Yesterday I participated in a conference held in Seoul, “Costs-Benefits of the Unification of the Korean Peninsula to Neighboring Countries,” sponsored by the Korea Institute for International Economic Policy. KIEP commissioned papers from American, Japanese, Chinese, and Russian authors to examine the economic impact of Korean unification on their respective economies. I contributed the paper on US interests.
One of the issues I examined in the paper was the possible increase in bilateral trade in a unification scenario. The basic issue is that today the US and North Korea trade very little. However, if North Korea were to undertake fundamental reform in a consensual unification scenario or South Korean practices were adopted through an abrupt collapse and absorption scenario, one could expect a substantial increase in trade between the US and North Korea (or the former North Korea).
In the paper I take three alternative approaches. One is to estimate a conventional gravity model of trade flows and then use the estimated parameters to generate a counterfactual estimate of trade flows if North Korea traded like a “normal” country. (Note this does not mean North Korea adopts free trade, simply that it exhibits the same trade propensities of a 100 other countries around the world.)
However, computable general equilibrium modeling work that Sherman Robinson and I did years ago, indicates that with fundamental reform both North Korean national income and its trade propensities would increase substantially, ultimately leading to a more than 20-fold increase in trade (albeit from a more autarkic base than is observed today).
These calculations are summarized in the table below. If North Korea exhibited “normal” trading patterns, its economic integration with the South would increase dramatically, accounting for the bulk of North Korea’s trade. North Korea would naturally be sending close to three-quarters of its exports to South Korea, and about 20 percent to China, followed by Japan, the US, and Russia, assuming that the existing pattern of trade (which is highly oriented toward China) does not generate some kind of hysteretic or persistent effects. If history mattered so to speak, China would maintain a higher profile in North Korea’s trade relations and the shift toward South Korea would be attenuated, and the shares for the US and other countries might be lower as well. And if North Korea were to enter into preferential relations with countries such as China or Russia, or if in a collapse and absorption scenario it effectively became part of KORUS or TPP, then the results would diverge from those reported here.
In absolute terms trade between the US and North Korea would rise from its derisory level today to something like $365 million. However, if one takes into account the rise in North Korean income associated with reform, potential merchandise trade with the US rises to nearly $1 billion.
Yet even this adjustment might understate the case. In a collapse and absorption scenario, the North Korean economy would effectively be taken over by South Korean firms. And they exhibit a much, much greater propensity to trade with the US than is predicted by the gravity model. It would not be implausible to expect their North Korean operations to exhibit similar propensities to trade as their South Korean facilities currently do, and as a consequence, actual trade-at least in the manufacturing sector, mining is a different matter—might exceed any of the model-derived results. If one applies those propensities to the North Korean post-reform case, potential bilateral trade rises to $20 billion.
However, unlike South Korea, mining would be an important component of North Korean exports, and it is unlikely that mining products would be exported to the US with the same propensity as manufactures. So the $20 billion figure is probably an overestimate of bilateral trade a decade after unification.
That leaves an enormous range of estimates: $365 million is probably too low and $20 billion too high. But what the analysis does underscore is that it is not adequate to simply talk about “unification”: the specific scenarios matter as demonstrated by these calculations.
These estimates pertain to merchandise trade; in a subsequent post I will address the issue of potential trade in services between the US and North Korea.