by
Max van der Sleen
[ECORYS Nederland BV]
posted Auguest 26, 2005
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 Preface : |
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Article : |
This article is an abridged segment of a larger paper presented by the
author entitle "Implications of East European Experience on North
Korean Development: Peace and Prosperity Require Inspiration and
Resource Mobilization," presented at the International Symposium on
North Korean Development and International Cooperation in Seoul, Korea,
July 6-7, 2005.
Political Choices for Development in North Korea
On the basis of the transition experience of the Central and East
European countries, and taking into account that all historical events
are unique, the choices facing North Korea in its unique path towards
advancement can be structured by looking at four main scenarios: 1)
Continuation of the current development path, which I prefer to call
independent liberalization; 2) deeper international cooperation,
leading to ASEAN and World Trade Organization (WTO) membership; 3)
Association with South Korea which involves transition towards full
economic integration with South Korea; and 4) Reunification, which
implies a full monetary and political union. The characteristics and
main socio-economic policies of these four scenarios are summarised
below.
Scenario 1: Independent Liberalization
This is the base case scenario. Continuation of the sunshine policy is
the core of the international cooperation efforts. Domestic reforms
include first steps towards price liberalization and private plot based
food markets. Trade policy reforms are typical for the first phase of
trade liberalization and include the construction of Free Trade Zones,
and regulated exports and imports and regulated foreign direct
investment (FDI) deals for natural resource based export oriented
companies and with foot loose manufacturing companies investing in the
cheapest production locations. The benefits from trade liberalization
are mainly limited to employment effects. International cooperation
provides humanitarian aid. The only source of development policy
funding is the state budget (domestic savings) and very limited FDI for
the establishment of export zone facilities. The speed of advancement
is slow.
Scenario 2: ASEAN Membership
In this scenario North Korean leadership makes the choice to seek
membership of the international community and its organisations: the UN,
International Monetary Fund (IMF), World Bank. North Korea applies for
ASEAN and WTO membership, and starts to participate in the highly
regulated free market and aims to comply with the rules of
international trade. Export led growth is chosen as a main avenue for
advancement. Domestic reforms focus on liberalization of specific
sectors of the economy and include price liberalization, privatization,
macroeconomic stabilization, and the establishment of market
institutions, civil service reforms, and administration reforms. Trade
policy reforms include liberalization of imports and exports. Trading
houses provide the domestic market with consumer goods and facilitate
exports and are in due course replaced by direct trading networks and
FDI based export oriented enterprises. The benefits of the scenario
include a normalization of international cooperation, and an increase
in access to resources for investment. These include IMF credits,
World Bank lending, and regular development cooperation from South
Korea and Organization for Economic Cooperation and Development (OECD)
countries. Moreover, the North Korea government gets access to
international capital market loans, commercial banking loans, and FDI
from companies worldwide, including South Korea. The potential for
rapid advancement is good especially because of the high economic
growth in surrounding countries (see Vietnam and China) but the
transition experience in East European countries suggests that
transition -- whether rapid or gradual -- is initially accompanied by
output declines, unemployment, and high inflation. To avoid a too
negative effect on the purchasing power and living standards of the
population, the smaller state has to be strong and well prepared to
take compensatory social safety measures. The rapid establishment of
macroeconomic stability is essential in this respect both for the
population and for mobilizing the resources needed for the realization
of rapid advancement and new job creation.
Scenario 3: Association with South Korea
In this scenario the governments of North and South Korea make the
choice to work towards lasting peace, stability and joined prosperity
in the two Koreas. The main domestic economic policy goal becomes to
develop first an economic union with common market institutions and
with the ambition of conversion between North and South Korean regions
and advancement levels. This scenario would involve the gradual
adoption of South Korean economic institutions, starting with a free
trade zone for goods and gradually working towards an internal market
for the free movement of capital services and eventually labor when
comparable prosperity levels can be secured. Export led growth is a
main external policy direction. The resources mobilized for the
transition in North Korea include restructuring funds from the South
Korean state budget and income transfers to finance the social safety
network standards agreed upon between the two governments. In addition,
substantial FDI flows and commercial banking loans from South Korean
organizations would fuel high rates of advancement in North Korea and a
substantial closing of the income gap between the Koreas in say two or
three decades.
Scenario 4: Reunification of the Koreas
This scenario would come about if the governments of the Koreas would
agree on full political and monetary union. The avenue towards
advancement and a properly spaced out conversion towards comparable
living standards, would with two notable exceptions be similar to
scenario three in economic policy terms. The income transfers would
reach higher levels in the first decade of reunification, and
government borrowing from international capital markets would provide a
substantial additional source for restructuring the Northern part of
the Korean peninsula. In this scenario the credit rating of Korea
would weaken because of the magnitude and risk involved in the
reunification process, which would slow down development in the living
standards of the population living in the South. Overall however, this
scenario would see the most rapid increase in advancement for the
unified population of Korea.
The four scenarios are interesting for their theoretical differences in
the sources and levels of funding that could become available for
assisting North Korea on its avenues towards advancement. The economic
logic which supports this is not the historical analogy with what has
happened in East European countries and East Germany, but the simple
fact that the credit rating of North Korea would increase and the risk
aversion premium for investment in North Korea would decrease if
cooperation with South Korea intensifies and a choice is made for
accession and/or eventual reunification. The following table
illustrates the relation between the scenarios, risk management, and
resource mobilization
Table 1: Access to Resources in Four International Cooperation
Scenarios for North Korea
Scenarios
Resources for Investment and 1 2 3 4
Income Transfers
1. DPRK government savings Yes Yes Yes Yes
2. Humanitarian aid and
development cooperation Yes Yes Yes No
3. IMF credits and World Bank
loans No Yes Yes Yes
4. FDI from South Korea Yes(-) Yes Yes(+) Yes(+)
5. FDI rest world Yes(-) Yes Yes Yes
6. Commercial loans ROK
Banking sector No Yes Yes(+) Yes(+)
7. Commercial loans rest world No Yes Yes Yes
8. Investment by ROK
government No No Yes Yes(+)
9. Income transfers ROK government
budget No No Yes(-) Yes(+)
Overall resource mobilization
potential - + ++ +++
Years needed for comparable income
levels ---- 40? 25? 15?
Modelling Reunification
An interesting paper on the macro impacts of unification of the two
Koreas was published in Germany in 2004 and in the Journal of Asian
Economics in 2005. The authors Michael Funke and Holger Strulik
examine the impact and implications of Korean unification based on a
two-region endogenous growth model which they also used to analyze the
German unification process. Their model provides an interesting
attempt to give policy guidance. Their first conclusion is that if the
two governments agreed to adopt a goal of comparable living standards
in North and South, then the fiscal burden for South Korea would in
relative GDP terms be five times larger than West Germany's. The reason
is that the starting conditions of the two Koreas in 2005 might be some
five times further apart than those in the two Germanys' in 1990. This
estimate takes into account that the GDP/capita in South Korea is
likely to be ten times higher than in North Korea, while in Germany's
this difference was a factor of five. Moreover, the size of
the population in South Korea is twice the size of North Korea, while
in West Germany the population was five times that in the east. In
Germany's case, the income transfers and capital stock investments
mobilized by the state amounted to 20 percent of the budget or 10
percent of GDP per year. In the Koreas, the pursuit of a similar
unification goal would then require an annual transfer of 50 percent of
GDP. These magnitudes would become more manageable if the social goal
of comparable income standards after unification is reduced or phased
in over a decade or so. In this respect it is noted that the national
debt of the South Korean state is minimal at present.
Conclusion
Here we looked at the choices and avenues for development in North
Korea. Our implicit starting point was the
observation that all historical events are unique and that historical
analogies are therefore not a good basis for predictions. In
particular, the transition experience of the Central and East European
states was triggered by a combination of political and economic reforms.
In Asia, the transition experience of China and Vietnam shows that
there is no necessary link between market liberalization and multi-
party democracy.
What we offered here were four scenarios for North Korea's future
development. Which scenario will be closest to future historical
events, only time will tell. Politics inside and outside North Korea
will determine the choices that can be made and different choices lead
to different scenarios and development paths.
Economics starts with the fact that resources are needed to produce
goods and services. Therefore to reach higher prosperity levels for
North Korea's population, substantial resources will be required to
modernize the economy. The implication is that the extent to which
North Korea will succeed in mobilizing new resources will determine the
speed of development towards higher prosperity levels. Export-led
growth has in this respect been a successful policy already for decades
in East Asia. For North Korea such a scenario seems promising, given
also the economic dynamics in the region. However, the experience of
East European EU accession countries and the reunification of Germany
suggest that international cooperation and close cooperation with South
Korea could substantially increase North Korean resource access. The
central idea behind the scenarios approach is that political choices
rather than economic laws shape the economic road to the future because
they impact on the risk profile of investment in North Korea. The EU
accession experience of former communist countries in Europe implies
that the North Korean population could benefit substantially from a
development path that would be guided by the political wish for future
economic association with South Korea and possibly reunification in the
long term. Such policy inspiration would make good economic sense.
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