Reunification costs

According to Peter Beck in the Wall Street Journal:

The cost [of reunification] will depend in large part on how that transition unfolds. The best of the plausible scenarios would see Korea following the German path of sudden and bloodless reunification. The worst outcome would be violence akin to the unification of Vietnam or Yemen. A middle road would resemble the chaotic post-Communist transitions of Romania and Albania. This seems most likely given the similarities between Kim’s autocratic, autarkic rule and Nicolae Ceausescu’s and Enver Hoxha’s reigns in their countries.

Any of these outcomes is sure to be expensive because the North will require massive investments to build a modern economy. The economy collapsed in the 1990s amid a massive famine that likely killed hundreds of thousands. Infrastructure, starting with the power grid, railway lines and ports, will require tens of billions of dollars to build or upgrade. Few factories meet modern requirements and it will take years to rehabilitate agricultural lands. The biggest expense of all will be equalizing North Koreans’ incomes with their rich cousins in the South, whether through aid transfers or investments in human capital like education and health-care.

Even the best-case German model will cause heartburn in South Korean officials. Despite the $2 trillion price tag West Germany has paid over two decades, Bonn had it relatively easy in the beginning. East Germany’s population was only one-quarter of the West’s, and in 1989 East German per capita income was one-third of the West. The two Germanies also had extensive trade ties.

In contrast, North Korea’s per capita income is less than 5% of the South’s. Each year the dollar value of South Korea’s GDP expansion equals the entire North Korean economy. The Northern population is half the South’s and rising thanks to a high birth rate. North and South still barely trade with each other—China-Taiwan trade is 54 times greater in dollar terms than inter-Korean trade. That the North is starting from so far behind means even more resources will be needed than Germany required to achieve convergence in standards of living.

More than a dozen reports by governments, academics and investment banks in recent years have attempted to estimate the cost of Korean unification. At the low end, the Rand Corporation has figured on $50 billion. But that assumes only a doubling of Northern incomes from their current level, which would still leave incomes in the North at less than 10% of the South. At the high end of these projections, Credit Suisse estimated last year that unification would cost $1.5 trillion, but with North Korean incomes rising to only 60% of the South. I estimate that raising Northern incomes to 80% of Southern levels—which would likely be a political necessity—would cost anywhere from $2 trillion to $5 trillion, spread out over 30 years. That would work out to at least $40,000 per capita if distributed solely among South Koreans.

All of this leads to the question of who would foot the bill. China is the greatest supporter of the current regime in Pyongyang, with trade, investment and unconditional economic assistance worth $3 billion a year. Yet even if that flow continues to the Northern part of a reunified Korea (it most likely would not), it will be a fraction of the $67 billion a year that would be needed to equal $2 trillion over three decades. After South Korea, Japan would become the largest source of aid, but the $10 billion it is prepared to pay in reparations for having colonized the North would barely make a dent.

That leaves international institutions like the World Bank—and Seoul and the United States. It will be a wise investment to secure peace and prosperity in North Asia, but that money won’t grow on trees. Policy makers need to start considering now how they would spend it, to minimize the risk of wasting it in post-reunification confusion. And officials need to think about where they’ll secure the cash. Multinational corporations will rush in, but the bulk of the burden will fall on the shoulders of South Korea—requiring careful fiscal management, borrowing and tax increases.

Korean unification is unlikely to take place in the near future, but since it will most likely be sudden and cost trillions of dollars, the time to prepare is now.

I cannot find a copy of the Credit Suisse research on line this evening.  Here and here are a couple of media stories reporting on its findings.

Here is a link to the Rand Corporation study, “North Korean Paradoxes,”  mentioned above.

Here are some additional studies on this topic:

Global Economics Paper No. 188: A United Korea? Reassessing North Korea Risks
Goldman Sachs Slobal ECS Asia research
Goohoon Kwon, CFA
September 2009
(Post here)

Currency Conversion during Korean Unification
Brookings Institution
Yeongseop Rhee, Nonresident Fellow, Foreign Policy
January 2009
(Post here)

Prospects from Korean Unification
Colonel David Coghlan
Strategic Studies Institute, US Army

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