North Korea's Economic Integration and Growth Potential

Abstract

The growth projections based on cross-country evidence show that North Korea could achieve higher economic growth in the long run if it embarks on substantial policy reforms toward a market-oriented and open economy. Using an empirical gravity model of trade and direct investment, we forecast that, when the two Koreas pursue economic integration and cooperation without military conflicts, North Korea's trade with South Korea can increase by up to 36 percent of North Korea's GDP and its foreign direct investment (FDI) flows from South Korea by up to 6 percent of GDP. Overall, by promoting trade and FDI integration with South Korea, North Korea can boost its GDP growth by approximately 3 percentage points per year. Combined with a market-oriented reform, the North Korean economy could grow by approximately 4.7 percent per year over the coming decades. Conversely, if more rigid sanctions imposed on North Korea become effective, its trade and investment will decrease and its GDP growth rate is expected to fall by approximately 2 percentage points per year.