The Increasing Costs of Reunification for Aging South Korea

July 19th, 2012

Under nearly any possible reunification scenario between South and North Korea the southern half will have to fork out a lot of money. The costs are easy to imagine. North Korea lacks adequate infrastructure, health care, food resources or social services to match the South. Understanding this, South Korea’s Unification Minister, Yu Woo-ik, has taken the initiative in his first year of office by lobbying for a reunification fund of 55 trillion won (KRW). This amount will be earned by donation, as opposed to a tax or other funding mechanism.

Starting now with such a fund is wise from the South Korean government’s standpoint. South Korea has an ageing population poised to lose numbers over the long term. The country’s total fertility rate is 1.23, or the sixth lowest in the world, with 2.1 the number necessary to maintain a population’s current level. While the country may be walking toward a demographic cliff, it is also uniquely positioned right now to maximize aggregate earnings across its economy. The middle-aged core of the country are at the prime point in their careers to maximize their earning potential, and the country’s earning potential, in a way that has previously not been possible. This also means that the population is uniquely situated to make contributions toward reunification.

Making these contributions now is more important than it sounds for these same demographic reasons. It is projected that 15% of South Korea’s population will be 65 or older by 2020, making it an ‘aged society’. With this demographic change comes economic fallout.  The national debt is projected to jump to 138% of GDP by 2050, with 40% of the population senior citizens. This risks putting too much of the societal and economic burden on the shoulders of the young. The private sector risks are equally severe, as firms will have fewer employees to maintain output at competitive levels. There are other long-term structural concerns too. With fewer employees and less opportunity for innovation, economic growth for South Korea is forecast to shrivel to a mere 1.7 percent through the 2030s – nearly 75 percent less than growth over the past decade.

From Highest OECD Birth Rate to Lowest

What may seem shocking today  is that South Korea possessed one of the highest birth rates worldwide in the 1960s. Decades of public awareness initiatives led by the government encouraged parents to stop after two children. In the 1980s there was even a push for parents to be happy with one child. During this period of rapid economic expansion, the emphasis was placed on the immediate impediments to growth that a burgeoning population represent. Over the past decade, the government in Seoul has changed course dramatically on this point, urging families to consider having multiple children if possible. Despite the encouragement, as well as a pro-natalist action plan in place, the country is witnessing little change in birth rate.

The reasons for this in South Korean society are numerous. The costs of children and education have increased in a context of high competition in school. A competitive society can foster robust economic growth, but it also carries high costs for citizens forced to spend more resources to compete. There has been little done to keep these costs down either. In a country obsessed with higher education, students in South Korea pay the third highest amount for a degree among OECD nations. At the same time, they receive fewer scholarships and financial aid opportunities than the OECD average. These kinds of expenses make having more children in South Korea a less attractive option than elsewhere in the world.

The country also possesses a business culture which pressures women into making a choice between work and family. Less than half of women over the age of 15 are part of the workforce. Of those who are in the workforce, many of them have chosen to be at the cost of having children. Lee Myung-bak’s government has offered incentives to keep women working – such as free care for children under two – but with little discernible behavioral change, it may be a case of too little too late. Female participation rates in the workforce have been stagnating for nearly 25 years.

Different Story North of the Border

North Korea on the other hand, despite its smaller overall population, maintains an estimated total fertility rate of 2.01. This means that North Korea would have a significantly younger population during a future reunification scenario. Also keeping the population in North Korea younger is a lower average life expectancy than much of the rest of the world, at approximately 69 years. On the one hand, North Korea could be a ready-made solution for concerns about the South’s decreasing number of workers. On the other, an infusion of younger and middle-aged people with different educations, mentalities and backgrounds could skew the Korean political and economic picture dramatically. Also, there is a great deal of evidence suggesting that the demographic tendencies of North Korea – lower life expectancy and higher number of children per female – would revert closer to South Korea’s tendencies over time.

Economic Lessons from German Reunification

While the differences are stark, Germany’s reunification 20 years ago offers plenty of insight for the peninsula. East Germany after reunification received funding from west Germany through a ‘solidarity’ tax on the West. However, the economic restructuring that took place with these funds did not make the two sides of Germany an equal whole. Unemployment was and still is significantly higher in the eastern side. Many of the best educated and most skilled left to pursue better jobs in west Germany – an easy to imagine scenario in a reunified Korea. While we might imagine that much will be spent on retraining programs for less educated North Koreans, figuring out how to integrate them into a larger knowledge and export oriented economy will also bear significant financial costs.

Especially because there are structural problems constraining a possible Korean reunification that have consistently constrained German reunification. East Germany is more rural and sparsely populated than the west, just as North Korea is more rural and agricultural than the South. The economic difficulties that result from this are well-documented. There is less efficient resource and labor allocation as people are not optimally matched with employment opportunities. The spillover effect, or positive externalities of economic growth in cities, are also largely absent from rural communities.  The same is true for the kinds of economies of scale that emerge in public and private sector services in urban environments. While the gains from investment in rural North Korea would be initially dramatic, it is likely that prosperity and quality of life would reach an equilibrium significantly lower than that found elsewhere in Korea.

It is  also likely that the South Korean won (KRW) will appreciate in the coming years as the population maximizes its earning potential and increases its current account balance. However, many analysts place the value of the North Korean won (KPW) significantly lower due to poor monetary policy controls leading to rampant inflation. A currency union between the two countries during a process of reunification could wipe out the meager wealth that many possess if it is largely denominated in KPW. German reunification also shows that price levels on necessities like food in  North Korea would rise significantly, deteriorating the ability of North Koreans to get by without assistance from Seoul during a period of reunification.

However the biggest lesson from German reunification is that 50 trillion KRW is not enough to cover the full costs of bringing South and North Korea together. As of 2009 west Germany had transferred an estimated 1.3 trillion euros to the east. This would be equivalent to 1,809.4 trillion KRW, not 50 trillion. Contextually, it is also important to recall that East Germany was significantly less poor than North Korea is today. Estimates place South Korea’s economy as being anywhere from 15 to 40 times the size of North Korea’s (depending on the measurement used). There is a very high chance that the South could need even more money over the long-term for North Korea’s economic reconstruction than west Germany ever did.

Money Trap

All of which would seem to indicate that future reunification represents a money trap for South Korea. With decreasing economic growth on the horizon and an accompanying high debt to GDP ratio, the ability of South Korea to cover future costs of reunification with North Korea is in serious doubt. It is certainly the case that 50 trillion KRW will be insufficient for this task. Even if fiscal shock can somehow be avoided through an imposed taxation scheme in South Korea, the burden will be placed on a shrinking number of working aged people – people already hard pressed to pay for their parents’ anticipated pension, health care, and housing costs.

Even a best case scenario would still see public debt pass 100% of GDP over the next half century before the costs of reunification are tacked on top. If South Korea wants to achieve reunification on the peninsula, it is necessary to spend more now to fund aggressive pro-natalist policies and a substantially larger special fund for economic reconstruction. If not, the economics of reunification may well turn a country’s aspirational dream of a unified Korea into little more than a pipe dream of uncontrolled costs.

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About the Author

David Matthew

David Matthew is pursuing a Master’s degree in Public Policy at Edinburgh University in the UK with a focus on security, trade, and technology in the Asia-Pacific.