The economics of Korean reunification

With North and South Korea in the process of arranging a fourth summit, talk of uniting the two countries is getting louder. However, much needs to occur before a reunification could be considered economically viable

North Korea’s supreme leader Kim Jong-un walks with South Korean President Moon Jae-in following the Inter-Korean summit in September 2018 

Considering North and South Korea are still officially at war – the armistice signed in 1953 brought an end to hostilities but did not deliver peace – relations between the two countries have been surprisingly cordial of late. Since April 2018, three inter-Korea summits have been held involving the South’s president, Moon Jae-in, and the North’s supreme leader, Kim Jong-un.

Most significantly, the April summit saw the two heads of state sign the Panmunjom Declaration, which called on both leaders “to jointly endeavour to strengthen the positive momentum towards continuous advancement of inter-Korean relations as well as peace, prosperity and unification of the Korean Peninsula”. It no longer seems as outlandish as it once did that the two Koreas could become one in the foreseeable future.

Except, nothing is straightforward when North Korea is involved. Although the three 2018 summits were promising, in May of this year Kim oversaw new ballistic missile tests that some have adjudged to be an act of provocation. With such a leader in charge, it will remain difficult to predict unification with much certainty.

Putting political obstacles to one side, the economic difficulties of uniting North and South Korea remain significant

Putting political obstacles to one side, the economic difficulties of uniting North and South Korea remain significant. Disparities in wealth and productivity are substantial and bridging them is likely to be burdensome, chaotic or both. Equally, the enduring economic benefits that would become available to the Korean peninsula may make such short-term pain worthwhile. So far, the pros and cons of unification are merely hypothetical talking points, but they may not stay that way forever.

When two become one
Ever since the Cold War split Korea in two, people have been making noises about how it might be put back together again. Those noises have been getting louder of late; back in April, President Moon declared that he was ready for a fourth summit with Kim.

The talks would primarily focus on curtailing the North’s nuclear weapons programme, but Moon also declared his hope that they would become “a stepping stone for an even bigger opportunity and a more significant outcome”. Such ambitions are to be applauded, but they do not necessarily mean unification is just around the corner.

“I think in the near term, the likelihood of unification is very low,” Troy Stangarone, Senior Director at the Korea Economic Institute, told World Finance. “Essentially there are three different ways unification could come about: one would be through the collapse of the North Korean regime; another would be through a gradual, consensual process that would take place over time; and the third would be if war was to break out.”

Currently, both collapse and war appear unlikely, although reports of food shortages and Kim’s volatile personality mean that neither can be completely ruled out. However, if the dialogue between the two countries continues to strengthen, economic engagement could be ramped up and, eventually, a move towards a unitary state may not seem so far-fetched. It is likely to be a decades-long process, but it is one that is arguably already underway.

One of the positive developments to come from recent summits is a commitment by both Korean states to revamp the North’s ramshackle transport infrastructure. In late November, a train carrying a railway inspection team travelled from Dorasan station, just 650m from the Korean Demilitarised Zone, into North Korea in order to begin a joint survey of around 1,600 miles of the North’s railways. It was the first train journey between the two countries for a decade, and will hopefully act as a prelude to reconnecting transport links between the states.

A few weeks later, an official groundbreaking ceremony took place at Kaesong, North Korea, to mark the start of greater infrastructural engagement across the Korean Peninsula. But for now, that’s as far as the two countries can go: UN and US sanctions mean the actual reconstruction work that railways in the North desperately need is prohibited.

Economic alignment
The economic ramifications of Korean unification would depend heavily on how, and how quickly, the North and South were reunited. Ideally, the process would be a gradual one that is underpinned by bringing the two countries’ respective economies into closer alignment.

Although economic data for North Korea is scant, estimates by Trading Economics put the country’s GDP at $16.12bn in 2015, significantly smaller than the South’s $1.38trn in the same year (see Fig 1a and 1b). Structural differences in the two nations’ economies may be even more challenging to overcome: while South Korea boasts a market-based economy governed by internationally recognised standards, North Korea has multiple economies.

There are informal markets known as jangmadang that developed during the famine of the 1990s; according to the Institute for Korean Integration of Society, they account for approximately 60 percent of the North’s economy. Alongside these is an authorised state economy that largely consists of exporting raw materials, like seafood, coal and iron ore, to China. This part of the economy has been hit hardest by economic sanctions: last year, North Korea’s exports to China fell 88 percent, while total exports dropped by 63 percent in 2017 (see Fig 2).

The two North Korean economies, however, are not entirely distinct from one another. A lot of resources used by the jangmadang are informally lent from state-owned businesses in exchange for a portion of the profits. According to a recent paper by Hwang Jin-hoon of the Korea Development Bank in Seoul, “state power and the up-and-coming capitalists have formed a symbiotic relationship” that has blurred the line between private enterprise and the centrally planned economy. Still, more needs to be done if North Korea is to complete a formal transition to a market economy. This must occur before any unification efforts can proceed, and South Korea may need to lend a helping hand.

The South certainly has a great deal of knowledge concerning economic development. When the Korean peninsula split in the 1950s, both the North and South had similarly sized economies. Today, as well as being home to world-famous businesses like Samsung, South Korea has the 11th-largest economy in the world. It would surely take a hands-on role in preparing the North for economic reintegration.

“The hope would be that unification would take place over time, and the South would invest in things like upgrading the rail network, repairing the roads and rebuilding the energy infrastructure,” explained Stangarone. “Of course, alongside South Korea, the US, China, Japan and others may also contribute. Regulatory issues need to be addressed to start opening the economy up, and South Korea could provide the capital and advice needed.”

Previous South Korean leaders have shown themselves to be more than willing to offer assistance to North Korea’s ailing economy: Lee Myung-bak, South Korea’s president between 2008 and 2013, had ambitions to raise the North’s per-capita income to $3,000 a month and, going further back, President Kim Dae-jung’s Sunshine Policy was aimed specifically at reducing the economic gap between the two nations. More initiatives like these will need to be implemented by Moon and his successors if there is to be any hope of creating a single Korean state.

If the dialogue between the two countries continues to strengthen, economic engagement could be
ramped up

Better together
While it would undoubtedly create difficulties in the short term, a united Korea would eventually become a major player on the world stage. A 2009 Goldman Sachs report predicted that the GDP of a unified Korea would exceed that of all the current G7 nations except for the US within 30 to 40 years. Despite the economic chaos that currently exists in the North, its supply of cheap labour and raw materials would provide a growth boon when added to the existing infrastructure present in the South.

“South Korea would be able to provide capital investment and managerial know-how to the North,” Stangarone said. “From the perspective of the South, the North brings a few different things to the table that would be advantageous. One would obviously be a lower-wage workforce that would help to deal with rising wage pressures. Also, a lot of the natural resources on the Korean peninsula are actually on the northern half, so whether it is coal, iron ore, rare earth minerals – essentially all of those minerals are in the North.”

In the years that follow reunification, it is highly likely that North Korean wages would rise substantially, creating a larger consumer market on the Korean peninsula. Collectively, the population of a combined Korea, based on current demography, would total roughly 75 million, creating a sizable domestic market for private businesses to target.

The restructuring of both states’ economies would also help remove a number of structural inefficiencies. Military spending could be significantly reduced, as well as diplomatic expenditure. A large number of citizens would be freed from relatively low-productivity jobs in the armed forces and released to take up employment that contributes more heavily to the national income and tax receipts.

Today, growth appears to be the number one goal for most economists and government ministers. Despite the South’s many successes, a slowdown is predicted in the near future, driven primarily by low productivity and an ageing population. In the North, moves to modernise the economy have had only limited impact – unification would certainly be one way of delivering growth for the entire peninsula.

Sharing the spoils
It’s easy to get carried away with headline-grabbing GDP figures, particularly when they do not tell the full story. While reunification would provide a boost to the Korean peninsula as a whole, individual Koreans will not necessarily benefit.

How the economic spoils will be shared is sure to depend on how unification is handled politically, but if the free movement of labour is allowed – or if South Korea’s chaebols are able to relocate to the North – then low-wage South Koreans will suddenly face a lot of added competition. This would create significant downward wage pressures that businesses would benefit from, but employees might not. These challenges would also have wider ramifications.

“Unification would place a significant economic strain on the South Korean state and would occur at the same time as the country’s population gets older,” Stangarone said. “South Korea, similar to Japan but to a lesser degree, is going through its own demographic changes. It’s going to be a super-aged society in the near future and it also has the highest level of old-age poverty in the OECD, with 45 percent of South Koreans over the age of 65 living below the poverty line. Taking care of the elderly is going to cause a lot of strain in the next few decades. So, there is going to be a potential resource conflict over how you take care of older South Koreans while investing in the North at the same time.”

Numerous studies have been authored looking at how North Korea’s economy can be brought closer in line with its partner to the south. Often a 60 percent per-capita income target is deemed to be an appropriate goal, but even this would require significant financial expenditure on the part of South Korea – upwards of $1trn. Alternatively, if income convergence were to be achieved purely by labour migration, three quarters of all North Koreans would have to move south of the border.

How exactly the government of a united Korea handles this strain will be vital. It could choose to reduce government spending by cutting back on welfare programmes, or at least restructuring them, but there is no guarantee that either method would alleviate the predicted social problems. Politicians should prepare for a backlash from those set to lose out as a result of unification.

The balance of power
Uniting the Korean peninsula would have impacts that stretch far beyond its geographic vicinity. It would remove a buffer state from the Chinese border and raise questions about what a unified Korean state would look like in terms of its foreign and security policies. It also poses questions for Japan, which has historically had a tense relationship with Korea.

Beyond China and Japan, Russia, the US and many other states would also have a stake in what sort of country a united Korea would be. This would not only have an impact on what kinds of economic priorities a united Korea would hold – it would also affect who the country is able to trade with.

If income convergence were to be achieved purely by labour migration, three quarters of all North Koreans would have to move south of the border

“From a geoeconomic standpoint, a unified Korea starts to change things,” Stangarone noted. “Firstly, Russia, which has long looked to be able to sell a lot of its resources from the Russian Far East, would now have the ability to do so. At a recent summit, [Russian President Vladimir] Putin and Kim talked about this – running a pipeline down to South Korea and eventually exporting to Japan as well. So, you would create new energy link-ups. There’s also been talk about an East Asia energy grid that connects the entire region – so you could mix in not only fossil fuels but renewable energy as well.”

Taking an even broader look, a unified Korea would have vastly increased potential in terms of imports and exports. Connecting the peninsula by rail would allow goods to be shipped all the way from Busan to Rotterdam unimpeded. Equally, such a move would open up what other countries could ship to the region and enable North Korea to become integrated within regional supply chains. Unification would recalibrate the entire economic architecture in the Asia-Pacific region.

Speculate to accumulate
Understanding how a united Korea would fare is an impossible task with so many variables to consider. To give it their best shot, many analysts have looked at how previous unification efforts from around the world have unfolded, including Germany and Vietnam. Such comparisons, however, are only of limited utility.

Relations between the two Koreas are far more acrimonious than they ever were between the Federal Republic of Germany and the German Democratic Republic. There was no German civil war and, although tensions between the two parties did abound, East Germany was far less economically isolated than North Korea is today. What’s more, in relative terms, North Korea’s economy is much worse off than East Germany’s was in 1990.

“I think the comparisons are useful in the sense of getting a general idea of the sort of things that the two Koreas should be considering,” said Stangarone. “If unification was to occur, [would] North Koreans effectively be second-class citizens in their own state or will the South try to make them as equal as they can as quickly as possible, at least in terms of benefits, access to capital and things like that? There is also the question of how to deal with state-owned enterprises. What sort of things do you want to do to reform the markets and integrate them into the broader economy? Comparisons with Germany are useful for identifying the kinds of challenges that are likely to arise, even if they don’t tell the whole story.”

Instead of looking at Germany, Eastern European states that have transitioned from communist, state-run economies to market economies may work better as proxies for what North Korea is likely to go through. North Korea is essentially a post-industrialised or deindustrialised state: a significant part of the population (about 60 percent) is actually living in urban centres. This is why comparisons with Vietnam often fall short.

Vietnam was a rural economy at the time when its northern and southern halves were reconnected. In fact, Vietnam is still more rural than North Korea. Other than the fact that both were Asian, communist states, the similarities start to fall away after a little probing beneath the surface. Every country faces its own unique challenges, which is exactly why the Eastern European economies provide such useful test cases for North Korea. They also went their own way, to an extent, and some proved more adept at transitioning to a market economy than others. Each provides a case study worth considering.

Perhaps the biggest hurdle to unification is the Kim regime and its volatile figurehead, although another is that, while many Koreans are sympathetic to reunification, it is not a priority for everyone. For the young, who have always known a divided peninsula, it is far less important than tackling unemployment figures or living costs. In fact, according to surveys by the Asan Institute, around a quarter of South Koreans in their 20s have little interest in unification.

Nevertheless, those in power do. For South Korean President Moon, any progress he makes towards reunification would cement his place in his country’s history. More than that, if he or any of his successors do manage to bring the two Koreas together, they will have a huge impact on the millions of North Koreans currently living in poverty, the families on either side of the border that thought they would never be reunited, and the economic landscape across the Korean Peninsula – and, indeed, the entirety of Asia.