A peaceful and market-oriented unification of South and North Korea is likely to give rise to a large investment boom in the unified Korea. An increase in domestic absorption in the unified Korea will also be necessary to achieve rapid economic development in the north and to reduce the huge migration pressure from north to south that would follow unification. This boom in demand is likely to substantially increase GDP and employment in Korea’s trade partners (Japan, the United States, etc.), most of which are currently suffering from a serious lack of demand. To realize this optimistic scenario, Korea and its trade partners need to collaborate to finance the temporary current account deficit Korea will experience after the unification. We examine these issues using a neoclassical growth model, an open macroeconomics perspective, the World Input- Output Database (WIOD), and other statistics.
The economic impact of unification on trade partners will crucially depend on how economic development proceeds in the unified Korea. Many preceding studies on the economic costs of unification, such as Song (2013) and Kang, Lee, Pyun and Hyun (2014), assume a gradual unification. However, if we assume a democratic unification process, it will be difficult to restrict migration (Wolf 1998) and the south will face strong pressure of immigration. To reduce this pressure, the unified Korea will need to try to achieve rapid economic growth in the north through large investment and income transfers. Since the present north-south population ratio is much larger than the east-west population ratio in Germany in 1989 and the present per capita GDP gap between the north and the south is much larger than that in the case of the German re-unification, Korean unification will cause a greater increase in domestic absorption than was observed in Germany.
In our analysis, we assume that the unified Korea will meet the supply shortage implied by the current account deficit through a proportionate increase in goods imports from its trade partners. Using the 2011 WIOD, we analyze the economic impact on Japan, China, the United States, and Russia by sector and by year. We take account of indirect effects (i.e., effects through changes in intermediate inputs). We conduct a standard Leontief-type analysis with the assumption of supply constraints in the unified Korea.
The analysis shows that Korea’s major trade partners will experience a substantial increase in GDP and employment. China will enjoy the largest benefits. If we sum up the increases in Japan’s GDP for the period 2015-25, the total will be US$234.5 billion. Job creation in Japan will be mainly concentrated in the machinery and leasing industries.
Korean unification also means the country’s position as a rival to Japan in the East Asian division of labor will be boosted. Empirical studies show that countries that are neighbors, countries with ethnic ties, and countries with FDI in each other tend to trade more (Felbermayr 2009, Fukao and Okubo 2011). Therefore, after unification, China-Korea trade may increase significantly. We examine how other countries will be affected if they are left behind by the deepening of trading ties between China and Korea. For this analysis, we assume that the total amount of Korea’s exports to China doubles for each good and service, but that China’s total imports of each good and service do not change. This means that other countries are crowded out by Korea from the Chinese market. Similarly, we assume that the total amount of China’s exports to Korea doubles for each good and service, but that Korea’s total imports of each good and service do not change. This means that other countries are crowded out by China from the Korean market. To focus on the crowding out effect, in this analysis we assume that Korea has sufficient production capacity to increase exports to China.
This analysis shows that the deepening of trading ties between China and Korea will have a larger negative impact on Japan than on the United States. The reason is that Korea, China, and Japan specialize in similar products. Job losses in Japan will be concentrated in a small number of sectors such as electrical and optical equipment, basic metals and fabricated metal, and leasing.
Infrastructure development is a necessary engine for regional development, and government should play an important role in such development and financing infrastructure projects. According to our simulation in the previous section, however, the domestic savings in Unified Korea are insufficient to finance this massive infrastructure investment. Therefore, Unified Korea should seek a way to procure the necessary funds from abroad.
Vast domestic savings in China and Japan should play a key role for financing North Korean infrastructure projects. Current availability of economic and social infrastructure in North Korea is highly limited. For example, the amount of electricity generated in North Korea in 2012 was only 5 % of that in South Korea. According to our estimation, the North Korea region will need to invest on average 2.9 billion US dollars per year between 2015 and 2025. Both the Japanese and Chinese governments hold a large amount of foreign currency reserves, and they might consider utilizing some portion of their reserves for investments to the North Korea region’s infrastructure funds. The funds would also be able to provide the guarantee against political, economic, and financial risks associated with the projects.
Japanese private firms may consider that participation in the Unified Korean infrastructure projects is a big business opportunity if the associated risk for the business is reduced by the international fund institution’s guarantee. Japanese firms continue to keep the international competitiveness in the participation in the overseas energy related infrastructure investment projects, especially power generation construction and managements.