The Low Cost of Korean Unification

The Korean President has proposed a reunification tax to prepare for the presumed high cost of Korean reunification. The North has predictably responded with anger and saber rattling. Many of the Korean scholars I have met in Germany believe, on the basis of German experience, that the costs of their reunification would be high, perhaps prohibitively so. The German experience, however, is not an appropriate benchmark for Korea for a number of reasons.

First, the German constitution’s federalism laws call for equal treatment in transfers among the states and also German labor unions demanded wage equality between East and West despite huge productivity differentials at the time of reunification. These two features meant that East Germans had immediate access to Germany’s generous welfare state and that East Germans were required to be paid wages well in excess of their productivity. The result has been persistent and exceptionally high unemployment in the East. In the Korean case, there are no constitutional requirements for equal transfers that I know of. Also the South Koreans can learn from the German experience and avoid the mistake of requiring wage equality between North and South. Another factor is that social welfare transfers in the South are a small percentage of total government, unlike the German case where they are the dominant state expenditure.

Second, East Germany had a large industrial sector, in fact, the most advanced in the communist bloc. After an initial period of optimism, Germany learned that, rather than bringing money into the state budget, former Eastern state enterprises required large subsidies to keep in business and then close down. North Korea has largely an agricultural economy that has been ruined by state and collective farms. We now have the experience of China, Russia and Ukraine that shows that agriculture recovers quickly once freed of collective and state farms. North Korean agriculture will quickly become an asset as opposed to a liability. As its productivity increases, living standards in both the North and South will increase.

Third, German reunification was accompanied by an immediate opening of borders. Although population transfers occurred, they were limited by the equalization of wages and benefits. In the case of Korean reunification, it would seem that borders would have to be opened gradually in light of the huge living standard differentials. Although such a policy might be regarded as harsh, the desperate welfare situation of the North could be immediately remedied, again at relatively low cost. Under any circumstances, the welfare of the population of the North would be improved by a huge factor.

Fourth and finally, there is an implicit and substantial cost to the South of having an unstable nuclear power next door. Although the probability of a nuclear holocaust is low, the cost to the South of such an event would be astronomical. Weighed against the expected-value cost of such a disaster, any economic cost of reunification would be small.