S&P Highlights Costs of Korean Reunification

According to the Financial Times:

John Chambers, managing director for sovereign ratings at S&P, told reporters in Seoul that state collapse in North Korea was just a matter of time and could cause a bigger shock to the South’s economy than the 1997 Asian financial crisis.  He urged South Korea to build financial reserves to cope with the cost of reunification.

North Korea has started to reform its rigid command economy in recent months by liberalizing prices and wages but S&P said the regime was too rigid to emulate the market openings adopted by communist governments in China and Vietnam.

“Although some other Asian nations that used to have centrally planned economies have successfully moved to a market-based system, the North Korean leadership probably lacks the flexibility and the vision to undertake such a change,” said S&P in a statement. “Unless South Korea has substantially built up fiscal reserves in the meantime, its [credit] ratings would fall from their current level upon sudden reunification of the peninsula.”

Analysts have been predicting collapse of the North Korean regime since 1989, when communist states started to fail in eastern Europe. The state has proved more resilient than many expected, surviving a famine in the mid-1990s that killed at least 1 million people and recording modest economic growth over the past three years. However, dwindling international food aid to the country and U.S. attempts to block some of the regime’s most important sources of cash, such as exports of arms and drugs, has prompted fresh doubts about the durability of the world’s last Stalinist state.

Mr. Chambers said reunification with the North could cost South Korea up to 300 percent of its annual gross domestic product, considering the reconstruction and welfare provisions that would be necessary.

South Korea’s policy of engagement with its neighbor – including humanitarian aid and economic co-operation – is designed to prevent economic failure in the North and encourage gradual reform of its economy and political system.

In a recent report, Dominique Dwor-Frecaut, economist at Barclays Capital, said state failure in North Korea need not lead to credit rating downgrades in the South. She said the cost of reconstruction would be spread over many years and would be offset by the economic benefits of reunification.

“The Korean peninsula could become a new Asian economic powerhouse if it could associate Chinese-level labor costs in the North with OECD-level financial and legal systems and R&D in the South,” she said.


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