Korean Unification: Economic Adjustments under German Assumptions

Abstract

This paper explores the impact of Korean unification on North and South Korea under the hypothetical scenario that unification takes place along the peaceful but unanticipated path similar to the experience of German reunification. Using a global dynamic intertemporal general equilibrium model, we find that if the unification process is managed peacefully and North Korea adopts comprehensive market-oriented reform and opening, the North Korean economy could capitalize on its growth potentials and experience fast GDP growth. As with the experience of West Germany, unification reduces the growth rate in South Korea for a certain period following the unification shock due to the transfers of resources out of the South into the North and an increase in risk on the Korea peninsula. Given that the relative sizes in population and per capita GDP of the two Koreas are very different from those of East and West Germany, unification can bring about more disruptive effects on North and South Korea, compared to the experience of Germany. The critical factors determining the economic effects of unification are the nature of wage-adjustment, the size of resource transfers from the South to North, and exchange rate policy.