Modeling the Economic Impacts of Korean Unification

• Author: Cheol Jong Song,Jong Wha Lee,Weifeng Liu,Warwick J. McKibbin
• Date: 01 September 2018
• DOI: http://doi.org/10.1111/asej.12160
• Published date: 01 September 2018

Modeling the Economic Impacts of Korean

Unification*

Warwick J. McKibbin, Jong Wha Lee, Weifeng Liu

and Cheol Jong Song

Received 24 March 2017; Accepted 1 June 2018

This paper explores the economic impacts of Korean unification on North and

South Korea. It presents a new consistent database on macroeconomic, sectoral

and trade data, and an input–output table for the North Korean economy, and then

incorporates it in a global intertemporal multi-sector general equilibrium model.

Assuming hypothetical scenarios such as North Korea’s reform and gradual con-

vergence, its sudden collapse and immediate unification, and chaos and crises in

both Koreas, we quantify the consequences of Korean unification on economic

activity, trade and capital flowsin the two Koreas. The results highlight the impor-

tance of the unification processes and of alternative policy responses in both Kor-

eas to the economic impacts of unification.

Keywords: convergence, dynamic general equilibrium, economic integration,

economic growth, Korean unification, North Korea.

JEL classification codes: F15, H77, O19, O23, O53.

doi: 10.1111/asej.12160

I. Introduction

There is significant uncertainty and concern about the current situation and pros-

pects in the Korean Peninsula. Amid its economic hardship, North Korea

launched its nuclear weapons program and is highly unlikely to denuclearize, at

least in the immediate future, despite harsh sanctions by the USA and the United

Nations. Looking into the economic and political future of North Korea is

highly speculative at this moment. In the immedi ate future, no one would expect

*McKibbin (corresponding author): Crawford School of Public Policy, Australian National Uni-

versity, Acton ACT 2600, Australia. Email: Warwick.McKibbin@anu.edu.au. Lee: Department of

Economics, Korea University, 145 Anam-ro, Sungbuk-gu, Seoul 02841, Korea. Liu: Crawford

School of Public Policy, Australian National University, Acton ACT 2600, Australia. Song: Korea

Institute for Health & Social Affairs, Building D, 370 Sicheong-daero, Sejong City 30147, Korea.

The authors thank Michael Burda, Marcus Noland, Rod Tyers and an anonymous referee of this

journal for helpful comments. We also thank participants at the workshops at the Australian National

University, the Bank of Korea, the Brookings Institution and Korea University for useful comments

and suggestions. This research is funded by a grant from the Australian Research Council #

DP150103821. The views in this research are those of the authors and do not necessarily reflect the

views of the organizations with which they are affiliated.

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

Asian Economic Journal 2018, Vol.32 No. 3, 227–256 227

any significant change in North Korea. The North Korean leaders will likely

continue current policies, obstinately avoiding domestic reforms and developing

nuclear weapons and long-range missiles. Although it is a slim possibility, North

Korea could adopt serious market reforms and open up its economy, which

could lead to gradual and peaceful unification. On the other hand, the North

Korean regime may collapse, but it is hard to predict when and how this col-

lapse would happen. No one expected the fall of the Berlin Wall and the Ger-

man reunification or the end of the Vietnam War and the sudden unification of

North and South Vietnam until they happened.

This study quantitatively assesses th e impacts of Korean unificatio n on

North and South Korea an d the rest of the world under three hypoth etical

scenarios, including (i) North Korea’s reform and gradual convergence,

(ii) North Korea’s sudden collapse an d immediate unification; and (iii) chaos

and crises in North and Sou th Korea. Regardless of th e scenarios, Korean

unification would have far-reaching political , economic and strategic cons e-

quences not only in the two Koreas but in n eighboring economies in A sia

and the Pacific.

There are many studies suggesting various views on the future of North Korea

and consequences of Korean unification. One major branch of the literature con-

structs general equilibrium models for North Korea to simulate unification sce-

narios.

1

Noland et al. (2000) use a computable general equilibrium model to

analyze economic integration between North and South Korea. They show that

product market integration generates large welfare gains for North Korea, in

contrast to only a trivial gain for South Korea. Bradford and Phillips (2005) and

Bradford et al. (2011) construct a dynamic general equilibrium model to exam-

ine the impacts of economic reform and unification of North and South Korea.

Their results suggest that the gains for North Korea in all scenarios are dramatic

in the short run as well as in the long run. Funke and Strulik (2005) construct a

two-region endogenous growth model in which the productivity is determined

by productive public capital. They argue that with fiscal transfer from South to

North Korea, the productivity level of North Korea can increase quickly, reduc-

ing its gap with that of South Korea. St. Brown et al. (2012) also build a growth

model of productivity catchup, and show that the economic consequences of

unification hinge critically on speed of productivity convergence, labor migra-

tion from North to South Korea, and capital flows from South to North Korea to

South Korea.

The present study contributes to this line of literature with a particular focus

on the linkages between the North Korean and South Korea economies and the

world economy and the dynamics of adjustment to economic reform and unifica-

tion, with various unification scenarios. We construct a new consistent database

of macroeconomic, sectoral and trade data (including an input–output table) for

1 Lee and McKibbin (2018) provide a complete review of the literature on estimating the eco-

nomic impacts of Korean unification from an economic perspective.

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