Some Unpleasant Arithmetic Concerning Unification

Marcus Noland

No WP96-13, Working Paper Series from Peterson Institute for International Economics

Abstract: Barring a second war on the Korean peninsula, Korean economic integration will occur, be it through successful economic reform and opening in the North, collapse and absorption along the lines of the German case, or a period of "muddling through" in which the North Korean government makes hesitant and insufficient economic reforms, and the South is drawn into supporting the North economically to stave off collapse. Whatever the mechanism, certain processes of economic integration such as increased integration of product markets, and the movement of labor-intensive light manufacturing industries from the South to North, are likely to occur regardless of the political specifics of reunification. Moreover, the divergence of economic conditions between the North and South has grown so wide, that the costs of unification, defined as the capital investment in North Korea necessary to raise incomes in the North to a sufficiently high level to choke off mass migration to the South, are so large as to be improbably attained. As a consequence, even under optimistic scenarios, there will be enormous economic incentives for North Koreans to move South. This has important implications for current South Korean domestic policy, regardless of the specific political modality under which economic integration occurs. The imperative for South Korean policy will be to minimize the burdens imposed on South Korean taxpayers by the exigency of financing the economic reconstruction of the North. This requires policies to encourage foreign capital, specifically foreign private capital, to flow into North and South Korea. Specifically, South Korea needs to continue to improve its foreign direct investment regime, as well as encourage the development of efficient domestic bond markets of all maturities which can be used to mobilize large sums of capital when the need arises. Creating this capacity to mobilize global private capital quickly will be particularly important if economic integration occurs through Northern collapse and the extension of South Korean laws and institutions throughout the unified Korea.

Date: 1996
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