Unification, again

Mention the name “Lothar de Maiziere” in most conversations and one will elicit blank stares. But de Maiziere, who visited Seoul in November, is actually one of contemporary history’s more interesting personages. He was elected to the parliament as a Christian Democrat in East Germany's only free election, served as Prime Minister for 5 months, and signed the unification treaty, essentially turning off the lights on the communist system.  He visited Seoul as part of a 20 person German delegation that had come to South Korea at the behest of Deputy Unification Minister Kim Chun Sig, to make sure, as German magazine Der Spiegel put it, “history repeated itself.” The three part series in Der Spiegel, by Jochen-Martin Gutsch, is well worth reading.

To the Germans’ astonishment, South Korea appears to be intent on maintaining border controls, post-unification or as one of the delegation members put it “I'll be damned! They seriously intend to close the border after the wall has fallen!" The reason is not hard to fathom: while the ratio of per capita incomes in West Germany to East Germany was perhaps 2 or 3 to 1. The gap between North and South Korea is far, far, wider and growing by the day.

Fears of mass cross-border migration have been stoked recently by a report issued by the Korean Employers Federation that claims that a sudden collapse of the North Korean state could send as many as 3.65 million North Koreans across the DMZ. Obviously such estimates are conjectural, but for what it is worth, when Sherman Robinson, Tao Wang, and I built a computer model of Korean unification and did a conceptual experiment where we allowed only labor and not capital markets to integrate, North Korea was virtually depopulated. But this is an admittedly extreme, indeed, fanciful, scenario.  In a more plausible scenario where there is considerable investment in the North, and limited cross-border migration for a period of ten years, the two economies eventually converge to an equilibrium where the incentives for mass migration have been eliminated.  But as observed in an earlier post, the situation today is comparably worse than a decade ago, and in any event, this scenario requires the maintenance of border controls for an extended period of time.

Nevertheless, there are lessons from German history for the prospective case of Korean unification, discussed in chapter 8 of Avoiding the Apocalypse:

• The establishment of civil order is critical.
• Rapid clarification of property rights is essential: there will be no investment and no real recovery until property rights are established.
• The real lessons of the German case appear to have been miscomprehended or ignored.

• The good news is that unification would accelerate peninsular economic growth and dramatically reduce poverty.
• The bad news is that the bill could easily exceed $1 trillion, roughly equal to South Korea’s annual gross national product.

From the standpoint of South Korea, the policy lessons can be grouped into

• Policy changes that can be made in anticipation of unification, and
• Mistake to avoid.

In the former category,

• Run surplus in anticipation of eventual unification costs,
• Strengthen KFTC and campaign finance laws: Chaebols will be called upon to rehabilitate failing North Korean enterprises—don’t let them act anti-competitively.

In the event, some of the things that can be learned from the German experience involve the exchange rate, those these are more subtle that than the conventional view that the Germans got the initial conversion rate wrong (and we won’t make that mistake).  A more considered review of the German case would suggest:

• Focus on wage setting, not initial currency conversion rate,
• Don’t worry so much about inflation—when demand is dropping like a stone, a little extra liquidity may not be such a bad thing, and
• Dollarize North-South to get an idea of the North Korean real exchange rate

Clarify property rights quickly:

• Without property rights there is no investment and without investment no recovery,
• Pursue policies of compensation, not restitution, with respect to property claims,
• Give land to the tiller and housing to the resident, possibly tied to remaining on the farm or in the residence for some specified period post-unification,
• Channeling assets to owners with skin in the game will restrain wage increases, and
• Write-off any intra-SOE debt, if any.
• In practice, this means rapid privatization but try to avoid wholesale transfers to foreigners at fire-sale prices.