely a function of Chinese money."

Exported North Korean slave labor

"It's believed that forced laborers earn North Korea between $1.2 billion and $2.3 billion a year." -September 2015 U.N. report

The largest driver of the North's economy is commodity exports including iron ore, nickel and rare earth minerals in the northern part of the Korean peninsula.

The category of minerals called rare earth is a misnomer. The chemical elements are available throughout the world, and are key to everyday tech gadgets and growing innovations, such as smartphones, high definition TVs, hybrid cars, missiles — even the extraction of natural gas known as fracking. The North's mineral exports are targeted at nearby Chinese provinces. The size and value of the minerals market are difficult to estimate because the North releases no official data about its economy.

When foreign visitors to the capital Pyongyang return, "they say the city looks pretty good," said Cha. "There are people in the streets, there's food on the shelves. But that's all largely a function of Chinese hard currency that's coming into the country because of these deals that were done on the minerals."

Read MoreWhy China wants North Korea's rare earth minerals

North Korea also exports slave labor to Africa, east and southeast Asia, the Middle East and even Europe. But the vast majority of the workers are employed in China and Russia.

It's believed that forced laborers earn North Korea $1.2 billion to $2.3 billion a year, according to a September 2015 U.N. update on the North's human rights situation. Workers earn on average $120 to $150 a month, while employers pay significantly more to the North Korean government. North Koreans work up to 20 hours daily, with only one or two rest days a month. Daily food rations are insufficient, according to the U.N. update.

According to various studies, an estimated 50,000 workers from the North operate abroad. They are forced to work abroad in mining, logging, textile and construction industries. Host authorities allegedly never monitor the working conditions of overseas workers, according to the U.N. data.

"That is a substantial amount of money that we have reasonable cause to believe goes into bankrolling the North's nuclear and missile programs," Cha told House Foreign Affairs Committee on Jan. 13. "They are sent abroad with the sole rationale of circumventing sanctions and earning the regime currencies it sorely needs."

People work in a field just outside Pyongyang, North Korea October 8, 2015.
Damir Sagolj | Reuters
People work in a field just outside Pyongyang, North Korea October 8, 2015.

Another important source of key hard-currency income has since been recently shut down by the South Korean government, the Kaesong industrial complex between the two Koreas. The joint economic complex opened in 2004 with hopes of economic cooperation and reconciliation.

But over the past decade, South Korean companies have invested some $900 million into the complex, said Thomas Byrne, president of the New York-based Korea Society. By comparison, South Korean companies have invested around $6 billion in Vietnam in just the first 10 months of 2015.

The assumption was foreigners would come in and invest in the region. "Backward linkages to the North Korean economy never materialized. The Kaesong industrial complex remained an enclave sealed off from North Korea except for the labor input into production," said Byrne, who previously worked at Moody's Investor Services with a focus on Asia and the Middle East.

And unlike other export processing zones in East Asia, Kaesong workers remained on the assembly line and didn't climb the management ranks. "The South Korean government came to the conclusion that Kaesong would not catalyze genuine economic reform," Byrne said.

Earlier this month, President Barack Obama signed a bill that tightens sanctions on North Korea, with targets including non-Korean companies that do business with the North.

A thread that emerged in a 2014 U.N. Security Council report was the North's ability to conduct business abroad. That includes the use of foreign-based individuals, front and shell companies, and joint ventures involved in legitimate business to mask illicit activities related to sourcing nuclear, ballistic missile and other weapons of mass destruction.

It appears even leader Kim — a basketball-loving leader of 25 million people — is no man on an island without connections or a vast network.

While North Korea has been under sanctions for years, the recent U.S. legislation is more pointed. It mandates frozen assets and travel bans on those engaged in trade or financial transactions that support the North's nuclear weapons program, human rights abuses and cyberthreats.

"Once you start talking about accountability and human rights, and tying it to the money they make off of human rights abuses, it leads to a much broader set of sanctions — mostly financial that penetrate the regime," said Cha.

The new sanctions are also mandatory if there's justifiable cause. Congress in the past had given the White House discretion in its actions.

Unlocking the monopoly on information

People buy inflatable clappers before a football match at the Kim Il Sung Stadium in Pyongyang October 8, 2015.
Damir Sagolj | Reuters
People buy inflatable clappers before a football match at the Kim Il Sung Stadium in Pyongyang October 8, 2015.

Beyond sanctions and other diplomatic efforts, cracking the North Korea problem likely includes unlocking the regime's monopoly on information.

Change in North Korea is incremental. Many adults who grew up and lived predominantly under Kim's father and grandfather have little or no knowledge of the outside world. But even that's changing, especially for the younger generation.

Comparable to the way Soviet dissidents hand copied banned books for distribution during the Cold War, North Korean activists and nonprofits help smuggle technology, largely from China, into the North, where the goods can be bought in black markets or just discreetly passed among friends and family. A single memory card can stores dozens of books.

Recent defector surveys indicate that before leaving the North, more than 92 percent of surveyed participants had watched a foreign DVD, more than 70 percent had access to a mobile phone, and nearly 30 percent had listened to a foreign radio broadcast, according to the State Department's Malinowski.

"I have a feeling," Malinowski said, "that there are people within the North Korean leadership who recognize that the future of their regime is uncertain, that one day the peninsula may look very different."

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