Institutional Economic Integration between South and North Korea and the Economic Impacts of Integration

• Author: Moonsung Kang,Soonchan Park
• DOI: http://doi.org/10.1111/asej.12158
• Date: 01 September 2018
• Published date: 01 September 2018

Institutional Economic Integration between

South and North Korea and the Economic

Impacts of Integration*

Moonsung Kang and Soonchan Park

Received 24 March 2017; Accepted 1 June 2018

This paper proves theoretically that bilateral trade between South and North

Korea, between whom many political barriers to trade exist, is Pareto-inefficient,

and that a Pareto-efficient situation can be achieved through the attainment of

institutional economic integration, enabled by mutual agreement between South

and North Korea. Based on our theoretical analysis, we propose a comprehensive

economic integration agreement as an instrumental framework for the gradual

integration of South and North Korea. In addition, we analyze the economic

impacts of such integration. We estimate that gradual integration would positively

affect North Korean GDP, increasing it by 3.55–4.88 percent from the baseline,

depending on the various scenarios we analyze.

Keywords: economic integration, North Korea, reunification, South Korea.

JEL classification codes: F15, F53.

doi: 10.1111/asej.12158

I. Introduction

Since the liberation of the Korean Peninsula from Japanese colonial control in

1945, there has been a gulf between the performances of the economies of South

and North Korea, ultimately resulting in South Korea’s 2016 nominal gross

national income (GNI) being 45.3 times greater than that of North Korea and

22.0 times greater in terms of GNI per capita.

1

These divergent economic per-

formances are not based on how the two countries’economic systems operate,

namely, market-oriented capitalism and centrally-planned communism, respec-

tively, but on the ultimate policy goals and the policy tools used to meet these

goals that their economic authorities have established.

2

*Kang (corresponding author): Division of International Studies, Korea University, 145 Anam-ro,

Seongbuk-gu, Seoul, 02841, Republic of Korea. Email: mkang@korea.ac.kr. Park: Department of

Economics and International Trade, Kongju National University, 56 Gongjudaehak-ro, Gongju-si,

Chungcheongnam-do, 32588, Republic of Korea. Email: spark@kongju.ac.kr.

1 See Bank of Korea, Economic Statistics System (http://ecos.bok.or.kr/; accessed 18 June 2018).

2 Kim (2012) argued that the differences in the economic performance of South and North Korea

are based on whether the economic authorities devise their policy tools to meet the goal of economic

development or to achieve other goals instead. He concluded that North Korea has ignored key ele-

ments of economic development in the process of developing its economic system to adhere to the

value of Juche (the ideology of self-reliance) that North Korea has been claiming to support.

© 2018 East Asian Economic Association and John Wiley & Sons Australia, Ltd

Asian Economic Journal 2018, Vol.32 No. 3, 257–276 257

Given the yawning economic gap between South Korea and North Korea, it

is expected that economic integration between the two countries would generate

various problems in the economic field as well as in the political, social and cul-

tural spheres. Therefore, it is important to consider the overall design of eco-

nomic integration between South and North Korea and the factors that would

affect it to reduce any turmoil, expected or not, if the process of unifying these

two countries is to be undertaken.

Therefore, the present paper aims to explore the optimal design of a process

of economic integration between South and North Korea from institutional and

theoretical perspectives. To meet this goal, the present paper assumes that the

two Koreas can integrate their economic systems gradually. This assumption is

critical because any precipitous integration would plunge both Koreas into tur-

moil, generating various problems in every single economic sector. One can

utilize key outcomes of this approach even in the case of both Koreas sud-

denly integrating with each other. However, the main results of this analysis

can be best applied when both Koreas agree to follow a gradual process of

economic integration, even if they are already unified politically.

3

This assump-

tion and approach derive from the lessons drawn from German reunification,

when Germany experienced the huge cost of rapidly integrating the economic

systems of East and West due to the populist policy of the time in West Ger-

many. This process included integration of the two currencies, even though

West Germany’s GNI was three times that of East Germany’s. In this light,

and having noted that South Korea’s GNI per capita was 22 times that of

North Korea’s in 2016, the two countries need to take a more gradual

approach, if possible, to reduce the potential for problems in the process of

reunification.

To meet this goal, Section II establishes a theoretical framework for the

analysis of the inefficiency in bilateral trade between both Koreas and provides

a theoretical foundation for any possible trade agreement between the two

countries, aimed at achieving Pareto efficiency after the adoption of a gradual

approach to the institutionalization of economic integration between South and

North Korea. Section III discusses issues surrounding the institutionalization

of economic integration between South and North Korea, and then provides

policy recommendations which would enable South and North Korea to gradu-

ally integrate the two economic systems. Section IV estimates the impacts of

this gradual integration, using a computable general equilibrium model.

Section V concludes.

3 This gradual approach could be criticized for being unrealistic because it is unlikely to be

adopted, and, in fact, both Koreas would likely integrate with more urgency, just as Germany did.

However, this gradual approach could suggest various implications for the process of reunification

because it encompasses cases in which both Koreas can pursue economic integration after political

reunification or agree to pursue economic integration gradually, even before political reunification.

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