A new model of Korean unification



This past Friday I had the pleasure of participating in a conference on Korean unification held at the Australian National University.  The highlight of the conference was the presentation of a new model of Korean unification by Warwick McKibbin, Jong Wha Lee, and Larry Weifeng Liu.  The authors are still tweaking the model and I do not believe that any formal paper yet exists, but I think that this work constitutes the most significant new modeling on this topic in a number of years.

The model is based on the well-known G-cubed model developed by McKibbin and Peter Wilcoxen.  It is a hybrid of a dynamic stochastic general equilibrium macro model and a multi-sector computable general equilibrium model. The setup allows for inter-industry output linkages a la a CGE, plus capital movements and consumption and investment dynamics.

The model has three primary factors of production (capital, labor, and energy) plus produced intermediate inputs. There are six sectors (energy, agriculture, non-durable manufacturing, mining, durable manufacturing, and services).  There are twelve regions: the United States, Japan, Australia, Europe, rest of OECD, South Korea, North Korea, China, India, Eastern Europe and the former Soviet Union, oil exporting developing countries, and rest of the world. Short-run unemployment of resources is possible. There are financial markets and international exchange in goods, services, and financial assets.

They make a series of critical assumptions, namely no immediate collapse of North Korea, no cross-border labor mobility but complete intersectoral labor mobility, capital controls can slow the adjustment of the real exchange rate, and both the North and South have independent central banks and fiscal agencies.

The authors then analyze four scenarios: a continuation of the status quo, gradual economic convergence of North to South (this is essentially a North Korea reform scenario in which North Korea begins to catch up in terms of productivity and human capital), fiscal transfers from South to North (which is essentially about South Korean debt dynamics in a situation akin to German unification), and an undefined crisis which is modeled as a sudden increase in the risk premium on financial assets in both countries.

It would be unfair to the authors to go into detail on the specific results, which are obviously very preliminary. Given the hazardous nature of North Korean economic data, there is probably room to do some sensitivity testing using alternative parameters and perhaps even alternative data sources. And during the discussion I suggested that breaking out the military might allow the examination of a peace dividend and further differentiate the relative cooperative second and third scenarios, from the first and the fourth. The authors themselves identified immediate unification, labor migration, regional spillovers, and various alternative ways of conceptualizing macroeconomic policies and transfers as topics for future research.

This is the second conference in a three conference series (the first was held last year in Seoul).  The third is slated for next year in Washington, and I expect that by that time the authors will have a robust set of new results.  Watch this space.

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