Korean Unification: Economic Adjustments under German Assumptions

Abstract

This paper explores the impact of unification on North and South Korea under the hypothetical scenario that German-type reunification occurs in the Korean peninsula. Simulation results using a global dynamic general equilibrium model show that with comprehensive market-oriented reform and opening, the North Korean economy could capitalize on its growth potentials. Unification can reduce the growth rate in South Korea for a certain period following the unification shock due to the transfer of resources out of the South into the North and an increase in risk on the Korea peninsula. Due to the relative sizes in population and per capita gross domestic product of the two Koreas, unification can be more disruptive 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.