North Korea’s Economic Integration and Growth Potential

• Author: Ju Hyun Pyun,Jong‐Wha Lee
• Published date: 01 September 2018
• Date: 01 September 2018
• DOI: http://doi.org/10.1111/asej.12157

North Korea’s Economic Integration and Growth

Potential*

Jong-Wha Lee and Ju Hyun Pyun

Received 24 March 2017; Accepted 1 June 2018

The growth projections based on cross-country evidence show that North Korea

could achieve higher economic growth in the long run if it embarks on substantial

policy reforms toward a market-oriented and open economy. Using an empirical

gravity model of trade and direct investment, we forecast that, when the two

Koreas pursue economic integration and cooperation without military conflicts,

North Korea’s trade with South Korea can increase by up to 36 percent of North

Korea’s GDP and its foreign direct investment (FDI) flows from South Korea by

up to 6 percent of GDP. Overall, by promoting trade and FDI integration with

South Korea, North Korea can boost its GDP growth by approximately 3 percent-

age points per year. Combined with a market-oriented reform, the North Korean

economy could grow by approximately 4.7 percent per year over the coming

decades. Conversely, if more rigid sanctions imposed on North Korea become

effective, its trade and investment will decrease and its GDP growth rate is

expected to fall by approximately 2 percentage pointsper year.

Keywords: economic growth, trade, foreign direct investment, integration,

North Korea.

JEL classification codes: P27, P33, O11.

doi: 10.1111/asej.12157

I. Introduction

Korea commemorated its 70th anniversary of liberation in 2015. Unfortunately,

at liberation, the nation was divided into South and North and experienced war

over a 3-year period. The two Koreas have not yet established a firm foundation

for peaceful closure to the 70 years of division in the Korean Peninsula.

The economic gap between South and North Korea has widened since the

1970s, along with incessant military conflicts and political tensions. Moreover,

*Lee (corresponding author): Department of Economics, Korea University, 145 Anam-Ro,

Seongbuk-Gu, Seoul 02841, Korea. Email: jongwha@korea.ac.kr. Pyun: Korea University Business

School, 145 Anam-Ro, Seongbuk-Gu, Seoul 02841, Korea. The authors thank Creina Day, Tomo-

hiko Inui, Warwick McKibbin, Marcus Noland and Deok Ryong Yoon for their helpful comments

on an earlier draft. This work was supported by the National Research Foundation of Korea Grant

funded by the Korean Government (NRF-2008-362-A00001) and the Australian Research Council

Grant DP150103821.

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

Asian Economic Journal 2018, Vol.32 No. 3, 301–325 301

North Korea’s economy remains the most centralized and closed system in the

world today. As a result, North Koreans have suffered from devastating food

shortages and recurrent economic decline.

Overall, it seems unlikely that North Korea will recover from its plight and

achieve strong future growth with the current policies of central planning and

autarky. Wide-ranging economic reform and integration with regional and global

markets will be required for economic take-off and sustainable growth. Indeed,

North Korea’s new regime has recently introduced measures such as market

reform in the agricultural sector and promotion of special economic zones.

However, there has been no evidence that the current reforms have brought

about significant results.

One particular barrier to North Korea’s economic development is its lack of

economic cooperation with South Korea. The latter has demonstrated remark-

able economic performance since the early 1960s, achieving per capita income

of US$34,600,

1

and becoming the world’s eighth largest trading nation. Con-

versely, North Korea remains among the poorest countries in the world, with per

capita income of US$1,800.

2

For North Korea, South Korea is a natural trading

partner and should be a primary source of capital and technology. Hitherto, the

Kaesong Industrial Complex (KIC) operated as a collaborative economic devel-

opment project with around 53,000 North Korean workers under South Korean

management, and is the only case of economic cooperation between the two

Koreas. The inter-Korean trade volume was US$2bn in 2012, which amounted

to only 0.2 percent of South Korea’s total trade.

As peaceful reunification is one of the most important national goals for

South Korea, the South Korean Government is promoting initiatives to

strengthen dialogue and economic cooperation with North Korea. However, the

situation was in a stalemate as North Korea continued its nuclear weapon pro-

grams. In January 2016, North Korea launched a rocket and claimed it had con-

ducted a hydrogen bomb test. On 10 February 2016, South Korea announced

the shutting down of the KIC in retaliation, suspecting that the North Korean

regime had used hard currency earned from the joint venture to fund its nuclear

and ballistic missile programs. The USA and the United Nations toughened their

sanctions as well. However, recently there were signs of a turnaround. The

leaders of North and South Koreas met on 27 April 2018 and agreed to build up

a nuclear-free peninsula and formally end the Korean War. US President Donald

Trump and North Korean leader Kim Jong-un held a historic first summit meet-

ing on 12 June 2018 in Singapore, agreeing to denuclearization of the Korean

Peninsula and a new peaceful relationship. The possibility of North Korea ’s

1 Gross nationalincome per capita based on purchasingpower parity (PPP), in 2014, fromthe World

Bank’sWorld Development Indicators(http://data.worldbank.org/indicator/NY.GNP.PCAP.PP.CD).

2 Gross national income per capita in 2013, adjusted by PPP, from the Central Intelligence Agency,

World FactBook (https://www.cia.gov/library/publications/the-world-factbook/geos/kn.html).

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