The crippled economy of North Korea is the direct product of its political system, a communist dictatorship. Severe economic problems are the legacy of years of Soviet-style development and controls that have ceased to function efficiently in a free market oriented world. Korea was annexed by Japan in 1910. In 1945, at the end of World War II when the Japanese surrendered to the Western allies, Korea was divided into North and South under the control of the Soviet Union and United States, respectively. The division, marked at the 38th parallel, was made permanent in 1948. North Korea, under the dictatorship of President Kim Il Sung, emerged as an autocratic, state-controlled nation. Despite the establishment of an extensive infrastructure and the introduction of mechanized agriculture, the government's emphasis on heavy industry at the expense of light manufacturing, service, and agriculture, and the isolationist nature of the regime, have cost the country dearly. North Korea has accumulated many economic problems, experiencing years of negative growth in its gross domestic product
The North Korean economy remains in decline, and the country is unable to meet its basic needs in food and consumer goods . It produces little for export, and its international isolation has limited its opportunities for trade or financial assistance, resulting in a trade deficit of US$440 million in 2000 and a growing dependency on foreign aid. High expenditures on defense (estimated at between 25 and 33 percent of GDP in 1998) has worsened the situation, while floods and drought between 1995 and 1997 devastated the country's agriculture and led to famine.
North Korea established its economy with assistance from the major communist powers, the Soviet Union and China. Until 1991, both regimes provided assistance in funds, equipment, training, and technology, enabling North Korea to advance more rapidly than South Korea during the 1970s. The government has also received loans from Japan, France, West Germany, Sweden, and Austria. By 1997, the country's foreign debt amounted to US$11.9 billion, of which US$7.4 billion was owed to China and Russia. Although hampered by financial problems in paying its debts, the government has refused to pay back loans even when it has been able to do so. It has acquired poor status in the international community, depriving the country of foreign loans. This is a serious situation for a country that requires substantial investment to modernize and expand its crumbling infrastructure, heavy industry, agriculture, light industry, and services.
The deteriorating economy has inclined the North Korean leadership to consider shifting to the Chinese model of socialism , which leaves room for a degree of free enterprise (though not a corresponding political and social openness). In 2000 President Kim Jong Il (who replaced his father upon his death in 1994) indicated a shift, reflecting constitutional revisions made in 1998. These revisions allow increased scope for private property ownership and the establishment of farmers' markets. By tolerating the expansion of these markets and increasing trade with China, North Korea's government has sanctioned the creation of a private sector . With its politically conciliatory hosting of official visits from South Korean President Kim Dae-jung and U.S. Secretary of State Madeline Albright to P'yongyang in 2000, North Korea hoped to create ties that would help in restructuring its economy. South Korea has offered to rebuild infrastructure in the North and to invest in its economy.